Description

Shares Outstanding - Common 6,527,671
Shares Outstanding - Preferred 669,355
Shares Outstanding – Total 7,197,026
Price @ 2/24/02 $11.80
Equity Market Value $84,924,907
Long Term Debt (holding co.) $71,000,000
Less: Cash (holding co.) ($111,000,000)
Enterprise Value $44,924,907

Maxxam represents an unusually favorable risk/reward opportunity to the contrarian value investor. Maxxam is a Houston based holding company whose business units include harvesting its 200,000 acres of northern California timberlands, owning and developing real estate, and aluminum manufacturing. Maxxam and its CEO, Charles Hurwitz, seem to cause a rolling of the eyes among people everywhere, just at the mere mention of their name!

The shares have declined from the $60 range three years ago and have recently fallen from $17 to $11.80 due to the bankruptcy of one of Maxxam’s subsidiaries, Kaiser Aluminum Corporation. Notwithstanding the erosion of intrinsic value due to Kaiser’s problems, Maxxam remains an asset rich company worth well more than it’s current trading price.

The common response to a proposed purchase of MXM shares is: “of course it’s cheap but it always has been and always will be…”. This perception, combined with the “Hurwitz factor” and the low level of liquidity in the shares has created a security, which has a large margin of safety and potential catalyst. The summary and conclusion first, with reasons for large discount to follow.

Maxxam’s intrinsic value is approximately $50 per share while its trading price is just under $10 per share. The intrinsic value is comprised as follows:

Estimated
Note Per share
Cash (net of debt) $5.50
Real Estate (approx. book value) (1) $22.00
Forest Products (est. fair market value) (2) $21.00
Kaiser Aluminum Corp. (KLU – NYSE) (3) $1.80
Total $50.30


(1) Maxxam invests in and develops commercial real estate primarily in Puerto Rico, Arizona, and California. The company owns 1,293 acres and resort facilities at Palmas Del Mar in Puerto Rico; 1,763 acres and 94 developed lots in Fountain Hills, Arizona (Scottsdale area); and 57 acres and 69 developed lots in Rancho Mirage, California (Palm Springs area). Additionally, the company owns 1,253 acres and 85 developed lots in other locations in Arizona, New Mexico, and Texas; and has two joint venture investments as well. The book value of the real estate properties at 12/31/00 was $157 million, or $22 per share. The company believes the current fair market value of the property equals or exceeds the book value.

(2) The Forest Products operations are conducted primarily through a wholly owned subsidiary, Pacific Lumber Company. Pacific Lumber, which has been in continuous operation for over 130 years grows and harvests redwood and Douglas-fir timber and mills logs into lumber and other finished products. Pacific Lumber owns and manages over 200,000 acres of contiguous timberlands in Humboldt County along the northern California coast. The timberlands are 67% redwood, 26% Douglas-fir and 7% other.


The following chart summarizes the forest products operations:
Proj. Est.
(millions) 2002 2001 2000 1999 1998 1997 1996
Board Ft.
Harvested 190 175 150 100 160 250 250
Revenues 210 185 200 188 234 287 264
EBITDA 65 12 27 13 63 111 100

It should be noted that in March 1999, the company executed a landmark 50 year agreement with the federal and California governments whereby the parties agreed to certain permitted harvest levels and habitat conservation procedures. This agreement, which took years to negotiate, disrupted the company’s harvest levels significantly. Because of difficulties in implementation of the agreements between the various agencies, it has taken three years for Pacific Lumber’s harvest levels to achieve those contemplated in the agreements. Recently, the company indicated that its run rate harvest is approaching its target of 200 million board feet per year. During the past few years, the company has had to purchase timber, rather than harvest timber, in order to meet its sales requirements. Such purchases are costly and erode margins quickly. For 2002, due to increased harvests, lower costs, and firmer lumber pricing, the company expects to achieve significantly higher cash flow than 2001.

When valuing the forest products operations, one should look at both cash flow as well as price per acre. Valuing the 215,000 acres the company owns at the industry average $5,000 per acre (for this type of timberland) yields a gross value of $1.1 billion. This compares to a recent appraised value of $1.2 billion. With net debt of $650 million, a $1.1 billion valuation would equate to an equity value of $450 million or $63 per share.

