As Far As We Could Get

This is a report about the last two days of the Pacific Lumber Company bankruptcy hearings that were held in Corpus Christi, Texas, from April 8th-11th. By rights, it should have been the final of the series of reports on those hearings and been published on the 13h or soon thereafter. Instead, it comes more or less as a preface to the next series of hearings scheduled for April 29th-May 2nd (unless there is a mediated settlement first). The report is in enough detail so that parties with only a passing interest might well tire before the conclusion. For them, the drafter of the report has tried to tell the story in as interesting a fashion as possible. To those whose lives will be affected by the outcome, it is doubtful that much about the events discussed here will lack interest or drama.

I ended what turned out to be the first week, rather than the only week, of the PL confirmation trial sharing drinks accidentally (in terms of the company, not the alcohol; after four days of riding that brutal cherry wood bench, a drink was in order) with a semi-jubilant crew of Fulbright and Jaworski lawyers at the bar of the Omni Hotel in Corpus Christi. Their good cheer, I supposed, had to do with the facts that a draining week was over, their billing was going to be even more substantial and a modest smell of success was in the air. What’s not to celebrate? They were at the top of their game, an elite team from one of the nation’s most prestigious law firms gathered in the luxury of Corpus Christi’s best hotel, about to head home to no doubt similar comfort.

The only problems with this scenario were mine, not theirs. Our community’s hopes for a better deal in the post-Hurwitz era had just been presented with a major new challenge engineered at least n part by these attorneys The price someone pays for timberland is not the only determinant of how much has to be cut. It is, though, the most important one, and it looked like the price had just gone up in one 20%, $100 million leap.

During the prior two days of the hearing–the last in the first session–a series of witnesses called by the note holder had been paraded before the judge. During the first two days of the hearing, witnesses had been called by MRC/Marathon. PL’s witnesses are to be heard and cross-examined starting on April 29th, though this ‘day in court’ for them is considered procedural rather than substantive.

Jim Fleming, long-time forest evaluator from Sacramento, gave the initial testimony for the ‘notes’. His was to establish the “fair market value” for the Scopac lands. Using the ‘income’ method which is a discounted cash flow analysis as to how much money in today’s dollars one could make selling trees off the land over a certain period, he had arrived at $ 605 million. Keep I mind that valuation is everything here. If the Judge could be convinced as to what fair value was, he’d have no problem confirming the plan that was based on it. Of course, there were as many ideas about value as there were evaluators

The date Flemming originally delivered the completed estimate to his clients had been January 30th. That was one day before the drop dead date of January 31st that Judge Schmidt had decreed for the submission of plans to the Court–by participants with standing. It also came, miraculously, a day before the Beal ‘family’ of entities stealth submission of a letter of interest to the Court suggesting that they might be willing, in the event of an auction, to submit a bid for $603 million, a hair’s breadth from the Fleming figure. “Stealth is the functional word here because no one seemed to be aware until this week that such an ‘interest’ had been formally indicated.

These coincidences point at a major complexity in the new deal, dare I say the Beal Deal.

Beal is the major creditor among the note holders—since 2001 he has held approximately 38% of the total notes secured by the Scopac lands. That’s about $280 million. (All of it was acquired on secondary markets a few years after original sale.) Word has it he “wants his trees” and that Beal is used to getting what he wants. (Many people down in Texas calls him ‘Andy”, often with a hint of ill-contained reverence. (I will resist the temptation to worship), It is important to try to understand that he is both the major Scopac creditor as well as an independent bidder in the note holders auction process if indeed that process is confirmed by the Judge. What, one might ask, does this mean? I think there is a win-win somewhere in here.

If Flemming’s valuation, meanwhile, was to be the basis for Beal’s plan—and there is no reason to think that it might not be—there are distinct problems. In his calculation as to value, 1678 acres a year are to be clearcut. He also sees the Marbled Murrelet Conservation Areas as candidates for clear cutting down the line. “It is environmentally sound to cut old growth,” he said. This would make him a kind of dinosaur among Humboldt loggers who have long ago understood that they would forebear from these practices in the future.

