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Weyerhauser's Financial Engineering Confronts Financial Integrity at Willamette Industries

PORTLAND, Ore., June 19, 2001   Today Parish & Company released a summary report on financial engineering at the Weyerhauser Corporation.  Please see Part I for important background information.  This report concludes that Weyerhaeuser itself could become the target of a hostile takeover attempt, not Willamette Industries.

One overarching quesiton both investors and securities regulators might ask is the following. Is Weyerhauser using "acquired sales" in addition to manipulating its pension expense via a "cookie jar" approach in an effort to manage earnings and inflate its stock price and compete for capital with a pyramid scheme at the Microsoft's corporation?  Earnings were inflated 11 percent in 1999 and 15 percent in 2000 by such pension adjustments, not yet covered in the media, and more than 24 percent of gross annual revenues at 12/31/2000 were purchased in 1999 and 2000.  At  Willamette Industries such pension adjustments represent less than one percent of pre-tax income.  In addition, sales growth at Willamette is core growth mostly resulting from the existing businesses, as outlined in a recent report, rather than acquired growth.

Summary of Key Financial Data - Fiscal Year Ended 12/31/2000

	Weyerhaeuser	Willamette Industries
Pension Expense	($193) million	($6) million
Pension Adj. NI Impact	14.8 percent increase	1.1 percent increase
Debt/Equity Ratio	89 percent	68 percent
Acquired Sales Since 1999 - See Assumption	33 percent	none

Bob Herbold, Microsoft's Chief Operating Officer from 1995-2000, who I believe is a key architect of Microsoft's pyramid scheme, became a Weyerhaueser board member in 1999.  Two previous CFO's, Mike Brown and Greg Maffei, both directly reported to Herbold.  At one time Brown was CFO of Microsoft, Chairman of the Board of the Nasdaq stock exchange and along with Herbold publicly boasted about his ability to influence accounting standards.  Also noteworthy is Brown firing Microsoft's own internal auditor, his former boss at Deloitte and Touche, who claimed what they were doing constituted securities fraud.  This former Deloitte partner and later chief of internal audit at Microsoft was paid a $4 million settlement which included a gag order.  
 
It is surprising that Institutional Shareholder Services supported Weyerhauser's proxy battle to place three new member on Willamette's board at its recent annual meeting, one of whom is a recent member of Microsoft's management team.  Clearly their focus on corporate governance mechanics was not broad enough to see that financial engineering at Weyerhauser should have been addressed.
 
Weyerhauser is now attempting a hostile takeover of Willamette Industries when in reality Weyerhaeuser should be vulnerable to a takeover.  Chainsaw Al provided a valuable lesson and that is that companies should deserve to make acquisitions based upon outperforming.  Rewarding Weyerhauser with the ability to acquire Willamette industries based upon prowess in financial engineering would eliminate what could be an excellent long-term investment, Willamette Industries, and leave Weyerhauser grossly overleveraged.

Many companies, including IBM and Citigroup, have converted their defined benefit pension plans to "cash balance" plans with the specific goal of reducing costs.  Cash balance plans are similar to 401K plans in which employees make contributions and the employer is only responsible for an "employer match."  Such conversions are controversial and can produce significant one-time increases to net income as surpluses are eliminated.

What Weyerhaeuser is doing is more sophisticated.  Rather than convert its plan, Weyerhauser is using the plan as the equivalent of a "cookie jar" to inflate net income. They also appear to be using unrealistic assumptions to justify peeling off significant amounts on an annual basis and thereby inflating pre-tax income, roughly 15 percent in fiscal 2000 and 11 percent in 1999.

We are all familar with the glories of compounding and this works for pensions also.  Imagine the impact of Weyerhaeuser assuming a future annual return 2.5 percent greater than Willamette's assumed return and then also assuming 1.75 percent less inflation.  If Weyerhaueser does indeed have a surplus of $1.8 billion, Weyerhaeuser could be subject to a takeover itself and this suplus used to finance a large part of the acquisition.  Willamette does also have a surplus yet neither it nor related pension adjustments are significant to financial results.

