Description

Keweenaw Land Association (KEWL:OTC)

Executive Summary

Keweenaw Land Association is an under-valued company which owns timberlands with significant mineral resources in the Upper Peninsula of Michigan and Wisconsin; the current market cap is $113M (~1.3M shares outstanding) versus an appraisal of the timberlands of $139-169M which excludes mineral rights and potential carbon credit benefits.  The Company, incorporated in Michigan trades on OTC Pink Sheets and is fairly illiquid with insignificant trading volume.  It would be suitable for personal accounts or smaller funds.

Information about the company can be obtained at their website:  http://www.keweenaw.com/

The Company whose origin dates back to 1865, is a natural resource company committed to the long term management of its forest resources.  The land was initially bought by several wealthy Boston families several generations ago and is still controlled by the Ayer Family through a family trust with former-CEO David Ayer serving as Chairman of the Board and the majority of the board having served for 20+ years; the Ayer family and board members own over 30% of the company.  Cornwall Capital owns a 27% stake and is currently on the Board.

We believe the asset is highly mismanaged, under-producing, under-earning and undervalued relative to its market price.  We believe that the catalyst for value unlocking would be a sale of the company to a timber investment management organization (“TIMO”).   A TIMO would be better suited to maximize the value of the land.  There has been significant interest in recent sales from high net worth individuals per the Sewall appraisal (see below) which include wealthy overseas families looking to buy real assets and diversify away from their domestic holdings.    

We believe in the downside case that management would be pressured to make more efficient use of the land – by altering the operation in order to fully utilize the asset.  We would expect investors in the stock to push for some sort of liquidity event.  

We believe that the Company could be worth as much as $140 per share in the base case and potentially as high as $170 in the upside case in a sale through a competitive auction representing a return of 55-88%.  Further, from numerous conversations with shareholders we believe that a sale of the asset is inevitable and even if there aren’t immediate catalysts, the investment by itself appears to have attractive upside/downside returns.  The downside to this investment is that the Company does not have material cash flow and as such this could be “dead money” for some time.  

Company Overview

• Owns 168K acres of fee timberland, 402K acres of severed & attached mineral rights and 1,700 surface acres which includes 4 miles of Lake Superior frontage and 30 miles of major river frontage

• Annual harvest of over 79,000 cords per year

• 2,500 acres of commercial recreational & city property

• Timberlands are currently managed in a sustainable manner with the goal of maximizing long term value but appear to be sustainably under-forested and have the following species by acre:

• Mineral lease agreement with Highland Copper which includes an annual fee + royalty stream which is actively being developed; dates for extraction to begin are not known.  In 2015 there were three mineral leases on KEWL property encompassing approximately 11,662 acres (out of over 400k acres of mineral rights).  There is an option for a lease on additional land (Satellite) and the minerals discovered are:

Source: Highland Copper website

The mineral rights are leased to Highland Copper for an annual fee of $10-90K / year depending on the year of the contract.  Once production begins (although it is under no obligation to do so), Highland will pay a smelter-royalty of 2-4% with credit for prior lease payments which could be worth ~$60M (2%*69.6Mt*$2.15) at the current copper price assuming mining of all measured & inferred copper for both Copperwood & Satellites; this value would significantly increase if copper prices would rise as the royalty would increase to 4% if prices were above $4 / pound (versus the current price of $2.15).  The silver royalty rate is not listed in the report we reviewed but assuming a similar royalty structure, it would be worth up to an additional $8.7M (4%*11Moz*$19.88) at the current price.  The 2015 annual report holds mineral rights on its balance sheet based on fair value analysis at $5.3M clearly a disconnect with intrinsic value.

Appraisal Summary (conducted by James W. Sewall Company)

The scope of the appraisal was to provide an estimate of 168K acres in northern Michigan and Wisconsin.  The appraisal used several methodologies to get to an estimate of $151M ($901 / acre) with a market value range of $139-169M.

Sales Comparison Approach used the below table of comps and got to a value of $158M ($943 / acre).

Income Capitalization Approach is a DCF which assumes responsible ownership by a TIMO or REIT with a hold period of 10 years and a 5.5% discount rate.  Income is assumed to be timber revenue from stumpage sales and sale of HBU properties with costs assumed to be management and property taxes.  The DCF produced a value of $141M ($839 / acre).

Financial Performance Summary

KEWL generates the majority revenues from sale of logs harvested from their forestland and from recreational leases, mineral rights leases, sales of sand and gravel, and by providing wood scaling and inventory management services for various customers.