Another aspect of how Flemming got to $605 million is rate of cut. His discounted cash flow analysis only goes 10 years out. In the first 9 years he foresees harvesting 81 million board ft. per year–more than the 71 million Scopac managed to get in 2007 and almost 30 million feet more than the 53 million MRC/Marathon has committed to log in the first 10 years of their plan if it is confirmed. Cut per annum may be the simplest criteria, beneath all the hype and financial flimflammery, to determine what’s up and what’s down in the morally fluid environment of the bankruptcy proceeding.

Next to testify was Lynn Daniel, Managing Director of Houlihan Lokey. Houlihan serves as financial advisers to the note holders. With offices in 8 cities in America and more in Asia, Houlihan offers a reputable if high end way to determine the value of an asset. High or low, Mr. Daniel seemed a man somewhat pained by the nature of his work. It was hard to tell whether he had greater contempt for the process, the lawyers who interrogated him or for his own role.

Daniel’s idea of the timberland’s value, determined by averaging three different methods. was a low of $ 575 million and a high pf $676 million with an average of $ 622 million.

He also said that in Houlihan’s conceptualization, near term cash flows would be heavier than those that came later, the exact opposite way to stack payment than others projected, including MRC/Marathon’s. He talked about “investment characteristics” but admitted he knew nothing about the redwood markets or timber for that matter.

More important, Daniel contradicted himself in a major way. He said that it was “rational” to limit harvest for a few years and then go to 100 million Board Ft. per year in perpetuity. But under grilling by Marathon’s bulldog lead attorney, David Neier, he said “If you chose not to cut the trees, you don’t get the cash flow. {Under these circumstances} the note holders have the right to get the full value.” In other words, it’s nice to limit harvest for a while but we have a right, then, to the value of the timber you leave on the stump and it’s growth. Since the Notes do not seem to be looking to sustain an investment into the distant future when the regeneration will start being available to expand harvest levels, it is safe to assume they want that value in front. This in turn means that you have to cut more timber early on to pay the added price. Then there will be no long-term bonus from rebuilt inventory for anyone. It’s a major twist of forestry logic.

Jeff Barrett, PL’s Vice President and chief ‘scientist’ testified next. I suppose the Notes had to try to make it clear that PL was entirely out of the running. Under those circumstances, Barrett conducted himself well, giving cautious but essentially honest answers as to the likelihood of his company’s real estate ambitions with their monumentally inflated sense of the value—approaching a billion dollars. He was eminently polite and managed to escape with a shred of his dignity still in tact. While his science had often been impugned, his swan song, if this is what it was, was marked with a few grace notes. He even went so far as to compliment MRC’s intentions as ‘appropriate’, even ‘beneficial’.

The other PL executives, huddled behind their table-full of lawyers, sat stoically through this testimony that rang as a penultimate blow to their employment. One was almost tempted to feel sympathy. Almost. PL/Maxxam will need a legal miracle to come out of these hearings with control over much of anything. It is hard to imagine “Golden Rule” Charles Hurwitz humbly bent in prayer for that miracle, but it is, after all, the Passover season, a celebration of freedom. If only he hadn’t taken up the role of Pharaoh quite so whole-heartedly.

That was the morning of the hearing’s last day. It was in the afternoon that the real bombshell was dropped. Jacob Cherner, President of Beal Financial Corporation (do not hold me to this title–there seem to be a slew of legally constructed entities the names of which start with ‘Beal”) took the stand.

Cherner, from the back of the courtroom, looked to be of medium height and above average breadth, not overweight, just chunky, a block of a man, probably strong. A first impression ran toward the shy or phlegmatic but once he’d relaxed into his seat, and his testimony, a basic intelligence came through.

Cherner made it clear that the $ 603 million price mentioned in the Jan. 31st Letter of Interest was now something more formal—not quite a purchase agreement but close to binding. A “Term Sheet’ had been developed upon request of Houlihan in early March.

At first, it was a challenge to take the whole thing seriously. Cherner kept talking about the “tree farm’ and “tree farming”, a far cry from the mildly hyperbolic “Great Redwood Forest” that The Nature Conservancy uses

He also announced the existence of “Scotia Redwood Company” which has two employees, Andy Beal and himself, and will soon have a treasury that may or may not have total deposits somewhere between $ 40,000 and $40,000,000. It was hard to tell.

