SOURCE: Parish & Company at www.billparish.com.
Enron Lessons for Weyerhaeuser, Willamette Industries, the SEC and Arthur Andersen
PORTLAND, Ore., January 24, 2002 The recent collapse of the Enron Corporation highlights the importance of supporting companies with financial integrity and these companies include Willamette Industries. Three areas of significant concern at Enron are merger accounting, pension abuse and conflicts of interest between auditor's and their clients. All three of these issues also converge at Weyerhaueser who, like Enron, uses Arthur Andersen as its auditor. Remarkably, the business press has extolled the benefits of such a merger.
Also noteworthy is the powerful role of Institutional Shareholder Services (ISS), a subsidiary of Thomson financial. Thomson, a publicly traded Canadian firm, makes most of its revenues selling investment products to investment bankers. Most large mutual funds vote their proxies based upon ISS's recommendation and it is most unusual that the SEC has not conducted a full review of ISS given their role regarding major mergers of US based corporations. ISS's investment banking customers push for such mergers in order to generate bond underwriting fees, which could exceed $250 million at Weyerhaeuser.
The SEC might also contact James Burton, CEO of Calpers, and inquire why he issued a press release pressuring Willamette to accept Weyerhaueser's hostile takeover proposal when Calpers investment is tiny in relation to its overall portfolio. Two years ago I alerted another major California public pension system, the State Teachers Retirement System of California (STRS), regarding significant fraud at the Microsoft Corporation and how it would cost the teachers of California and Calpers more than a half a billion dollars of their pensions. The reply I received from CEO James Mosman was a nice letter indicating that the system trusted its advisors. Sadly, the loss was incurred.
Calpers advisors include PricewaterhouseCoopers, a large accounting firm, that also audits Institutional Shareholder Services and Weyerhaeuser's largest shareholder, Capital Research and Management Group.
Calpers other audit firm, Deloitte and Touche, also audits the Microsoft Corporation. It is also noteworthy that Microsoft's former Chief Operating Officer, Bob Herbold, is on the board of directors of Weyerhaeuser. At Microsoft from 1995-2000, even the CFO reported to Herbold.
Even though this takeover is a spectacular financial fraud upon Willamette shareholders, who loose a good long term investment, and Weyerhauser shareholders, who will be left with an overleveraged balance sheet, Willamette management had little choice but to agree due to the roles played by ISS and Calpers.
This is also a tragedy for the accounting community as it will be furthur demonized in the future for allowing such mergers to occur based upon financial fraud and rampant conflicts of interest. Weyerhaeuser's CEO is using a Chainsaw Al like strategy. Chainsaw Al is the former CEO of Sunbeam, a company also audited by Arthur Andersen which later collapsed
This report examines Weyerhauser's hostile takeover of Willamette Industries and these three key areas of concern regarding financial reporting practices. This will include recognizing Willamette Industies as a leader in financial integrity for having what accountants would call a "clean" balance sheet. Significant questions are raised regarding Weyerhauser's financial practices based upon SEC filings.
Similar to Enron, Arthur Andersen conducts the audit of Weyerhaeuser in addition to realizing significant consulting fees from the company. A successful takeover also brings Andersen significant new business since Willamette Industries now uses another accounting firm.
Based upon these findings, it is now the official position of Parish & Company, who maintains no financial interest in either company, that Weyerhaeuser's hostile takeover attempt of Willamette is more based upon financial engineering than business fundamentals. The SEC should require Weyerhaeuser to restate its earnings and exclude withdrawals from the employee pension plans that were used to inflate net income, write-off more goodwill from past acquisitions and examine potential conflicts of interest between Institutional Shareholder Services, Calpers and other entities invovled.
In light of the Enron situation, it is also recommended that the SEC examine the activities of Institutional Shareholder Services (ISS), for reasons identified in this report, to verify that no conflicts of interest exist regarding their voting merger proxies. These votes that are generally followed by large mutual fund companies are significant since much of these mutual fund balances are in retirement accounts and fall beneath the ERISA 404C prudent fiduciary guidelines.
Weyerhauser CEO Steve Rogel has declared that it will finance the takeover with the issuance of "investment grade" bonds. If $5 billion in bonds are issued this will generate roughly $250 million in commissions to the firms who underwrite the bond issue. These investment firms all aggressively support the takeover. Three levels of commissions are generated from issuing such bonds and combined they generally exceed five percent. These are the management concession, sellor's concession and finally the broker's commission.
