Plum Creek: Deal Breaker or Deal Maker?

On Oct. 28, Plum Creek Timber (NYSE: PCL  ) announced its plans for acquiring 501,000 acres of timberland, plus the associated wind and mineral assets from MeadWestvaco  (NYSE: MWV  ) . Long-term investors should be overjoyed with the market's initial reaction to the $1.1 billion deal, because the stock decreased in value. Apparently traders weren't so thrilled with the 65% equity and 35% debt financing mixture— PCL traded lower by more than 10% within 36 hours of the announcement. This type of knee-jerk decision making plays right into the hands of long-term investors. It provides us with an opportunity to buy quality goods at a discounted price. Believe it or not, much of the "smart money" is not as keen on the underlying trends within the forestry business as you are.

Curiously, shares of MeadWestvaco also sold off heavily on the news (hmm, you wouldn't think the deal could be bad for both companies...). I think the market just threw a bit of a temper tantrum, upset with Plum Creek for selling roughly 14 million new shares to help fund the deal. It's true, the market can be childish at times, but Plum Creek played the responsible parent by structuring the deal this way (preserving its strong balance sheet). Management made it clear on the conference call: they are not constrained in any way from doing future deals (accretive ones of course).

Man that's some nice land!
All in all, the acquisition, which was described by management as the most compelling set of land they've seen in many years, results in a $430 million net increase in debt for Plum Creek-- nothing they can't handle. In exchange, Plum Creek has secured another 501,000 well-stocked acres of very productive timberland from MeadWestvaco. They've done it with a mixture of cheap money (call it a 4.3% note) and equity that will be placed in the coffers of institutional investors. I don't think these investors will be high-frequency trading their Plum Creek holdings either. It's more likely they'll just sit back, collecting their dividends for the next decade, watching the trees grow.

Hedge against inflation?
It's not every day (or even every year) that massive tracts of quality timber acreage become available at the right place (southern US) for the right price. Therefore, you've got to act decisively when they do and I think that's precisely what Plum Creek has done here. The team at Plum Creek commended MeadWestvaco for their excellent management of the 500,000 acres and investments made into silviculture; the majority of the trees are 21 years old (try supplying those on one year's notice). On top of that, Plum Creek is expecting harvest levels of 61 tons per acre, compared to the 45 tons per acre they are more accustomed to.

Expected to close in Q4, the deal should be cash accretive in the first twelve months, assuming today's log prices. Obviously Plum Creek is expecting a higher pricing environment in the years to come; should those days ever arise shareholders will be praising their foresight. As pellet facilities start competing with OSB manufacturers for pulpwood, pricing there should firm too.

JV1 and JV2
Two distinct deals are included; don't worry too much about the details because Plum Creek and MeadWestvaco already have the business plan in place. In JV1, Plum Creek has invested $12 million for a 5% interest in 22,000 acres being developed (commercial and residential) by MeadWestvaco. From here, Plum Creek is paid up and will only be participating in the profits.

JV2 is a 50/50 split on 87,000 higher-value acres in Charleston, SC. Plum Creek assumes the royalties on coal and wind assets, currently generating $6 million annually. It believes this particular tract will eventually bring more than $3,100 per acre.

A few more olive branches
Plum Creek only anticipates hiring 40 additional foresters; while not great for unemployed woodsmen it is great for keeping costs under control. Acreage in West Virginia more than doubles, a portion of which is contiguous to land already owned. Harvest levels should increase by 3 million tons per year starting in 2014, then stay at the higher output for at least a decade. Plum Creek's fourth quarter EPS guidance is $0.26-$0.31.

Forgive me if the headline was misleading, but I feel this deal was a smart acquisition on behalf of Plum Creek. If a 4% yield suits your fancy, purchasing PCL below $44 should lock it in for you.


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