Plum Creek Builds on Its Success with Timber Company Deal
by Lorna Pappas

Walter Hodges

Investors are taking notice as Seattle-based Plum Creek Timber Company grows into one of the largest land owners in the nation. Plum Creek’s long-awaited acquisition of The Timber Company, formerly a separate operating group of Georgia-Pacific Corporation, transformed the inconspicuous, 12-year-old company into a highly visible investment vehicle with nearly 8 million acres of U.S. timberland, an attractive asset class and a strong position for future growth.

If that wasn’t enough reason for notice, on January 15 of this year, Plum Creek replaced Kmart on the Standard & Poor’s 500-stock index. The company is the third REIT to be added to the widely followed benchmark since October 2001, when S&P reversed its long-stranding ban on including REITs in the S&P 500 and its other equity indexes.

Plum Creek’s earnings for the period prior to the merger with The Timber Company, the first nine months of 2001, were $85 million—or $1.23 per share. During the same period, Plum Creek generated $122 million in operating cash flow. In the first quarter of combined operations, Plum Creek posted pro forma earnings of $44 million—or 24 cents per share, excluding non-recurring merger-related items. During the fourth quarter of 2001, the newly expanded company generated funds from operations of $81 million.

Timber!

In keeping with its long-standing goal of becoming the leading timber company, Plum Creek made its largest acquisition to date in October 2001 when it merged with The Timber Company, more than doubling its size and transforming itself into the largest pure timber investment vehicle in the U.S. The transaction was valued at more than $3 billion, and included an estimated $600 million of The Timber Company debt that was refinanced at closing. The merger increased the company’s land holdings to 7.8 million acres in 19 states, including 4.4 million acres in the southern U.S., where faster growth rates and strong long-term supply/demand dynamics make owning timberlands particularly attractive, according to Rick Holley, chief executive officer and president of Plum Creek.

What drew Plum Creek to The Timber Company was not only these southern timberlands, but its very attractive valuation, for which Plum Creek paid “a large premium,” notes Holley. “Some investors felt The Timber Company was worth $50 a share, and at the time we bid on the company, shares were trading at $22 a share. So even though we paid a 40 percent to 50 percent premium, we still got a very good acquisition, which will be accretive to both earnings and cash flow in the first full year [2002].”

In addition, the merger not only made Plum Creek more attractive to investors looking for size, liquidity and large blocks of stock, but increased the company’s sustainable harvest and inventory rate, and produced a widespread geographic land base offering diverse opportunities for value creation and growth. Its geographic and market flexibility makes Plum Creek less susceptible to particular short-term shocks in timber supply/demand, because when the market slows in one region, the company can compensate by increasing production in other regions.

With the merger, Plum Creek has also identified several natural resource opportunities such as a joint operating agreement for coalbed methane, cell tower agreements and heavy mineral exploration agreements, while timber management remains its primary objective.

“Overall, the message this merger sends out is that companies in the paper and forest products industry need to start focusing on what they do best. Integrated producers like Georgia-Pacific, whose primary businesses are making paper, do not need to own the timber. At Plum Creek, we’re focused on timber, because owning and managing timber is what we do best. We’re a pure timber play,” Holley says. “We believe our acquisition of The Timber Company will be the catalyst for companies in this industry to begin focusing more closely on their core businesses.”

Kevin R. Morris

Strong as Oak

At the root of what Plum Creek does best is an incredibly strong asset. Plum Creek’s primary business is as owner and manager of timberlands, as well as producer of manufactured wood products.

“Timber is a great asset class because, unlike any other commodity, it increases in size and value every day,” Holley says. “Timber is the only commodity that, over an extended period of time, has had real price appreciation, averaging 2 percent to 4 percent growth over the last 25 years. Timber’s stable returns—annualized 13.3 percent from 1960 to 2000—allow the category to perform well in periods of high inflation.” Holley adds that timber also generates high cash flow margins of more than 40 percent, since over time trees grow in value without a significant reinvestment. Furthermore, demand for timber, a renewable resource, is stable, while pressure on supply steadily increases due to urban sprawl, environmental concerns and government regulation.

The analyst community agrees. Merrill Lynch & Co., Inc. first vice president Anna Torma concurs that timberlands are an excellent long-term investment opportunity. “Timber has had significant long-term real price appreciation due to scarcity, and we expect that appreciation to continue,” Torma says, pointing to ongoing environmental pressures that are reducing the amount of timber available for harvest on top of already existing tight supply/demand situations.

