Wooden Nickels

Last spring, the Weyerhaeuser Co. closed its wonderful Pacific Rim Bonsai Collection to the public. The company didn’t say how much it would have cost to keep the bonsai exhibit open, but this move was one more belt-tightening measure blamed on the recession.

Weyerhaeuser had opened the bonsai exhibit at its Federal Way headquarters just 20 years before, as a gift to the people of Washington on the state’s centennial. The company and its environment were very different then. George Weyerhaeuser, a grandson of founder Frederick Weyerhaeuser, still chaired the family’s namesake business, although only the year before, he had been replaced as president by Jack Creighton. Weyerhaeuser was still the nation’s largest private timberland owner, having nearly 10 percent of King County, where its Snoqualmie sawmill had operated since World War I.

But Weyerhaeuser was trying to refashion itself. The company—which Forbes magazine profiled that year in an article entitled “Lost in the Woods”—had been less profitable than its competitors. It started jettisoning non-core businesses it had acquired or developed in the 1960s and 1970s, including financial services and disposable diapers. But it refused to emulate some competitors by unloading timberland in the Northwest.

Now, the company is refashioning itself again. In January, its board of directors announced that the business will morph into a Real Estate Investment Trust, or REIT. Shareholders will vote on the plan at the firm’s April meeting. The news drew relatively little attention, but it could have a major impact on the region. The transformation, which would require the company to channel virtually all of its income back to shareholders, puts pressure on Weyerhaeuser to maintain strong cash flow to pay dividends. A business that has long been considered a good steward of the state’s forests could find itself under pressure to sell land to maintain that flow. 

Even without a change in corporate governance, Weyerhaeuser has become a very different entity from when its bonsai exhibit opened in 1989. It still owns 1 million acres of Washington forest, but since the start of the millennium, Weyerhaeuser has closed its Snoqualmie and Enumclaw mills (the Snoqualmie mill had largely shut down in 1989), and sold its timberlands in King, Pierce and Snohomish counties. It has shifted nearly all its Washington operations to the southwestern corner of the state.

The firm has also unloaded its paper and container board businesses. In 2007, when Weyerhaeuser got rid of the paper unit, then-CEO Steve Rogel told Reuters, “We are focusing in on the core businesses that we intend to grow with in the future,” which at the time included container board. But not for long: In 2008, Weyerhaeuser sold its container board operations to International Paper.

Increasingly, Wall Street has based valuation of Weyerhaeuser on its vast timber holdings, which still total some 20 million acres, including roughly a million each in Washington and Oregon. A 2007 report by the University of Washington’s College of Forest Resources observed that forests had changed from industrial assets to financial assets. Pension funds, university endowments and other institutional investors have long liked timber’s combination of long-term appreciation and steady cash flow.

“Institutional investors, endowments, and private equity funds hold over $50 billion in U.S. timberland assets,” George A. Fasano and Thomas J. Straka wrote last year in the Journal of Financial Planning. “The land has been sold by traditional forest products companies and bought by timberland investment management organizations (TIMOs) [which buy and manage timber for investors] and real estate investment trusts (REITs). Analysts predict that TIMOs/REITs and other investor groups will buy another 10 to 15 million acres in the next decade.” 

But the market for forest products has been volatile. When American housing starts, which topped 2 million in 2005, dropped three years later to less than half that level, wood prices plunged. Weyerhaeuser lost $175 million in the last quarter of 2009, $545 million for the year. The company slashed its dividend twice last year, first from 60 cents to 25 cents per share and then down to a nickel. It has announced another 5-cent dividend for the first quarter of 2010. Even when the economy recovers, no one expects housing starts to hit 2 million again. Much of Wall Street has looked gloomily on Weyerhaeuser’s prospects.

But not everyone has shared the gloom. Two years ago, Kent Croft of Croft-Leominster, which manages investments and mutual funds, told U.S. News & World Report that “one [stock] everybody hates right now is Weyerhaeuser, the timber company. We like it for the timber assets to be realized over time.”

Croft says basically the same thing today. “REIT or not, we’re just attracted to the assets,” Croft notes. “Everything else is sort of gravy.” He tries to look three to five years down the road. Should the company appeal to investors with shorter horizons? “I think at these prices, yeah,” he says. Investors weren’t attracted by the REIT announcement, but they may be by the actual REIT conversion in April, Croft explains. Will Weyerhaeuser outperform the market from here on? Croft thinks so. But then, “if you had asked two years ago, I would have said the same thing—and I would have been wrong.”

By transforming itself into a REIT, many believe, Weyerhaeuser will boost its stock price. But the conversion’s not a simple process. To become a REIT, a company must jump through a number of hoops, not least distributing retained earnings to its shareholders. For Weyerhaeuser, this step means coming up with some $1.3 billion in cash. Without saying it planned to become a REIT, Weyerhaeuser made it clear that last year’s second dividend cut enabled it to hoard cash, just in case.

Congress created the REIT form in 1960 so that more people could invest in commercial real estate. The law allowed people to securitize and bundle individual investments, creating, in effect, a mutual fund for real estate. In 1999, Congress “modernized” the legislation, allowing a REIT to own a taxable operating subsidiary that provided services to tenants of REIT property.  

