Weyerhaeuser Co. (NYSE:WY) moved higher the last few days after Franklin Mutual Advisers, a 7.6% holder in the company, increased its pressure on Weyerhaeuser to convert itself from a C-corp to a Real Estate Investment Trust (REIT). According to the hedge fund, the move would enable the company to avoid unnecessary double taxation along with a host of other disadvantages to running the company as a C corporation as opposed to a REIT. As a result, the company could save as much as $24 per share in value that would be lost between now and 2010.

Franklin submitted their full proposal today in a 13D/A filing with the SEC:

"Franklin Mutual Advisers (FMA) owns approximately 18 million shares of Weyerhaeuser stock and has been a 13-d filer on the company since April 2005. We acknowledge the positive steps the company has taken over this period to restructure the business, including the sale of the Fine Paper business that is scheduled to close during the first quarter of 2007.

However, FMA continues to believe that the share price of Weyerhaeuser reflects a substantial discount to the intrinsic value of its underlying assets and core businesses. While the restructuring actions taken to date have been rational and objective, we believe the management and board of directors of Weyerhaeuser must act with an increased sense of urgency and accelerate its efforts to enhance and crystallize this intrinsic value for the benefit of all shareholders.

These steps include (1) a corporate reorganization that will eliminate the tax disadvantages of owning timber properties in a C corporation and (2) accelerating the time frame for the planned restructuring of the containerboard business.

Despite the best efforts of the company and other similarly situated entities, it now appears that the tax law will continue to favor holding timber properties in entities such as Timber Investment Management Organizations (TIMOs) or Real Estate Investment Trusts (REITs). The structural disadvantages to Weyerhaeuser include the inability to competitively bid on timberlands undergoing a sale process, a higher weighted average cost of capital and the full double taxation of timberland generated earnings. According to a recent report from one major Wall Street analyst, by 2010 the current structure, as opposed to a REIT structure, would destroy an incremental $24 per share of shareholder value, or nearly 35% of today’s equity value. FMA strongly believes Weyerhaeuser must immediately take steps to eliminate this disadvantage, including possibly converting the current corporate structure to a REIT.

Many paper and forest product companies such as Rayonier, Potlatch, Georgia Pacific, International Paper and the former Boise Cascade have become more competitive, realized substantial operating benefits and experienced significant share price appreciation by either converting to a REIT or by selling their timberlands. For example, since becoming a REIT in January, 2004, Rayonier produced (according to Bloomberg) an annual equivalent return (including reinvestment of dividends) of 20.4% through 12/12/06. Potlatch has produced (according to Bloomberg) an annual equivalent return (including reinvestment of dividends) of 25.3% through 12/12/06 since becoming a REIT in January, 2006. In contrast, Weyerhaeuser has generated (according to Bloomberg) an annual equivalent return (including reinvestment of dividends) of 3.9% since January, 2004. While we are not today suggesting that Weyerhaeuser divest its timberlands, we are strongly suggesting that the Company must modify its corporate structure to become more efficient vis-à-vis the REIT structure. FMA believes that this step, along with the closing on the sale of the Fine Paper business and executing and accelerating the current restructuring plans in the containerboard business, will enhance shareholder value over the long-term." (Read More)

Weyerhaeuser immediately responded in a subsequent 8-K filing with the SEC, citing uncertainties surrounding current legislation as their reason for hesitation. The 8-K filing also noted several other actions that the company has taken to actively unlock shareholder value:

"Weyerhaeuser’s Board of Directors and management are firmly committed to improving the company’s financial performance and enhancing shareholder value. Our ongoing review of options to create additional value has included a detailed analysis of the benefits, complexities, and risks of various alternative structures. That review has led us to the determination that the most value creating alternative would be equitable tax treatment for C-corp. timberlands owners. We will continue to actively support the industry initiative for tax legislation, however, in light of the uncertainties surrounding a legislative remedy we are now revisiting alternatives.

As you note, during the last 18 months we have taken action to restructure Weyerhaeuser’s operations to create value for shareholders. In August 2006, we announced a definitive agreement to combine our Fine Paper business and related assets with Domtar. The transaction will give Weyerhaeuser shareholders 55 percent ownership in the new company, which will be the North American market leader in fine paper, and includes a $1.35 billion cash payment to Weyerhaeuser. The transaction with Domtar will provide Weyerhaeuser shareholders with the opportunity to participate in the benefits of owning the combined company. This compelling combination is expected to be tax-free for Weyerhaeuser and its shareholders and is on-track to close in the first quarter of 2007.

With regard to the Containerboard Packaging restructuring, the benefits of increased customer service and more efficient asset utilization are already being realized. Upon completion of the restructuring, we expect to achieve substantial earnings improvements. We share your sense of urgency and are committed to completing the restructuring of these operations in the shortest time possible.

In addition to the actions discussed above, we strategically grew our real estate business through the acquisition of Maracay Homes to give us access to the high-growth markets of Phoenix and Tucson, and expanded existing real estate operations into the Portland, Oregon and Sacramento markets. We are also growing our timberlands in South America and we have begun a process of constructing converting facilities.

The Board has demonstrated a strong commitment to returning value to shareholders. Over the last 18 months, we have increased Weyerhaeuser’s annual dividend twice to $2.40 per share, an increase of 50 percent. We have also continued to aggressively execute on Weyerhaeuser’s 18 million share repurchase program." (Read More)

While the company has a very competent management team that is actively increasing shareholder value, Franklin's recommendations becoming public only increase the pressure on the company to institute new restructuring plans aimed at unlocking shareholder value. This pressure has already materialized in Weyerhaeuser's announcement late Thursday that it will revamp its lumber operations in Washington to be more competitive. Many analysts are also excited by the value potential of the C-corp to REIT proposal along with other structural changes, which caused a series of upgrades lately by USB and others. This long-term value potential makes WY a stock worth watching!

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