A major lesson from the Enron debacle has been the importance of reviewing potential conflicts of interest between the company, its auditors and investment firms. Such conflicts do exist and are yet to be reported in the media. They are also being ignored by Moody's, Standard and Poors and other bond rating agencies.
One overarching quesiton both investors and securities regulators might ask is the following. Is Weyerhauser using "acquired sales" in addition to manipulating its pension expense via a "cookie jar" approach in an effort to manage earnings and inflate its stock price? Earnings were inflated 11 percent in 1999 and 15 percent in 2000 by such pension adjustments, not yet covered in the media, and more than 24 percent of gross annual revenues at 12/31/2000 were purchased in 1999 and 2000. At Willamette Industries such pension adjustments represent less than one percent of pre-tax income. In addition, sales growth at Willamette is core growth mostly resulting from the existing businesses, as outlined in a recent report, available at www.billparish.com, rather than acquired growth.
Summary of Key Financial Data - Fiscal Year Ended 12/31/2000
|Pension Expense||($193) million||($6) million|
|Pension Adj. NI Impact||14.8 percent increase||1.1 percent increase|
|Debt/Equity Ratio||89 percent||68 percent|
|Acquired Sales Since 1999 - See Assumption||33 percent||none|
Bob Herbold, Microsoft's Chief Operating Officer from 1995-2000, who I believe is a key architect of a pyramid scheme at Microsoft, became a Weyerhaueser board member in 1999. Two previous CFO's, Mike Brown and Greg Maffei, both directly reported to Herbold. At one time Brown was CFO of Microsoft, Chairman of the Board of the Nasdaq stock exchange and along with Herbold publicly boasted about his ability to influence accounting standards. Also noteworthy is Brown firing Microsoft's own internal auditor, his former boss at Deloitte and Touche, who claimed what they were doing constituted securities fraud. This former Deloitte partner and later chief of internal audit at Microsoft was paid a $4 million settlement which included a gag order.
It is surprising that Institutional Shareholder Services supported Weyerhauser's proxy battle in 2001 to place three new member on Willamette's board at its recent annual meeting, one of whom was a recent member of Microsoft's management team. Clearly ISS focus on corporate governance mechanics was not broad enough to see that financial engineering at Weyerhauser should have been addressed. This is another important lesson from the Enron experience.
Weyerhauser is now making a hostile takeover of Willamette Industries when in reality Weyerhaeuser should be vulnerable to a takeover. "Chainsaw Al", who ruined the Sunbeam Corporation, provided a valuable lesson and that is that companies should deserve to make acquisitions based upon outperforming. Rewarding Weyerhauser with the ability to acquire Willamette industries based upon prowess in financial engineering would eliminate what could be an excellent long-term investment, Willamette Industries, and leave Weyerhauser grossly overleveraged.
Many companies, including IBM and Citigroup, have converted their defined benefit pension plans to "cash balance" plans with the specific goal of reducing costs. Cash balance plans are similar to 401K plans in which employees make contributions and the employer is only responsible for an "employer match." Such conversions are controversial and can produce significant one-time increases to net income as surpluses are eliminated.
What Weyerhaeuser is doing is more sophisticated. Rather than convert its plan, Weyerhauser is using the plan as the equivalent of a "cookie jar" to inflate net income. They also appear to be using unrealistic assumptions to justify peeling off significant amounts on an annual basis and thereby inflating pre-tax income, roughly 15 percent in fiscal 2000 and 11 percent in 1999.
We are all familar with the glories of compounding and this works for pensions also. Imagine the impact of Weyerhaeuser assuming a future annual return 2.5 percent greater than Willamette's assumed return and then also assuming 1.75 percent less inflation. If Weyerhaueser does indeed have a surplus of $1.8 billion, Weyerhaeuser could be subject to a takeover itself and this suplus used to finance a large part of the acquisition. Willamette does also have a surplus yet neither it nor related pension adjustments are significant to financial results.