The financial mumbo jumbo he went through to substantiate that Beal had the cash and where and in what form was over my head.

It was one of several moments at the hearing where one had to admit defeat in the ongoing battle to penetrate the dense legal business-speak. With only an MBA one might have been able to determine when the language was a smokescreen hiding hogwash—which it often was–and when it added up to something that might be of substance. This mental struggle to grasp the meaning of these arcane bits of information and perceive underlying patterns easily surpasses Ambien as a guarantor of sleep.

The moment with the greatest potential for outright comedy came when Mr. Cherner was asked how much experience in owning and operating a timber company Mr Beal and he had. His answer–they once owned and operated timber land in….Estonia! A new Global Timber Giant is born, ranging from Humboldt County to Eastern Europe.

Assurances that Beal had dedicated staff resources to manage this timber empire starting on 2003, were not altogether effective. When asked of the details, Cherner said that those staff resources resided in the hands of a “Mr. Irwin” who’ he admitted, was not a forester. nor had yet conferred with representatives of any regulatory agencies.

The sum total of this testimony did not give one great confidence in the ability of the Beal team to take on the responsibility for PL, the single most important economic asset in our community. In fact, a sense of dread began to grip the hearts of those who cared for Humboldt’s future, a sense, dare we say, of déjà vu.

I asked the closest Texas lawyer, who was two feet to my right (there was another two feet to my left, but I’m right-handed) whether he found this thin soup a comforting perspective for those hoping for successful management. His answer was, “Andy went onto Aerospace without knowing anything about it and he made a fortune at it.” Could this be a defining feature of billionaires? They think they can do anything, no matter how little their previous experience or training, that they can buy all the expertise they need. How might this chutzpah play out in the lives of the thousands of us “little” people whose futures are intertwined with that of Pacific Lumber Company?

McMarathon’s lawyers launched an attack at Mr. Cherner based on the understandable surmise that the plan he represented was not credible, that it was in reality a gambit to drive up the price. This interpretation is favored by the fact that Mr. Beal is well-known as maybe the highest stakes poker player in the United States, McMarathon’s attack dog, Neier, called the Beal Deal a “Round Trip” that does not do what the note holders have insisted all along only an auction can do—establish fair market value. In other words, it’s a gambit, maybe even a bluff. Is he prepared to run the company if they (he) do not get a price they can live with? Is he just trying to pressure McMarathon into enriching their bid?

All this being said–the ironies, the thin soup, the miniscule experience in timber–the Beal Deal has to be taken absolutely seriously if for no other reason than that any way you cut it, the ultimate price that will be paid for PL is going up. As we said, price and rate of borrowing determine how much timber must be cut. Beal and his representatives have tried to assure us that they know what happened with Hurwitz and they will not under any circumstances repeat that history, but if they or anyone pays too much, what is to make a difference? We’re back to Maxxamville. Beal has also said that if this process reverts to a Chapter 7 Liquidation, he will still bid the same amount meaning that he believes that’s the bottom-line value of the land and timber–maybe

Beal’s and Cherner’s is now the Stalking Horse Bid, a position that at one point The Nature Conservancy’s consortium were designated to hold (before MRC hooked up with Marthon when an auction seemed like the only possibility). The advantage of this position is that in order to trump their price, the next bidder must increase his offer by $21 million. That means bidding starts at $ 624 million. So if they are serious and there is an auction–or even if there isn’t–the price is going up substantially, perhaps well beyond what many feel can allow any other options but the most intensive management regimes. We all know how that plays out,

There is also the credit bid issue. The Indentured Trustee is required by law to assure the note holders that their asset cannot be sold for less than what is owed on the property. The debt on the Scopac lands, without adding interest for the last 16 months, is around

$ 714 million, depending on who you listen to. If no one meets that price, which no one will, the note holders can bid on the property using credit equal to the debt their owerdf and easily outbid everyone else. If 2/3rds of the creditors don’t want the property, they can vote to allow a sale at a lesser price to go through. Since Beal controls more than 1/3 of the property, he can block a vote to allow a sale priced below the debt to go through. It gives him even more leverage in the situation. It is stated as Beal having a “Blocking Interest”.

