VALUING a company is not easy. Especially a company like United Fiber System (UFS), which has had many false starts and is yet to generate a steady flow of income. To compound the situation, there are many if's: a deal may go through, it may not; one may have got in-principle approval from the government but is awaiting official approval.

The permutations are mind-boggling. So it takes a brave analyst to come up with a value.

Back in August 2004, all UFS had was its construction business - formerly Poh Lian - and a forest concession in Kalimantan. And even then, the concession was the subject of a dispute between the company and the Indonesian government. UFS also had plans to build a wood chip plant and pulp mill, to be funded by debt.

What's happening: The appointment of Jaka Prasetya, Deutsche Bank's Indonesian head of equities, as chief executive is one of the developments at UFS in the past years

Based on that concept, DBS Vickers initiated coverage of the stock with a target price of 26.5 cents, giving UFS a market capitalisation of $480 million. At the time, the stock was trading at 16.5 cents.

'UFS is poised to take a giant step into the lucrative US$100 billion-a-year pulp and paper industry, armed with a forest concession area about four times the size of Singapore,' DBS Vickers said. 'The concession guarantees the long-term supply of low-cost raw material to its 600,000 tonne per year bleached hardwood Kraft pulp mill.'

However, it cautioned that because the pulp mill was expected to be completed only in mid-2007, the execution risk remained high at that point in time. This was reflected in the hefty discount to DBS Vickers' discounted cashflow valuation of the stock. Without the discount, it reckoned the stock was worth 92 cents.

Punters in Singapore were fired up. By mid-March 2005, UFS shares reached 39.5 cents - more than exceeding DBS Vickers' target. The market cap was $715 million.

The broking firm then issued another report - this time raising the target price to 54.5 cents, for a market cap of $987 million. The reasoning was that UFS had received a letter from the Indonesian authorities indicating their willingness to settle the legal dispute over the forest concession.

'This is positive news as it not only dispels doubts over the ownership status of the forest concession, but also increases the likelihood of the pulp mill project taking off,' DBS Vickers said.

The pulp mill was to start operating in 2008. But as of today, construction is yet to start. A contract has been signed with China National Machinery & Equipment Import and Export Corporation (CMEC) as the turnkey contractor. CMEC will also finance 80 per cent of the US$863 million project.

But UFS officials say China's State Council is yet to give the green light. 'The in-principle approval has been given, we just need the final stamp,' said one.

In the meantime, UFS has tried to take over existing pulp mill Kiani Kertas. But this too has run into numerous obstacles, and whether it will go through is unknown. And even if UFS managed to buy Kiani Kertas, a big overhaul would have to be done to the plant's machinery to restore it to working condition.

The wildly speculative nature of trading in UFS shares two years ago - it went from 16 cents in December 2004 to 54.5 cents by April 2005, and then plunged 40 per cent in two hours on April 18, 2005 - prompted many broking firms to impose trading curbs on the counter. Many of the curbs remain today.

But a few things did happen in the last three years.

One, the company's US$45 million woodchip plant - also built and part-financed by CMEC - is completed and has received a certificate of operation test acceptance (Cota).

Two, the construction business under Poh Lian is in an upturn.

Three, UFS's acacia mangium trees have grown.

And four, the company has a new chief executive - Deutsche Bank's Indonesian head of equities Jaka Prasetya - to drive it.

This recent progress has tempted two analysts to put a value on UFS. In November last year, DMG & Partners initiated coverage of the stock with a 12-month target of 44 cents. This week, it raised that to 52 cents after it was announced that UFS received the Cota for its woodchip mill.

In January, Westcomb Financial Group made a 'buy' call and pegged UFS's fair value at 68 cents apiece.

Macro view

There is no denying that, based on the big picture, the business makes sense. The economic development of China and India will increase demand for paper and board products. It is estimated that by 2015, China's consumption of paper and board products will almost double to nearly 92 million tonnes, from 54 million tonnes now. And India's demand is expected to surge to nearly 13 million tonnes, from about eight million tonnes now.

For the whole of Asia, 180 million tonnes of paper is required by 2015, up from 120 million tonnes last year.

And tropical countries have a competitive advantage in producing the raw material for paper - that is, wood. In the words of Sukanto Tanoto, Indonesia's richest man, as reported by Forbes: 'The Scandinavians grow trees for their grandchildren, Americans grow them for their children. Here in Indonesia, you grow trees for yourself.'

That's because trees take about 60 years to mature in the cold European climate, about 25 to 30 years on American soil, and only six to seven years in Indonesia.

Mr Tanoto made his fortune from Asia Pacific Resources International, one of Asia's biggest pulp and paper companies.

The future looks rosy, according to him. 'I looked at China, India, two billion people at that time - half the world's population. When they become economically developed and need paper resources, where are the trees going to come from?' Indonesia with its vast lands, warm weather and large work force would be ideal for the business, he said.

So if UFS can deliver on its plans, it could be a very lucrative business - its relatively small size vis-a-vis other pulp and paper companies notwithstanding.

The problem is its history of promising too much and delivering too little so far.

However, any investment is about price. So let's look at what has been factored into UFS's current share price and what hasn't.

As of yesterday, the company had a market capitalisation of $635 million or 1.7 times the book value of its equity.

Of its assets, US$226.2 million or $357 million were represented by forest assets. According to Mr Prasetya, UFS has planted the acacia trees on 80,000 ha of land and the trees average 10 years old today.

Planting stopped because the company ran out of funds. It restarted in October last year when 10,000 ha was planted. Between October 2007 and April 2008, a further 15,000 to 20,000 ha will be planted.

In total, about 130,000 ha of the concession area is suitable for planting.

Independent valuer Poyry Forest Industry Consulting valued the trees at US$226.2 million as of Dec 31, 2006. That is the value that UFS is expected to get based on the latest market price for the trees, net of cutting and transport costs.

This part of the asset of course is not generating any cash flow yet.

As for UFS's woodchip mill, Mr Prasetya is aiming for output of 350,000 tonnes this year. Assuming a selling price of US$160 a tonne, and production and wood costs of US$70 and $30 a tonne each, UFS is looking at earnings before interest, tax, depreciation and amortisation of about US$20 million this year. After accounting for interest, depreciation and taxes, UFS may be able to chalk up a net profit of just under US$12 million or about $18 million.

Meanwhile, its construction business has an order book of about $150 million and is in the running for another $150 million of projects. Assuming it is able to complete $150 million at a net profit margin of 5 per cent, that will rake in $7.5 million net earnings.

So excluding the forest asset, UFS's other businesses are trading at about 11 times earnings this year, and possibly just over seven times next year's earnings after accounting for the full year's production for the woodchip mill and some growth for its construction business.

From this perspective, the numbers do no look excessive. But as mentioned, investors have been disappointed too many times before. Unless and until they see that cash is being generated in the business, the 'discount' seems fair.

At the moment, UFS is at best a contrarian play. And as with all contrarian plays, the wait can be long and excruciating. But if and when things do turn around, the reward can be tremendous. UFS is definitely not a stock you should sell your house to buy. But for those itching for a thrill ride, it may be worth a small bet, just like Asia Food and Properties (AFP) or Golden Agri four or five years ago. There is, of course, no guarantee that the outcome will be as good as that of AFP or Golden Agri, four or five years on.

《Business Times》