The Weyerhaeuser Company has finally dropped that other shoe, or at least has decided to drop it. Last month, Weyerhaeuser announced that its board of directors had finally committed the company to becoming a Real Estate Investment Trust or REIT. The company may make the switch in 2010. Or it may not. The only question is when.
Arguably, that has been the question for a long time. Many investors and observers have been awaiting this news for years.
In 2008, the company lobbied successfully for legislation that cut its tax rate in half, comparable to the corporate tax paid by a REIT — if a REIT paid taxes. But a REIT isn't likely to have much taxable income. Instead, it channels 90 percent of its earnings to shareholders, who pay as individuals, avoiding the 'êdouble taxation'ê levied on most corporate profits and dividend income.
Weyerhaeuser will hardly be the first on its block to take the plunge. Congress created the REIT back in 1960, evidently in order to make the joys of commercial real estate speculation available to Everyman. (This was, of course, long before Everyman started viewing his own house as a speculative investment.) As that long-gone Congress conceived them, REITs 'êare, in essence, financial vehicles that allow investors to pool their capital for participation in real estate ownership or mortgage financing, while providing those investors with the benefits of many of the tax advantages available to larger and more sophisticated investors and businesses who can afford to invest directly in real estate,'ê Jack H. McCall explains in The Legal Basics of REITs (PDF), published by Tennessee Journal of Business Law in 2001. 'êHence, REITs can generally be thought of as ... a kind of business enterprise that is analogous to a mutual fund for real estate investments.'ê
Twenty-nine years later, Congress 'êmodernized'ê the legislation, allowing a REIT to own a taxable operating subsidiary to provide unconventional services to tenants of REIT property. This could mean providing telecom services to the people who live or work in your high-rise. It could also mean milling the timber cut on your forest land. Plum Creek got the IRS to say yes, the REIT laws applied to timber too. By now, Jada A. Graves wrote a few years ago in REIT.com, 'êtimber REITs have joined an assorted group of equity REITs specializing in movie theaters, correctional facilities, and car dealerships.'ê
Once the IRS said yes, Plum Creek quickly reorganized itself as a REIT. Plum Creek'ês transformation attracted a lot of outside capital. The company promptly used its new wealth to buy The Timber Company, which owned all of Georgia Pacific'ês timberland. Thanks to the GP purchase, Plum Creek has supplanted Weyerhaeuser as the nation'ês largest private timber land holder. Other traditional forest products companies have restructured accordingly. In 2004, 2005, and 2006, Rayonier, Longview Fibre, and Potlatch became REITs too.
And no wonder: In many analysts' and investors' eyes the advantages of the old vertically integrated forest products company have been outweighed by disadvantages in the federal tax code. Wall Street doesn'êt want the timber without the tax breaks. A flow of logs to nearby mills has been replaced by a flow of tax-advantaged dollars to distant investors. To Wall Street, forests are no longer about wood; they're about money.
'êForest land is increasingly a financial, rather than an industrial asset,'ê the UW College of Forest Resources reported to the Washington Legislature last spring. The report observed that 'êold-line companies have monetized their forest assets and been replaced by institutional investor-managers, or reorganized into real estate investment trusts.'ê
Wall Street has just been waiting for Weyerhaeuser to join the 21st century. Scott St. Clair wrote in Crosscut that 'êWall Street effectively made the decision that it will no longer measure the value of Weyerhaeuser by what it makes but, rather, by what it owns.'ê
What it owns no longer includes much of King County. Since 2000, Weyerhaeuser has shifted its geographic focus within Washington, abandoning East King County for Southwest Washington, where it ships logs and lumber through the Port of Longview. Weyerhaeuser still owns or manages more than 20 million acres, over a million of it in Washington, from its headquarters in Federal Way. But the company has closed its Snoqualmie and Enumclaw mills and sold its timber in King, Pierce, and Snohomish counties.
While the company hasn't rushed into changing its corporate form, it has already laid the groundwork for a REIT conversion. A Real Estate Investment Trust may be basically a tax scam created by federal law, but it's a tax scam that operates under very specific rules. Structurally, a company that wants the tax dodge can't get more than 20 percent of its earnings from operations that aren't REIT-qualified.
At the beginning of August 2008, right after Weyerhaeuser announced 1,500 layoffs, St. Clair wrote that 'êstarting a few years ago, Weyerhaeuser began spinning off assets. Always committed to focusing only on businesses in which it could be a major player, it now shifted to getting out of many of those businesses altogether. Its printing and writing-grade paper operations became, in a complex trade, part of Canadian-based Domtar Industries. And just last week, in perhaps the biggest blow of all, Weyerhaeuser closed on the sale of its packaging business to [International Paper]. Some 114 facilities, including paper mills, carton plants, and recycling centers, were sold for $6 billion.'ê
Unloading the paper and container board operations gets Weyerhaeuser through that particular hoop in the REIT law, and many people assumed that was why the company unloaded them. Weyerhaeuser spokesman Bruce Amundson said early last year that wasn't so, that neither division fit into Weyerhaeuser's view of the future. With the proliferation of online communication, the future of paper looked questionable. And with Asian companies starting to supply the Asian market for container board, the future of that product line looked questionable too. To compete, the company would have had to start manufacturing abroad. It had no experience manufacturing outside North America, and no interest in investing the large amounts of capital that offshore container board plants would have required.
Nevertheless, Amundson didn't deny that the company had made the structural changes it would need to become a REIT. It has already reorganized itself into two separate reporting units: timber, and everything else. It has also started reporting on a calendar-year schedule, as the REIT law requires.
And it has stockpiled cash. Weyerhaeuser's revenues are tied closely to the housing market. Not surprisingly, the company's 2008 annual report featured some pretty bleak numbers: Net sales and revenues from continuing operations dropped 25.9 percent. Basic and diluted net earnings per share dropped 255 percent. The company slashed its dividend from 60 cents to 25 cents per share, and then, in the second quarter, surprised many analysts by slashing it again, down to a nickel.
Some people saw the second dividend cut as a step in the right direction. To become a REIT, the company must distribute its retained earnings to its shareholders. Eighty percent can be distributed in the form of stock. That means 20 percent will have to be distributed as cash. Because the company has an estimated $6.5 billion of retained earnings, it would have to come up with about $1.3 billion in cash. Without saying it planned to become a REIT, Weyerhaeuser made it clear that the second dividend cut enabled it to hoard cash, just in case. After the second dividend cut, Longbow Research analyst Joshua Zaret observed that 'êeverything they're doing now is about preserving cash.'ê
And Zaret approved. He thinks the REIT conversion is long overdue. He'd prefer a pure timber REIT, but what Weyerhaeuser will have when it makes the switch looks far better to him than what it has now. What it will have, essentially, is the same tax advantage its competitors enjoy. Zaret sounds somewhat outraged by that suggestion that reorganizing Weyerhaeuser's entire corporate structure in order to save taxes is perverse. 'êIs there a better reason?'ê he asks.