Cambium Global Timberland IT: why money doesn’t grow on trees

I was interested to see that Cambium Global Timberland has become the subject of a requisition. This is a stock I held for a while in my pension fund, but I lost faith in it and turfed it out for a small loss some months ago. Since then, the price has been drifting off, and it now sits on a discount of around 35%.

The price fall has occurred despite stake-building by a rival forest-management company, Stafford Timberland, which now holds around 11%. Stafford is the requisitionist and is asking for the management contract to be transferred to it on the same terms as for the incumbent, Cogent.

It would be fair to say the existing managers have been disappointing – net asset value has fallen by a third since the fund was launched five years ago. To some extent, they have been accident-prone, but it looks as though there might be a problem with the business model as well.

Portfolio diversification?

Timber funds should be ideal portfolio diversifiers. The trees grow and you harvest some each year and replant new ones: simple. This process was supposed to generate a reasonable yield on the fund and, to the extent that the managers could trade the portfolio, they could add a little bit of value in real terms as well.

The caveat in the admission document was that it would take a little time to invest the proceeds of the issue before income would start to flow to cover dividends. The target yield was 5% on the £1 issue price; in practice they have been paying out 3p per share and it all seems to be coming out of capital.

They got hit with a fire in Texas and carbon monoxide poisoning in Hawaii, but the biggest problem has been the collapse of demand from the US housebuilding industry, which is depressing sales and timber valuations. Over the three years to the end of August 2011, they have generated gross revenue of just £3.4 million and timber sales were just £2.6 million of that.

The associated cost of sale seems to vary between 55% and 75% – some of that might be fixed, so the gross margin may pick up if sales start to recover. This leaves them with a gross profit of just over £1 million for the past three years.

Forest management costs

However, managing these forests is not cheap, and forestry management costs over the same period were close to £8 million. This might have been inflated by setting up new plantations in Brazil, but implies they need a much higher run rate of sales to generate a profit from the forestry operations.

On top of that comes more than £5 million of corporate overheads (£3 million was the investment management fee). That’s £13 million of expenses versus £1 million of gross profit: an average deficit of £4 million a year.

They want to pay a £3 million dividend a year so need an extra £7 million. Assuming a gross margin of 50% that’s £14 million of sales needed, but the value of the timber in their portfolio is only £36 million – it does not grow that fast.

Of course, my analysis is simplistic. I have ignored foreign exchange gains and losses, finance expenses and a raft of other P&L lines, but it seems that while owning and operating a diversified timber business might make sense and presumably somebody is earning a living out of the forestry management expense lines, Cambium needs to justify its existence.

Swapping the investment manager will not improve the lot of shareholders by much - and Cambiuim's independent directors are urging investors to reject all of Stafford's resolutions at an extraordinary general meeting on 6 July. However, I think rather than asking ‘do we need a new manager?’ perhaps they should be asking for their money back.

James Carthew is a former investment manager at UK Advance Trust.