The Attraction of Brownfield Investments in Teak
The Attraction of Brownfield Investments in Teak
Brown and Greenfield Investing
Teak is a prime tropical hardwood, which requires 20 - 25 years to grow in a commercial plantation environment. If the investor enters at project start this is defined as Greenfield investing. The other option, a Brownfield investment, means that a buyer enters later and buys into an existing but older plantation. On the market there are various investment opportunities available at different ages, in teak and other tropical woods, thus providing a wide choice for investors.
Main Risks for Teak Plantations
Teak plantations bear certain risks. From a technical point of view key risks are e.g. the soil quality of the site, the suitability of the location, climate and fire to name the major ones. Normally detailed soil analysis is performed before planting in order to determine the right planting strategy. A plantation manager should be familiar with the site as observation over time can tell best what grows on the respective site. The results of the original plantation strategy become visible in the years thereafter. In most cases the tree diameters are measured and compared towards industry benchmarks to evaluate the progress in growth.
From a financial point of view, main risk is that the management company would run out of money. Teak trees require pruning, thinning and clearing of the underwood for maintenance. Doing this properly ensures that the tree,s commercial value is maximized. However, this comes at a certain cost. Given the project period is 20 - 25 years, strict discipline on cash management is required. In case the plantation manager runs out of money, the investor looses two fold: First requiring additional financing and second the commercial value of the trees might be suboptimal due to savings in maintenance.
Exit Strategies from Teak: The Seller's Perspective
Like Private Equity, when investing in teak, an investor is required to think about exit: How and when do I sell this investment? - Investing in a teak project offers the following main exit strategies:
(1) Exit at final harvest (20 - 25 years)
(2) Sell the investment to another investor / buyer
Teak investors need to be patient and normally be prepared being invested for 20 - 25 years. The main reason is that as the trees grow, they increase in their commercial value when properly maintained. No cash flow is coming in, thus the investor needs to wait for the commercial thinnings. In order to get an attractive IRR, the investor will have to wait till final harvest. The value of the trees becomes more attractive at older ages and being able to sell large sized logs, thus getting better prices. Therefore, profit maximization requires to be invested till the end of the project, which requires patience and stamina for the investor.
The option to sell the investment along the road is a trickier one. First, the quality of the trees will be clearly visible and thus a potential buyer will pay based on visible results only. In case maintenance has been neglected, or the soil quality affected volume growth, the buyer will take this into account. Second, the market for existing plantations appears intransparent and illiquid. Thus for the seller it takes effort and time to find suitable buyers. The buyer will be very well aware of this and will pressurize the seller to offer a liquidity discount in order to increase his own IRR.
Buying an Existing Teak Plantation: The Buyer's Perspective
Buying into an existing teak plantation avoids certain risks for the buyer. First, the project,s results are clearly visible and he should bear less risk as soil quality and the suitability of the site can be better assessed. The difficulty lies more in doing the due diligence. Due to a lack of data, a non-sophisticated buyer might need some time to figure out if the said plantation complies to industry benchmarks or not. For the sophisticated buyer such opportunities are much more interesting, since for him he will be better able to provide an estimate of the target harvest volume based on the existing tree diameters. Thus buying into an existing plantation can reduce risk for the buyer.
The second aspect is that in a Greenfield project the 'lock-in' period can be up to 20 - 25 years while buying into an existing plantation reduces the holding period for the investor - dependent on the maturity of the plantation, quite considerably. Smaller holding periods mean less risk for the investor. Also, for cash flow estimations various assumptions need to be made (inflation factor, expected selling price and harvest volume). Those assumptions affect cash flow estimations. In case of errors - an estimation in its definition is not be the same as the actual outcome - the difference to reality is less severe for a Brownfield project than in case of a Greenfield project, where initial assumptions have a higher compounding effect and thus can lead to bigger variation from reality.
Conclusion
From a risk point of view it might be smarter to be invested in a plantation at older age. Several previously unknown variables become more clear, the investment period is shorter and the risks should be reduced. However, this approach requires more due diligence and close attention to the price to be paid.
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