by Aaron Levitt | November 8, 2013 11:43 am
When it comes to investing in timber, the long haul is what matters. And for shareholders of timber-focused real estate investment trust Weyerhaeuser (WY), the long term just got better.
The timber company’s latest deal to sell its homebuilding and real estate company — WRECO — will allow it to focus on the business of owning and operating boring profitable timberlands. That’s a prime spot to be in as timberlands’ stable and inflationary-beating returns continue to trounce other investments.
At the same time, the proposed merger/spin-off with Tri Pointe Homes (TPH) will create a growth-oriented company that should benefit as the U.S. housing market takes off. That should help WRECO trade at a much higher multiple once it’s no longer tucked inside the boring timber-focused firm.
Essentially, the deal allows investors to have the best of both worlds, and they should be buying with both fists.
Weyerhaeuser seems to be making good on its promise to unlock value from WRECO. Back in June, the timber REIT said it was looking at “strategic alternatives” with respect to the company’s homebuilding and real estate development business. WRECO is one of the largest homebuilders in the country, with some of the best margins industry.
Yet, it was never fully appreciated inside the REIT structure … hence the deal with Tri Pointe.
While the transaction seems complicated at first, the basic premise is that Weyerhaeuser will distribute ownership of WRECO to its current shareholders. Then there will be a merger in which WRECO will become a unit of Tri Pointe. It’s called a Reverse Morris Trust transaction, and it enables smaller firms to “buy” a larger company. (TPH’s market cap is only about $500 million, WY’s is nearly $17 billion.)
However, Weyerhaeuser isn’t giving the company away for free — its shareholders will own the majority of the new, combined homebuilder. WY will receive 130 million shares in the deal and 80.5% of TPH/WRECO, as well as about $700 million in cash. The spin-off/merger will be treated as a tax-free distribution for WY.
Overall, the total value of the deal is worth about $2.7 billion.
For shareholders in both Tri Pointe and Weyerhaeuser, the deal will be quite lucrative in the long term.
First, Tri Pointe immediately leaps into the upper tier of U.S. homebuilders. So far, TPH has been focused on the Californian and Colorado housing markets. But with the WRECO buy, it can now expand into Las Vegas, Texas, Arizona, D.C., and the Puget Sound region in Washington state. The deal would also up its average home selling price and move toward more upscale buyers.
Additionally, land assets for Tri Pointe would surge — roughly 10 times higher — after the deal. TPH will have about nine years’ worth of lot supply, compared to an average of 7.4 years for other homebuilders like D.R. Horton (DHI) and Pulte (PHM).
The spin-off is pretty good for Weyerhaeuser, too.
By selling or spinning off its homebuilding division, WY becomes a “pure-play” on timber assets. Many analysts believe that the company has been held back because most investors don’t understand Weyerhaeuser’s hybrid business model. Slimming the company’s portfolio from 4 to 3 businesses will unlock the true value of WRECO as a growth play and better showcase the stable nature of the timber asset class.
Not mention, the deal frees up resources to plow back into that core timber business — such as this year’s accreditive $2.65 billion purchase of Longview Timber from Canadian asset manager Brookfield Asset Management (BAM).
Homebuilding has been great lately, but is prone to booms and busts. Those busts have hurt Weyerhaeuser’s earnings in the past. By simply focusing on growing and harvesting logs, WY should be able to report “smoother” earnings going forward and produce steadier cash flows — the kind of cash flows that lead to big dividend increases in the future. After the transaction closes, analysts estimate that WY will see year-over-year growth in earnings of 97.3% and 16.8% for the next two years.
All of this should sound familiar to investors in ConocoPhillips (COP) and its spin-off of refiner Phillips 66 (PSX). It’s basically the same idea: Spilt “growth” from “stable” and watch them both trade at higher multiples.
For investors, timber investing is a game of patience and Weyerhaeuser seems to be setting itself up for the long haul. Ultimately, the spin-off/merger will help strengthen the shares long term appeal. At the same time, investors will be getting a bit of growth from newly created WRECO/TPH firm. It’s a win-win.
The play here is to buy WY shares. That way, you’ll get the best of both worlds and will still be able to keep the boring and dividend paying timber assets after the deal closes. You can always sell the homebuilder shares if the housing market starts to get rocky. Meanwhile, the timber assets should keep on pumping out dividends for the future.
As of this writing, Aaron Levitt was long WY
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