Summary of Key Defined Benefit Pension Data per SEC 10K reports. 
 

Pension Impact on Income	Weyerhaeuser	Willamette Industries
Pension Assets	$4.4 billion	$594 million
Pension Obligations	$2.6 billion	$441 million
Surplus	$1.8 billion	$153 million
Pension Expense YE 12/2000	($193) million	($6) million
Income Before Taxes	$1.323 billion	$514 million
Pension Adj Impact on Income	14.8 percent increase	1.1 percent increase
Pension Assumptions-Future
Expected Return	11.50 percent	9 percent
Expected Wage Inflation	3.25 percent	5 percent

 

Source:  Yahoo Company Profile as of June 15, 2001
 

Performance Data	Weyerhaeuser	Willamette Industries
Gross Revenues	$15.6 billion	$4.6 billion
Operating Margin	8.1 percent	13.4 percent
Debt/Equity Ratio	89 percent	68 percent
Return on Assets	3.9 percent	6.5 percent
CEO Pay	$3.1 million (FY 2000)	$894 thousand (FY 1999)
Market Value of Stock	$11.6 billion	$5.35 billion

 
Weyerhaeuser will claim that its debt to equity ratio is not 89 percent because that includes debt in their real estate development subsidiary.  This of course is ridiculous and in fact real estate debt can often be even more susceptible to economic cycles than a core business. Also not considered in the operating margin comparison are Weyerhauser's pension manipulations and their related impact.
 
The following table compares Weyerhaeuser and Willamette Industries gross annual revenues for the year ended 12/31/2000.  Clearly, Weyerhauser is achieving growth via acquisitions and such transactions provide significant fee benefits to investment bankers and accountants involved in the transactions.  More than 24 percent of gross annual revenues at Weyerhaeuser have been acquired since 1999.  In Willamette's case there have been various small acquisitions and partnerships established, similar to Weyerhauser, yet none are significant to financial results.

Weyerhauser is claiming that Willamette must merge to survive yet most businesses today would be delighted to maintain Willamett's 13.4 percent operating margins. Willamette is a solid business based upon strong fundamental factors whereas Weyerhaeuser seems to have evolved into a financial scheme more focused on Wall Street bankers than shareholders.

Source:  SEC Reports
 

Sales Growth Analysis	Weyerhaeuser	Willamette Industries
Gross Revenues	$15.6 billion	$4.6 billion
Deduct Major Acquired Sales (Firms Representing More Than 5% of Gross Revenues):
MacMillan Bloedel-1999 - Stock Purchase Using Pooling Loophole	($2.96) billion
TJ International - 2000 - Cash Purchase	($896) million
Acquired Sales	($3.856) billion	None
Sales Net of Acquired Sales	$11.744 billion	$4.6 billion
Acquired Sales - % of Total	24 percent	None

 
Perhaps Weyerhauser's strongest asset is its public relations staff.  Somehow they lobbied Wall Street into believing that this takeover of Willamette Industries makes sense when it is a sham.  Not only will Weyerhauser's shareholders be losers yet also its employees as their pensions are pilfered annually to sustain the scheme.

Parish and Company's message to Weyerhaeuser’s CEO is simple and sincere -  if you can’t run the company the way you want, why not retire, take up golf and travel a bit. The only real winners in this situation will be the lawyers, accountants and investment bankers involved who stand to make millions.  Meanwhile, long-term shareholders of both companies, along with employees of both firms, and their communities, end up losers.  Take a lesson from Chainsaw Al and Bernard Ebbars, step back and focus rather than run Weyerhauser off a cliff with Willamette Industries in the back seat.

Parish & Company is an independent fee based investment advisor to individuals, pensions and trusts based in Portland, Oregon.  No fees are accepted, either directly or indirectly, from any provider of investment products.  Your comments are most appreciated and please do visit my research archive at www.billparish.com.