Morgan Stanley Dean Witter & Co., Inc. has a similar outlook for timber and Plum Creek in particular. Matt Berler, Morgan Stanley’s senior analyst/global team leader for the North American paper and forest products industry, says timberlands are able to store and gradually grow value over time, owing to the organic, low capital intensive growth of the trees themselves. Berler highlights Plum Creek as the only publicly traded, large cap, liquid, pure-play timber company in existence. “It is one of only a small handful of public equities for which timberland is a core business and it is by far and away the largest and most liquid of those,” he says, adding that most REIT investors have little or no understanding of either Plum Creek or timber as an asset.

Kevin R. Morris

Competitive Position

As interested investors take a closer look at timber, they’ll see other strong players such as Rayonier Inc. of Jacksonville, FL, Deltic Land and Timber of El Dorado, AR, and Crown Pacific Partners of Portland, OR—Plum Creek’s closest competitors. Why would investors choose Plum Creek over these other firms?

The diversity of Plum Creek’s cash flow is one major distinction, Holley says, claiming that Plum Creek is active in more segments than any of its competitors. These segments include lumber, plywood and medium density fiberboard (MDF)—all three of which are focused on specific value-added markets. In the lumber segment, the majority of Plum Creek’s product goes to the repair and remodeling segment, with Home Depot as its single largest customer. In plywood, the entire business is focused on industrial markets, in lieu of home building, since the industrial segment is more stable and less competitive than housing. Plum Creek’s biggest customer in the plywood segment is Fleetwood Enterprises, the largest manufacturer of recreational vehicles in the world. For MDF, business is targeted toward value-added customers such as cabinetry and molding manufacturers.

Plum Creek’s good environmental reputation also plays a factor in attracting investors. Because timber is an asset that undergoes a continual cycle of growth and harvesting, accompanied by extensive environmental pressures, investors need to be confident that the timber owner is also a good environmental steward that can manage the assets in the long-term, claims Holley. “In our business, predictability and certainty in managing timberlands is a must. With strong environmental programs in place, we know exactly how to protect certain endangered species, which gives us the increased knowledge needed to manage our assets,” Holley says.

Plum Creek has spent millions of dollars to assure its timberlands comply with the American Paper and Forest Products Association’s Sustainable Forestry Initiative. The company signed a 50-year agreement with the U.S. government covering 285 species of birds, fish and plants, and also signed a 30-year protection agreement with the federal government’s Fish and Wildlife Service.

Plum Creek is also the only major timber company structured as a REIT, giving many investors yet another reason to select Plum Creek over its competitors, says Holley. In addition, the company’s good track record of returning shareholder value is distinctive. From its inception as a public company in 1989 through October 31, 2001, Plum Creek’s annualized total investor return was 21.3 percent. During the same timeframe, the S&P 500 returned 12.8 percent and the S&P Paper and Forest Products Index returned 7.4 percent. The Morgan Stanley REIT Index has returned 9.9 percent from Dec. 31, 1994 to Oct. 30, 2001, while Plum Creek provided annualized total shareholder returns of 13.4 percent during that same period.

“If I had to sum it up in one line, I’d say that investors choose Plum Creek because it is a financially sound and well-managed firm that delivers shareholder value as it acts on its clear strategic vision to become the premier timber company,” Holley says.

Plum Creek Timber Co., Inc. Headquarters 999 Third Avenue Suite 2300 Seattle, WA 98104 206-467-3600 CEO and President Rick R. Holley Sector Focus Specialty (timberlands) Core Markets Northwest, Southern and Northeast U.S. Ticker Symbol PCL 52-Week High $31.98 (NYSE) 52-Week Low $23.30 (NYSE) Established June 1989 Converted to REIT July 1999 Added to S&P 500 January 2002

Morgan Stanley’s Berler says Plum Creek’s competitive advantage lies in its broad geographic reach, extensive in-house acquisition expertise and the attractiveness of its equity. “Presently there are few if any large strategic or financial buyers of timberland to compete with Plum Creek. Many of the largest owners of timberlands (the integrated paper and forest products companies) are moving to lower their timberland holdings, while the number of financial buyers large enough to compete with Plum Creek can be counted on one hand,” he says.

On the Horizon

With The Timber Company merger now complete, Plum Creek has resumed its search for additional timber company acquisitions, concentrating on firms with land in certain geographic areas in which the company believes owning trees is attractive. “We are very focused on specific areas, but I won’t say where,” Holley says. “As part of our capital redeployment initiative, we also are looking to divest ourselves of selected timberland that, frankly, is unattractive to us.”

Going forward, as it prunes assets and branches out into additional geographic areas, all of Plum Creek’s strategic moves are intended to take it closer to one of Holley’s primary goals for the company: To be positioned in such a way that when people think of timber, they think of Plum Creek.