Street Capitalist: Event Driven Value Investments

Larry Light at the WSJ has a great article (ht: abnormal returns) on timberland and its outperformance as an asset class. I’ve never invested in timberland myself, but Light says it features some unique qualities that make it a great place to invest:

Timberland, which a few years ago became a popular investment among institutions and wealthy folks, has held up amid market massacres for most other assets lately.

Through Sept. 30, the value of timberland rose 5%. When the National Council of Real Estate Investment Fiduciaries reports 2008′s final quarter this week, this number is unlikely to move much. That marks a slower pace of growth, yet it is growth nonetheless. In 2007, timber appreciation was a towering 15%…

Timberland is the ultimate long-term investment, with relatively little bought and sold each year — and demand still respectable for what does change hands. “As long as the sun shines, the trees will grow,” says Jeremy Grantham, chairman of Boston money manager GMO and a long-time fan of timber investing. “Timber will never be an orphan.”

Timber often is likened to high-grade bonds, meant to be held for 10 years or more. The average annual timberland appreciation for the past decade is 4.1% versus minus 3.8% for the Standard & Poor’s-500 stock index. The timberland appreciation figure, which encompasses both the land and the trees, is based on sales and appraisals. After 10 or 15 years, investors cash out when the land is sold.

This isn’t the first time I’ve heard about timberland and its potential to beat the returns of other assets during times of economic turmoil. Shai Dardashti once offered the following passage from Hedgehogging by Barton Biggs:

Gerson Bleichroder was a nineteen-century German Jew who had a life filled with immense financial triumph, persecution, and personal sadness. Otto Von Bismarck represented the Old Prussia – aristocratic, agrarian, hierarchic – and it was his ambition and vision that welded the First Reich into an empire. In 1859, when he was 37, Bleichroder became the banker and investment adviser for the rising Junker diplomat, and for 30 years the two leveraged their insights and power to achieve great wealth and prominence…

Bismarck, the Prince, worked hard at projecting a magnificent exterior and omnipotence….His primary obsession, other than ruling Germany, was with making money in the stock market so he could buy more and more timberland. He treated everyone around him abominably.

However, both men must have had that mystical “seeing eye,” which enabled them to perceive the future chain of events that would be triggered by an action in the present. This is what successful investing still is all about. While suspended in the midst of times that were full of mystery, uncertainty, and doubts, they had the capacity to maintain their pose and world view and never to impatiently or irritably reach for a fact or conclusion.

Bleichroder exploited the insights that Bismarck provided to make both his patron and himself very rich. But he also had what Bismarck once referred to as “a certain timidity in investing.” He told his clients he would attempt to get them over the long run a real return (after inflation) of 4% per annum, which would mean that the purchasing power of their wealth would double every 17 or 18 years. His timidity kept him from becoming engulfed in the new-issues market of the 1870s or in the mania for colonial investing that later wiped out so many men and German banking houses. Bismarck was perfectly satisfied with this return, but always withdrew his profits and invested them in land and trees.

Bismarck’s appetite for timberland was insatiable. His theory was that the price of land would gradually appreciate in line with population growth, or about two percentage points annually. His studies had convinced him that German forests would grow 2.75% a year, so that his real return for timberland would be around 4.75% per annum, because inflation at the time was virtually zero. If there was inflation, he was sure timberland and log prices would appreciate in line with the inflation. He thought that with very little risk, this was a spectacular compounding of wealth. As it turned out, Bismarck was absolutely right.

Over the next half century in Germany of war, inflation, surrender, and depression, timberland held value far better than anything else.

Now many of you must be wondering how to invest in timberland. From what Light says, it’s quite difficult unless you’re a member of the mega rich or at least managing their money. He does mention one company though, Plum Creek Timber Co. (NYSE:PCL). I learned about PCL a few years ago, from Clyde Milton’s Cheap Stocks. I’m hesitant to say that investing in PCL is a way to expose yourself to timberland though.

The company does own some timberland, 8 million acres or so, with 21% of that being higher quality timberland. On a back of the envelope valuation basis, the company seems like it may be undervalued. Right now, it’s selling on an EV/Acre basis of around $890 versus $1500 on the low end for the price per acre of timberland.

I would caution investors to understand a few things about PCL before rushing into it. The way an equity security behaves will be quite different than an investment in timberland. Light makes a number of points that expresses the strength behind timberland: it’s relatively illiquid, takes years to unwind, and in a bad year you can simply let the trees and value grow. In some ways, this reminds me of frontier markets. Those too, are so remote and hard to access that they don’t suffer from Mr. Market’s fits of manic depression as much. PCL wont behave like that because it’s a common stock. Every day market participants will be putting a value on the company no matter what. In that sense, it will be influenced by a whole host of factors.

We all know that the price of a security and the value of a security are two very different things. What this all means is that even though timberland investors saw a 4% appreciation for their investment in 2008, a PCL investor would have seen a -50% decline in their investment. This is because PCL is subject to different influences. Over the longer term, its likely that value will follow in a company like PCL and in that case, if you’re bullish on timberland, it might be a good place to invest. An investor would have to look at the company’s current management and other business lines in order to accurately gauge whether the company is as undervalued as it looks based on the EV/Acre basis. This is something that could be worth looking into.