Overseas Discount Rates and Multi-Dimensional Timberland Investment Strategies

23 09 2012

This post includes summary comments from Brooks Mendell’s presentation “Evaluating Overseas Timberland Investments and Discount Rates” given on September 20th, 2012 in Portland, Oregon at Who Will Own the Forest?

Like NFL quarterbacks with respect to winning and losing football games, discount rates get a disproportionate level of credit and criticism with respect to the success and failure of timberland investments and valuations.  While simple math tells us that changing discount rates alters significantly the results of any valuation model, basic finance and market analysis remind us that client objectives, timeframes and risk tolerance actually dictate investment strategies when attempting to acquire – and to value – timberland assets.  This is especially true when evaluating international timberland investment opportunities.

Previous research (e.g. Mendell, Sydor and Lang. 2011. “U.S. Investor Perspectives of International Timberland Investments and Colombia” published in International Forestry Review) and investment due diligence efforts highlight the dimensions of client-specific experience and risk tolerance in developing investment strategies and discount rate assumptions.  In short, the “comfort” of clients and their asset managers with doing business in a given country can be more important than the availability and quality of available forestry assets in that country.

The dimensions of relative client experience and risk tolerance can manifest themselves directly in the estimating of risk-adjusted discount rates for overseas timberland investment.  Investors commonly “build-up” discount rates to account for a range of asset and market-specific issues.  For example, the relevant layers can include:

  • Base hurdle rate required by the fund or firm;
  • Country risk to account for regulatory or political concerns;
  • Market risk specific to the wood/forest industry specific issues in the country/region;
  • Firm/client risk to account for client comfort, execution concerns and “greenfield” investments.

Multiple approaches or assumptions can address each of these layers.  [The figure above includes examples of building up discount rates, along with an example of accounting for multiple client-specific dimensions over time for investments in a market such as Colombia.] A starting point for country risk can be the spread between ten-year US treasuries and long-term bonds of the foreign country.  Approaches to market risk vary by country and investment vehicle.  In addition, firm/client risk can change over time.  For example, investors can use a higher discount rate in the early years of a first, greenfield investment to account for the initial establishment and execution risk, and then apply a normalized discount rate for the duration of this and other investments in the country.

Timber markets are uniquely local and local experience is hard-earned.  Due diligence work for international timberland investments require the quantification of these realities in valuation models and investment timelines.

To learn more about Forisk’s screening of global wood and timberland markets, contact Brooks Mendell at bmendell@forisk.com, 770.725.8447. For a copy of the Mendell et al 2011 article “U.S. Investor Perspectives of International Timberland Investments and Colombia”, email Heather Clark at hclark@forisk.com

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