A last gasp before the Judge put the hearing to bed—Shelby Jordan, an attormey for PL, got up and said, “Your honor. We’re not out of it yet.” The Judge promised they’d have their turn when the hearings resumed on April 29th.

Finally, Judge Schmitz wrapped it up. He talked briefly about the potential conflict of interest posed by Beal the note holder versus Beal the bidder, but basically he turned again to the “two tables”—the Notes and McMarathon. He said the land is probably worth somewhere between what one side says its worth and what the other side says.

There are legal problems if he confirms either side, he suggested, and appeals can damage the winner’s ability to operate or borrow. It is perhaps the worst alternative. He was pretty specific about what he’d like to see. The property, he thought, was clearly worth the two bids—basically between $500 million and $ 600 million. Could MRC enrich its bid? Could the Notes come down? Could they, perchance, accept an equity position promising returns in the future rather than getting notes that had to be written down? Or do they just want the maximum amount of cash they can squeeze out of it right now?

He made it clear that he needed to be sure that the note holders were getting fair value for their notes before confirming a plan and he suggested a few ways by which that value could be assured. He was also clear that the McMarathon plan had strong community support even though the price they were offering might be too low.

He reiterated that this was an important piece of land and that he took this case absolutely seriously. He knew there were issues either way and dissatisfaction leading to an appeal could “kill the cure”. Judge Schmidt urged, almost begged, both sides to see how close they could come.

He concluded by making it clear that PL would have their final say. “I haven’t hear your side. I’m not ruling yet.” Then all went out of the courthouse, pleased to be momentarily released from the tedium of this event, looking blearily toward the next sessions two weeks off knowing that during the interim, serious conversations must take place.

So we wait. The battle is MRC’s to win or lose. If they do not come up with an offer that will work for the note holders it will probably be because they don’t think they can manage at those costs. There is no dishonor in that. (Remember, McMarathon has promised to cut at a level that conservationists and the community as a whole find very attractive—a level that will allow significant regeneration over the next 10 years. If they have to pay more for the land, they may well need to up the harvest which, as we outlined earlier, lowers the potential regeneration.)

An auction that would ensue upon failure to negotiate a settlement will probably take six months. How will the company survive and the jobs be sustained during that interim period? Rumor has it that the Notes are out there looking for someone willing to take on the mill.

There is also the Plan Agent, a position established by the Notes ostensibly for the express purpose of dealing with this situation. That exalted Agent, of course, is none other than former Governor, Pete Wilson. One might well ask how much does he know about running a timber company and is that worth the $ 150,000 per month he’s rumored to be receiving for his ‘expert’ interventions. Add that tidy amount to the vastly proliferating legal fees—all of which must come from the trees–and one wonders how much is going to be left for Humboldt County?

Addendum: As of April 27th, rumors of a connection or friendship between Andy Beal and Charles Hurwitz that could affect the outcome of events have not been corroborated.

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4 Responses to “As Far As We Could Get”

  1. As Far As We Could Get Says:

    […] As Far As We Could Get There is also the credit bid issue. The Indentured Trustee is required by law to assure the note holders that their asset cannot be sold for less than what is owed on the property. The debt on the Scopac lands, without adding interest … […]

  2. farm » Blog Archive » As Far As We Could Get Says:

    […] unknown wrote an interesting post today onHere’s a quick excerptThe other PL executives, huddled behind their table-full of lawyers, sat stoically through this testimony that rang as a penultimate blow to their employment. One was almost tempted to feel sympathy. Almost. PL/Maxxam will need a legal … […]

  3. Poker » As Far As We Could Get Says:

    […] Dispatches from David wrote an interesting post today on As Far As We Could GetHere’s a quick excerptThis is a report about the the last two days of the Pacific Lumber Company bankruptcy hearings that […]

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    Private Wealth Management…

    Make sure that any investment system you use is free of bias. If the purveyor of an investment system has a clear interest in a specific market or industry (oil industry, telecommunications, or precious metals for example) then his recommendations may…

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