Seattle-based Plum Creek Timber Co. received IRS permission to apply the new law to timber, then quickly reorganized itself as a REIT. Plum Creek’s transformation attracted a lot of investors. In 2001, the company used its new wealth to buy The Timber Co., which owned Georgia Pacific’s forest lands. Thanks to the purchase and subsequent acquisitions in the Midwest and East, Plum Creek has supplanted Weyerhaeuser as the nation’s largest private timberland holder. Many analysts and investors now believe that the advantages of the old vertically integrated forest products company are outweighed by disadvantages in the federal tax code. Other traditional forest products businesses have restructured accordingly. In 2004, 2005 and 2006, Rayonier, Longview Fiber and Potlatch also converted themselves to REITs.

Weyerhaeuser’s more tradition-minded board was reluctant to follow suit. “Five or 10 years ago, they did not like to discuss the REIT,” says Longbow Research analyst Joshua Zaret.

The price of standing pat was paying more taxes than forest products companies that made the switch. To reduce that disparity, Weyerhaeuser in 2008 lobbied successfully for legislation that cut its tax rate in half, comparable to the federal tax a REIT would pay on any taxable income. But the disparity remained. That’s because REITs typically channel 90 percent of their earnings to shareholders, who pay taxes as individuals, avoiding the “double taxation” levied on most corporate profits and dividend income. If you reorganize as a REIT, “your tax rate is probably zero,” Zaret says.

A company that wants the tax break can’t make more than 20 percent of its earnings from operations that aren’t REIT qualified. Unloading the paper and container board operations got Weyerhaeuser over that hurdle—many people assume that’s why the firm unloaded them. But Weyerhaeuser spokesman Bruce Amundson says that’s not so, that neither division fit into Weyerhaeuser’s new view of the future. With the growth of online communications, the future of paper looked questionable. And with competitors starting to supply the Asian container board market with products manufactured abroad, the future of that business looked questionable, too. 

Nevertheless, Amundson pointed out last year that the company had made the structural changes it would need to become a REIT. It had reorganized itself into two separate reporting units: timber and everything else. It had also started reporting on a calendar-year schedule, as the REIT law required.

Looking at the brave new landscape of REITs and TIMOs, former Washington Commissioner of Public Lands Brian Boyle, who now leads the University of Washington School of Forest Resources’ Northwest Environmental Forum, says “Everybody’s claim is that they manage for the long term.” But he isn’t convinced. 

“They’re in it to return money to their investors,” Boyle says. “If [timber] prices go down and the unit holders’ income goes down, they’re likely to say, ‘Cut more.’” 

The one thing that experience has shown, Boyle says, is that when companies change over, “they employ a whole lot fewer people.” Millworkers and other residents of timber towns accordingly tend to view changes in ownership with anxiety. So do conservationists, who have increasingly recognized that a working forest is better than no forest at all.

Conservation Northwest Executive Director Mitch Friedman says he doesn’t much like the idea of REITs and TIMOs taking over so much working forest in the Northwest. He appreciates the irony of a conservationist getting nostalgic about vertically integrated forest products companies, but he says the REIT form of corporate ownership has “enormous” long-term implications.

Boyle worries that virtually no private landowner has much incentive to keep land in timber production if there’s a chance to do something else. TIMOs are certainly converting forest land to other uses. And nonindustrial owners are, too. “If there isn’t some way that a landowner can make a buck,” Boyle says, “then, basically, the answer is to convert it.”

Boyle envisions different public agencies joining with private owners to create large
“anchor forests,” managed for timber production and environmental benefits for the long term. Friedman likes the idea of anchor forests, too.

As a way to maintain productive forests, Boyle envisions landowners getting money to provide environmental benefits. One obvious benefit is carbon sequestration: Weyerhaeuser’s trees may become even more profitable if Congress establishes a cap and trade system for carbon emissions. Weyerhaeuser is hoping for cap and trade, public affairs manager Anthony Chavez says, and it hopes to get tradable offsets for the carbon sequestered in sustainably grown lumber. 

But the people who have pushed Weyerhaeuser to become a REIT aren’t all pension funds and university endowments—the company’s traditional institutional investors who take a long-term approach to their investments. And Wall Street’s interest in REITs isn’t necessarily a good thing. Some people see this reorientation toward monetizing assets as a national problem. In Maine, “over 70 percent of industrial forest land . . . has changed hands in the past decade,” according to an article in Sustainable Management of the Acadian Forest last year, “and it seems that the industry is currently doing more inventory management than sustainable forest management.”  

Jack Creighton, who succeeded George Weyerhaeuser Jr. as Weyerhaeuser’s chairman, and who ran the company as CEO from 1991 to 1997, says he’s suspicious of Wall Street’s long-term intentions. “I put the pension funds in a totally different category [from the other investors],” Creighton says. For pension funds, “getting into [timber REITs] was a great decision.” Timber gives the pension funds the cash flow they need over long periods, without taking away any value of the underlying assets. Other investors may not have the same abiding interest in the long term. “I’m cynical in that Wall Street comes and goes,” Creighton says. “I think the people who want Weyerhaeuser to turn into a REIT [are really just] in it for the short-term profit.”