A Costly Payday for Weyerhaeuser Shareholders?

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The Mutual Series Group owned more than 14 million shares, or more than 6.8 percent of Weyerhaeuser's total shares outstanding, in its mutual funds as of Mar. 31, 2010. Segal and Peter Langerman, chief executive of the Mutual Series Group, said they see REIT conversion as the right move at this time.

Before Tax Cuts Expire

Institutional investors have been clamoring for Weyerhaeuser to become a REIT since 2007, when the company's accumulated earnings and profits, which are required to be distributed as the special dividend, were significantly higher than today, says Morningstar's Rohr. The company told shareholders last year that it planned to complete the conversion by the end of 2010, presumably to beat the anticipated expiration of the Bush Administration's tax cuts slated for Dec. 31, 2010. But Weyerhaeuser may well have delayed the conversion as long as possible in order to reduce the accumulated earnings and profits, he says.

"With all the losses that the wood products business has been generating, it can use those losses to offset the accumulated profits and earnings, which ultimately results in a less onerous tax bill for your shareholders," he says. The company's homebuilding business has also taken some big hits due to the prolonged housing market downturn.

The company posted a net loss of $545 million, or $2.58 per share, in 2009, following a net loss of $1.2 billion, or $5.57 per share, in 2008. The weakness has been reflected in the stock price, with the shares bouncing 43.3 percent in 2009 after a 55.4 percent decline in 2008. After the special dividend was announced, the shares shot 8.4 percent higher, to close at $38.86 on July 12.

Restructuring Its Basic Business

Langerman attributes the stock's underperformance in the past two years to a public perception that the company has a high exposure to the weak homebuilding industry, with the value of its timber assets not being fully appreciated. But the company has restructured its timber business by increasing its productivity and reducing the cash burn in its lumber business, selling its container board business to International Paper (IP) and exiting the uncoated copy paper business.

On the July 12 conference call, Weyerhaeuser's chief executive, Dan Fulton, tried to make the case that the company will continue to be regarded as a growth play after becoming a REIT, but that's a hard case to make. Turning over 90 percent of its taxable income to shareholders leaves just 10 percent to be reinvested in the company or put toward buying additional properties. That dramatically limits your flexibility in retaining cash flow to expand your business, says Brett Johnson, chief investment officer at fund company Grubb & Ellis. But in return for limited growth, shareholders are getting a much more reliable income stream in the future, he says.

Although Johnson hasn't made a list of land-rich natural resource companies that are potential REIT candidates, he says he doubts there are any outside the timber industry. The reason that no oil and natural gas producers, or mining companies—some of which have extensive land assets—have ever converted to a REIT, he suspects, is that none has a big enough percentage of its income coming from its real estate assets to meet the qualifying tax criteria.

Over time, there's been a rising correlation between the performance of the REIT market and financial stocks and between REITs and the Standard & Poor's 500 index, says Johnson. He hopes the high dividend income from REITs will create a different pool of investors, one willing to look past the stocks' volatility and value them more for their consistent income stream.

Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.

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