Gunns recently announced it no longer believed its plan for a new Tasmanian pulp mill was “probable to proceed”. After seven long years, the controversial mill now needs an Act of God to go ahead. So where did Gunns go wrong? How did the once-mighty forestry company end up in such dire straits?

No longer are there unencumbered assets of sufficient value to allow a joint venture with an enterprise value including plantations of $3 billion, to proceed with Gunns as a JV partner. Gunns’ measure of net tangible assets (NTA) is now negative.

In January this year, Gunns was granted an 11-month reprieve by bankers and has been trying to recapitalise at the same time as search for a JV partner and a financier for the project. The half-yearly report released in February suggested NTA of $750 million was about to be boosted by a capital raising of $282 million, including $150 million from the Richard Chandler Corporation (RCC). But RCC soon walked away after a look at Gunns’ books.

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Gunns has tried raising $400 million from existing institutional shareholders, but now, being underwater, such an event is unlikely, especially as the first $120 million of any contribution by ordinary shareholders will only benefit holders of hybrid securities, which rank ahead of ordinary shares. Long-suffering ordinary shareholders have in recent years already contributed $500 million in extra equity.

In 2007-08, Gunns completed the takeover of Auspine, a listed company with softwood plantations and sawmilling interests in Tasmania and the Green Triangle. The euphoria from being the largest processor of hardwood and softwood forest products in Australia, the largest exporter of native forest woodchips and with a profitable managed investment scheme (MIS) business, was soon tempered with the reality that it was burdened with $1 billion of debt.

The sale of most of the Auspine softwood trees for $175 million and a capital raising of $334 million in the 2008-09 year occurred before the effects of the GFC compounded the decline of native forest woodchipping and the unmasking of MIS as little more than an widely orchestrated fraud, and fortunately meant debt at June 30, 2009, was reduced to $662 million.

The disastrous half yearly results in February 2010 led to long-time chairman and CEO John Gay being shown the door, and precipitated a sale of non-core assets.

Until then, Gunns’ balance sheet resembled that of an old-fashioned conglomerate that had grown like Topsy without a clear plan. As well as forest and forest-related assets, it owned a wine business, managed wine and walnut MIS’s, ran a pub, a collection of hardware shops under the Mitre 10 banner, a heritage-listed country estate, and a commercial building division that at one stage found time to renovate the residence of the then-premier for an undisclosed price.

The answer as to how the board was able to manage such a diverse business as well as plan for a large technologically advanced pulp mill soon became apparent.

It couldn’t.

A lot of Gunns’ assets are old. Debt is still $500-plus million, despite the asset sales and further equity injection of $170 million.

Coincidentally, just when Gunns needed to window dress the pulp mill project by starting site works, it received a $23.5 million government ex-gratia payment, camouflaged as compensation for surrender of native forest harvest rights.

The noble gesture of exiting native forests was spruiked as a necessary precursor to long-awaited peace in Tasmanian forests, and as a way to assist Gunns obtain a “social licence” for the mill.

In reality, Gunns couldn’t continue operating unprofitable businesses with deteriorating assets and high debt, as well as build a mill.

The final crunch preceding the recent negative NTA revelation was a fall in plantation woodchip prices, further denting the value of the MIS business, the value of Gunns’ own plantations and the value of the underlying land used to grow its own trees plus those of some MIS growers.Notwithstanding $250 million of capitalised pulp mill expenses are to be written off given the project is unlikely, the permit will remain alive if Gunns can successfully defend court action by the Tasmanian Conservation Trust  that the mill was not “substantially commenced” by the requisite date of August 31, 2011, as per the permit conditions.

The key to any pulp mill is resource security but this too seems to be slipping from Gunns’ grasp.

80% of Gunns’ managed hardwood plantations are owned by MIS growers. The travails of insolvency practitioners unravelling the affairs of Timbercorp, Great Southern and FEA has served to highlight the MIS model may have cash-flow attractions when new money keeps flowing in the door, but when the flow stops, the ongoing legacy costs, the disappointing yields, the falling prices and the conflicting interests of lessees, lessors and managers have all combined to make the MIS structure a commercial nightmare.

Gunns’ MIS business now has a negative value. No future project of any scale is likely to be based on resources from such a structure, if indeed it can survive, and hence it will need to be dismantled.

New players such as New Forests, owner of the land growing Great Southern MIS’s, or Australian Bluegum Plantations, which took over Timbercorp’s land and trees and recently bought Gunns’ Portland woodchip export facility, are possible buyers. Neither has expressed any public interest in a pulp mill but they appear to have the wherewithal to own and manage plantations sufficient for such a project.

Gunns is unlikely to have much an equity interest in any future forest industry. It ran out of management expertise a few years ago and now its luck has all but gone.

But the memory of 2007 is still vivid. Just as Gunns was about to be told by the state planning authority that its mill permit application was “critically non-compliant”, it withdrew from the planning process. The then premier immediately tabled legislation, allegedly drafted by Gunns, to enable the mill dream to survive.

Another act of God, or maybe mammon, is now needed.

John Lawrence was employed as an economist for five years before returning to Tasmania as an accountant in public practice.

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