Looked at from a cash flow perspective, and giving the company credit for what it believes is a normalized cash flow number of $80 million, an 10 multiple would provide a gross value of $800 million, or equity of $150 million, or $21 per share. Keep in mind that Pacific Lumber’s timberlands are very high quality species, and that such timberlands are a naturally growing asset.

I have assumed the more conservative valuation of $21 per share.

(3) Kaiser Aluminum (KLU – NYSE) shares have been valued at their current market price of $0.26. Maxxam owns 50 million shares which equates to a per share value for Maxxam of $1.80.
How is it possible for such a company with $50 per share of net assets to trade at $11.80?

A full history of the answer would be too lengthy for this letter, but the main reasons are as follows, with mitigating commentary:

1. Charles Hurwitz is seen by many as a corporate raider who cares only about his own interests and not those of his fellow shareholders.

I believe there is some element of truth to this, however, Hurwitz owns over 36% of the company (note that Hurwitz controls the company with approximately 70% of the voting shares through his 100% ownership of the preferred stock) and has seen the stock market value of his holdings go from $160 million to $28 million today. During this time, Hurwitz has not enriched himself with salary, options, etc. In fact, the company has continuously repurchased stock in the open market, with such purchases exceeding two million shares over the past five years. The company has also recently been purchasing its own debt (holding company debt) in the low 80’s. Hurwitz has much of his net worth tied up in his MXM shares.

2. The company is heavily leveraged and one of its main assets, Kaiser Aluminum just filed for bankruptcy protection under Chapter 11.

Kaiser’s debt is non-recourse to Maxxam, as is the debt of Pacific Lumber Co. All of Maxxam’s recourse debt at the holding company level has been subtracted from the cash in the above chart. Kaiser Aluminum’s bankruptcy has decreased the intrinsic value of MXM from $85 to $60.

3. Maxxam is somehow exposed to the asbestos claims made against Kaiser Aluminum.

This is false and the notion is inconsistent with United States corporate law. Kaiser is a public company owned 63% by Maxxam and 37% by the public. Although Maxxam consolidates Kaiser’s operations in its financial statements, Kaiser is a subsidiary of Maxxam and has its own assets and liabilities. Subsidiaries are incorporated for this very reason; to create a “corporate veil” between parent and subsidiary. Since the actions creating the asbestos liabilities occurred many years before Maxxam’s ownership, one could not (and has not) assert that Maxxam somehow spun off Kaiser to avoid such liabilities. Maxxam has not been named as a defendant in any asbestos litigation. I have discussed this issue with the company and an attorney knowledgeable in asbestos cases.

4. Maxxam has exposure to the FDIC litigation concerning a failed Texas savings and loan in the late 1980’s.

Actually, in June 2001, the U.S. House of Representatives Committee on Resources recommended that the FDIC drop its case against Maxxam and Hurwitz. We believe the case will be officially dismissed in the near term.

5. Pacific Lumber is also highly leveraged, and like Kaiser, could be forced into bankruptcy.

This is true and as shown above, Maxxam’s valuation is highly sensitive to the value of its forest products division, Pacific Lumber Co. I have had the timberlands appraised and am comfortable with the value based on cash flow and on acreage/yield. The lumber company has struggled the last few years as it has had difficulty with the State of California honoring a federal agreement entered into in 1999 regarding permitted annual harvests. Recently, however, Pacific Lumber has made solid progress with California on increasing the run rate of harvested board feet. The value for Pacific Lumber shown in the above chart is net of lumber level debt. In a worst-case scenario, one would recoup more than today’s price of $10 even without Pacific Lumber Co.

Catalyst

I believe that Hurwitz has become fatigued battling a poor public perception and a falling share price. He was hard-pressed to take the company private or sell large assets in the face of the government litigation, which is now essentially (but not officially) resolved. Second, there were many problems at Kaiser Aluminum as it was fighting to avoid Chapter 11. With both of these issues resolved (albeit one unfavorably), I believe we shareholders are within striking distance of an extraordinary corporate event. Is it possible Hurwitz tries to take the company private “on the cheap”? Of course it is. However, with the shares at $11.800, one is likely to make good money in such an event. With a large margin of safety and possibly explosive upside, I recommend purchase of MXM .