Stock Ownership

 We believe that 40% of the holdings would be friendly to push for a sale while 26% would not be in favor of a sale of the company. 

Corporate Governance

7 directors with staggered election consisting of

• David Ayer, Director, Director and Chairman of the Board

• Brian D. Glodowski, Director, Chief Executive Officer, President, and Secretary

• John E. Earhart, Director

• Donald J. Hoffman, Director

• James A. Mai, Director

• Marjorie E. Nesbitt, Director

• Frederick J. Weyerhaeuser, Director

• James J. Simmons, Jr., Controller and Treasurer

The Company has 2 directors up for election – David Ayer and Don Hoffman both elected in 2014 for a 3 year term. The annual meeting in 2017 is expected to take place in May 2017.  Per Section 2.5 of the Company Bylaws notice must be given to the Company no later than 150 days before a date that is one year after the last annual meeting (which took place May 2, 2016).   Any registered holder can nominate anyone to be on the Board as simple as sending a letter to the Company.   The Company has an internal nominating committee. Any dissident slate will need to solicit their own proxies at the annual meeting.  

Company History

Keweenaw Land Association, Limited traces its origins to the period immediately following the Civil War and the construction of the ship canal across the Keweenaw Peninsula of Upper Michigan by the Portage Lake & Lake Superior Ship-Canal Company. A land grant by the 38th Congress was promised to the company completing the canal. After experiencing financial difficulties in completing the canal, the assets of the Portage Lake & Lake Superior Ship-Canal Company, including 400,000 acres of land grant properties in the Upper Peninsula of Michigan, were purchased by the financiers of the original project, and the Lake Superior Ship Canal Railway and Iron Company was formed. In 1891, the LSSCR&I Co sold the completed ship canal to the U.S. government, and the remainder of the assets, including the 400,000 acres of land, was transferred to the company’s successor, the Keweenaw Association, Limited. That company was reorganized in 1908, and Keweenaw Land Association, Limited came into existence as a Michigan partnership association. Keweenaw was reorganized again in 1999 as a Michigan corporation. Since the 1908 reorganization, Keweenaw has been managed both passively and actively, receiving timber stumpage and mineral royalty income. During the World Wars, Keweenaw timber properties were harvested heavily for war needs. In the early 1950’s, Keweenaw began to manage its timber assets by practicing sustainable forestry in order to maximize the value of its timberland assets over the long term. The current and more proactive operating management commenced in 1992. The company’s forest management practices have been audited and certified by the Forest Stewardship Council since 1994.

Valuation

It is our thesis that book value is significantly understated.  See below for valuation analysis. The following table comes from the 2015 Annual Report and is a summary of land, timber and mineral holdings less depreciation.

Risks

1. Inability to force change within the company

Mitigant:  it is our belief that shareholders are motivated to sell and could pressure management and the Board to make tough decisions.

2. Inability to acquire a meaningful sized position / Illiquidity

Mitigant:  our understanding is that there are enough shares available per our conversations with brokers.   It is unclear whether we one can acquire a meaningful position for their fund.   While the illiquidity could make selling the position difficult we believe the fundamental asset will retain value.

Other Risks

• Dead money – could take longer than expected for the Company to be sold or transformed in order to maximize value

• Deflation and lack of interest in real assets

• Housing market decline

• Negative volatility in timber prices

Exhibit 1: 2Q2016 Financial Statements

Exhibit 2: Map of Land Holdings

Catalyst

We believe the asset is highly mismanaged, under-producing, under-earning and undervalued relative to its market price.  We believe that the catalyst for value unlocking would be a sale of the company to a timber investment management organization (“TIMO”).   A TIMO would be better suited to maximize the value of the land.  There has been significant interest in recent sales from high net worth individuals per the Sewall appraisal (see below) which include wealthy overseas families looking to buy real assets and diversify away from their domestic holdings.    

We believe in the downside case that management would be pressured to make more efficient use of the land – by altering the operation in order to fully utilize the asset.  We would expect investors in the stock to push for some sort of liquidity event.  

We believe that the Company could be worth as much as $140 per share in the base case and potentially as high as $170 in the upside case in a sale through a competitive auction representing a return of 55-88%.  Further, from numerous conversations with shareholders we believe that a sale of the asset is inevitable and even if there aren’t immediate catalysts, the investment by itself appears to have attractive upside/downside returns.  The downside to this investment is that the Company does not have material cash flow and as such this could be “dead money” for some time.