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Sunday, February 26, 2006 - Page updated at 12:00 AM

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Weyerhaeuser buzz: trees or paper?

Seattle Times business reporter

Fighting for profit in a difficult industry, Weyerhaeuser has come to a crossroads.

It operates the way timber companies have for decades, with major timberland holdings that feed its factories. But that way of doing business has fallen out of fashion, and if Weyerhaeuser cannot generate higher profit with a recent overhaul, it could be forced to choose between timber and manufacturing.

Some competitors are selling businesses and changing their corporate status to appease restless shareholders who want higher yields from these old-line companies that for years went relatively unnoticed on Wall Street. Timber companies are considered ripe for greater profits now largely because of how valuable their land holdings have become.

Weyerhaeuser, one of the country's oldest and largest timber companies, is making strides. It is closing more than a dozen plants and mills, selling several operations, and improving the way it sells products.

But those moves might not be enough at a time when demand for many of its products is flat, the price of making them has risen, and low-cost competitors in Asia and Latin America are snatching up market share. Weyerhaeuser posted a 43 percent profit decline in 2005, and its stock has been torpid."The problem is, the paper business is not doing well at all for anyone," said Steven Chercover, an analyst at D.A. Davidson in Portland. "The whole world has changed, and the business has moved offshore. South Americans can grow trees faster, and paper use in North America is going down."

U.S. competitors have succumbed to the pressure in various ways, from selling timberland to converting to real-estate investment trusts (REITs), which pay lower taxes than corporations but can do limited manufacturing.

Such drastic moves would be difficult for Weyerhaeuser, but they are not unthinkable. Neither is the possibility of the company divesting its manufacturing operations, although that seems the least likely scenario.

"We believe the integrated approach makes us better able to compete," Weyerhaeuser spokesman David Larsen said. "We think [that] in the long term, it yields superior investment returns."

Weyerhaeuser began as a timber company without mills, but the manufacturing of paper, packaging and other wood products has become its core business. Even when paper and packaging products are losing money — together they sapped $449 million from Weyerhaeuser's bottom line in 2005 — the company remains a manufacturing powerhouse with a large slice of the U.S. market.

One possibility:

Sell manufacturing

Without manufacturing, Weyerhaeuser would look quite a bit like Seattle-based Plum Creek, a giant timberland owner whose stock has outperformed Weyerhaeuser in recent years.

Plum Creek was the first real-estate investment trust with major timberland holdings. Other timber companies have followed it by converting to the REIT structure, including Potlatch and Longview Fibre earlier this year.

REITs are attractive to investors because they pay much lower taxes (15 percent, compared with 35 percent for regular corporations), and they are required to pay out at least 90 percent of their timber income in dividends.

REITs have limitations: At least 75 percent of their assets must be in real estate, and at least 75 percent of their gross income must come from real-estate sources such as rent and property sales. REITs can sell trees but not logs, which sometimes leads to complicated contracts between an REIT and its non-REIT subsidiaries.

Because paper and packaging are so depressed right now, some timber companies could convert without having to divest significant manufacturing operations. But Weyerhaeuser is probably an exception because it is so large.

Company officials have said it would cost $15 to $20 a share to become a REIT, which amounts to $3.7 billion to $4.9 billion.

Another option:

Sell timberland

Another option is for Weyerhaeuser to sell its timberland, something that might seem impossible to fathom for the company that trademarked the phrase "Timber Is a Crop."

That's the avenue that another Stamford, Conn.-based International Paper, plans to take. It began marketing 6.8 million acres of U.S. timberland last year to help pay off debt and focus on its manufacturing operations.

Analysts say Weyerhaeuser would be stuck with a much larger tax bill than International Paper for selling its timberland, partly because Weyerhaeuser has owned much of its 5.6 million acres far longer and would have to pay enormous capital-gains taxes.

Timberland contributed more to Weyerhaeuser's bottom line last year — $784 million — than any other business.

It would be hard to let go for that reason and also sentimental ones. Weyerhaeuser was established in 1900, when Frederick Weyerhaeuser and 15 partners bought 900,000 acres of Washington timberland from the Northern Pacific Railway. At the time it was the largest private land transaction in U.S. history.

Weyerhaeuser also likes controlling its raw material — trees — for manufacturing.

"If you own the land, you have a long-term investment with more security that the timber will be there over the years," Larsen said. "If you let it go and it goes to other uses, you'll never get it back."

Still, Weyerhaeuser must consider the possibility.

The least pain: Congress cuts taxes

The company supports proposed federal legislation that would lower the tax on timberland businesses to 14 percent (paper and other related businesses would continue to be 35 percent). Proposed in both houses of Congress last year, the bill is touted as a way to help a struggling industry and to save jobs.

"If a paper company owns its own trees, it's more likely to keep an underperforming mill running longer," said Chip Dillon, a paper and forest-products analyst for Citigroup, with which Weyerhaeuser does investment banking. "Timber allows them to subsidize a money-losing operation in hopes that things will turn around."

The legislation's biggest beneficiaries would be MeadWestvaco, Temple-Inland (which investor Carl Icahn challenged last year), and Weyerhaeuser, which stands to save about $162 million a year in taxes, according to an analyst report from Deutsche Bank Securities. In 2005, Weyerhaeuser earned $733 million.

"If the tax structure does not change, we'll clearly have to do something else," Larsen said.

It might be too late for Weyerhaeuser to get the best price for its timberland, with two of the country's largest timberland owners flooding the market.

Harvard University's money-management arm beat International Paper to market last year when it sold an estimated $1.6 billion in timberland to Hancock Timber Resource Group, according to Deutsche Bank Securities. That is thought to be most or all of Harvard's U.S. land holdings.

Impatient shareholders

At least one major Weyerhaeuser investor is watching closely.

Peter Langerman, chief executive of Franklin Mutual Advisers in New Jersey, which owns more than 5 percent of Weyerhaeuser's common stock, believes the company is undervalued.

The tax situation is not the only problem, Langerman said. He likes the mill closings and sales announced last year and wants more of the same.

"We'd like to see the pace continue and accelerate," he said.

Franklin Mutual is the same company that, under its previous chief executive, David Winters, pushed Potlatch to become a REIT.

"Weyerhaeuser is a bigger, more complicated company," Winters said. "They're tackling some very tough things, but some of these things you can't resolve overnight, even though Wall Street is obsessed with the short term."

Winters said he spoke with Weyerhaeuser before he left Franklin Mutual but didn't tell the company precisely how to improve its stock price.

Winters can't say whether his new Wintergreen Fund owns Weyerhaeuser shares because securities regulations prevent him from disclosing those holdings for the time being.

Weyerhaeuser is no stranger to big changes. It has moved in and out of businesses for decades, at one point running a steamship company whose vessels were ordered into service during World War II.

It also has felt pressure to sell its timberland before, said Paul Latta, an analyst at McAdams Wright Ragen in Seattle.

"It goes back 30 or 40 years, whenever real estate or timber does well," Latta said. "We're at the apex of the pressure for Weyerhaeuser to do something.

"If the real-estate investors continue to drive the market, [Weyerhaeuser] might knuckle under. But if they can sit on the sidelines for a couple years, I suspect the pressure will fade."

Melissa Allison: 206-464-3312 or mallison@seattletimes.com

Copyright © 2006 The Seattle Times Company

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