Summary of Key Defined Benefit Pension Data per SEC 10K reports.
|Pension Impact on Income||Weyerhaeuser||Willamette Industries|
|Pension Assets||$4.4 billion||$594 million|
|Pension Obligations||$2.6 billion||$441 million|
|Surplus||$1.8 billion||$153 million|
|Pension Expense YE 12/2000||($193) million||($6) million|
|Income Before Taxes||$1.323 billion||$514 million|
|Pension Adj Impact on Income||14.8 percent increase||1.1 percent increase|
|Expected Return||11.50 percent||9 percent|
|Expected Wage Inflation||3.25 percent||5 percent|
Source: Yahoo Company Profile as of June 15, 2001
|Performance Data||Weyerhaeuser||Willamette Industries|
|Gross Revenues||$15.6 billion||$4.6 billion|
|Operating Margin||8.1 percent||13.4 percent|
|Debt/Equity Ratio||89 percent||68 percent|
|Return on Assets||3.9 percent||6.5 percent|
|CEO Pay||$3.1 million (FY 2000)||$894 thousand (FY 1999)|
|Market Value of Stock||$11.6 billion||$5.35 billion|
Weyerhaeuser will claim that its debt to equity ratio is not 89 percent because that includes debt in their real estate development subsidiary. This of course is ridiculous and in fact real estate debt can often be even more susceptible to economic cycles than a core business. Also not considered in the operating margin comparison are Weyerhauser's pension manipulations and their related impact.
The following table compares Weyerhaeuser and Willamette Industries gross annual revenues for the year ended 12/31/2000. Clearly, Weyerhauser is achieving growth via acquisitions and such transactions provide significant fee benefits to investment bankers and accountants involved in the transactions. More than 24 percent of gross annual revenues at Weyerhaeuser have been acquired since 1999. In Willamette's case there have been various small acquisitions and partnerships established, similar to Weyerhauser, yet none are significant to financial results.
Weyerhauser is claiming that Willamette must merge to survive yet most businesses today would be delighted to maintain Willamett's 13.4 percent operating margins. Willamette is a solid business based upon strong fundamental factors whereas Weyerhaeuser seems to have evolved into a financial scheme more focused on Wall Street bankers than shareholders.
Source: SEC Reports
|Sales Growth Analysis||Weyerhaeuser||Willamette Industries|
|Gross Revenues||$15.6 billion||$4.6 billion|
|Deduct Major Acquired Sales (Firms Representing More Than 5% of Gross Revenues):|
|MacMillan Bloedel-1999 - Stock Purchase Using Pooling Loophole||($2.96) billion|
|TJ International - 2000 - Cash Purchase||($896) million|
|Acquired Sales||($3.856) billion||None|
|Sales Net of Acquired Sales||$11.744 billion||$4.6 billion|
|Acquired Sales - % of Total||24 percent||None|
Perhaps Weyerhauser's strongest asset is its public relations staff. Somehow they lobbied Wall Street into believing that this takeover of Willamette Industries makes sense when it is a sham. Not only will Weyerhauser's shareholders be losers yet also its employees as their pensions are pilfered annually to sustain the scheme.
Parish and Company's message to Weyerhaeusers CEO is simple and sincere - if you cant run the company the way you want, why not retire, take up golf and travel a bit. The only real winners in this situation will be the lawyers, accountants and investment bankers involved who stand to make millions. Meanwhile, long-term shareholders of both companies, along with employees of both firms, and their communities, end up losers. Take a lesson from Chainsaw Al and Bernard Ebbars, step back and focus rather than run Weyerhauser off a cliff with Willamette Industries in the back seat.
Bill Parish of Parish & Company was previously a CPA for Arthur
Andersen in the later 1980's and for the last 7 years has been an independent
Registered Investment Advisor. His work has been widely quoted in
the NY Times, Bloomberg, USA Today and other leading publications and these
reports are available for review at www.billparish.com Bill is a
strong supporter of former SEC Chairman Arthur Levitt's reform agenda announced
on September 28, 1998 and he has also been a keynote speaker at various
conferences of investment and accounting professionals. You can contact
Bill at firstname.lastname@example.org if you would like to have him speak at your
Parish & Company is an independent fee based investment advisor
to individuals, pensions and trusts based in Portland, Oregon. No
fees are accepted, either directly or indirectly, from any provider of
investment products. Your comments are most appreciated and please
do visit my research archive at www.billparish.com.
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