Keweenaw Land Association

Last August, we wrote about a pink sheet company called Keweenaw Land Association Ltd. The original post is here:

Keweenaw Land Association Ltd.

The company is a timberland company in Michigan that owns 158,000 acres of land in the Midwest and trades under the symbol KEWL.PK. I passed on buying it because I thought that KEWL would be categorized as a "real estate" company and would be dragged down with the rest of the sector. It was selling at $215 per share.

It seems that KEWL has attracted an activist investor who is agitating for change at the company. The stock is now up to $263 per share.

Ronald S. Gutstein, a private investor, has announced his intention to seek two board seats at the upcoming meeting in July 2008. The other nominee is Scott Frisoli, an associate of his. You can read his letter here.

Gutstein said, “Keweenaw has massive mineral reserves. Despite record demand and rising prices, management has done nothing to take advantage of current, unprecedented market conditions. Instead, they have been content to remain a small timber company and real estate developer. If management was determined not to exploit its extensive mineral reserves, at a minimum, they should have taken advantage of the tax benefits from becoming a REIT.”

KEWL fired back by releasing early the Chairman's Letter that is to be included in its annual report.

It stated in part that "we have reviewed this option (REIT) several times but there are two significant problems: 1) we would have to distribute all of our retained earnings (over $12 million), which would force us to sell assets to raise the money for this distribution, and 2) on an annual basis we would have to distribute 95% of earnings, which would preclude us from growing the company out of earnings."

KEWL also defended its pace of developing its mineral resources.

"The process of bringing a mine to production is a very long and expensive procedure. There is a very tedious and time consuming permitting process, plus tremendous opposition from anti-mining groups. Any given mining company needs to weigh all these factors when making the decision to go forward with a mining project"

Gutstein then countered in a press release yesterday:

"In his letter Mr. Ayer (Chairman of KEWL) states that as a REIT, Keweenaw would have to distribute 95% of earnings to shareholders. This was in fact true prior to 2001. Since 2001, however, REITs have been required to distribute only 90% of earnings to shareholders. Mr. Ayer and his advisors appear to be unaware of changes in the tax law made more than seven years ago.”

"Responding to Mr. Ayer’s claim that REIT dividends are not eligible for the favorable qualified dividend tax rate of 15%, Mr. Gutstein stated: “The Plum Creek Timber Company in its February 2008 press release states that its dividends should qualify for a 15% rate because the income generated by the sale of timber is considered long-term capital gain. In any event, all other things being equal, shareholders are always better off without the corporate double tax.”

So what does this all mean? At the end of 2006, KEWL did an appraisal on its land holdings and came up with a value of $118 million, based on a single transaction approach. Using a present value of cash flows, it derived a slightly higher value of $121 million. Management admitted that this appraisal understated the land value that the company holds because it ignored the development value of the land, the appraisal used a low intensity harvesting for the DCF approach, and it completely ignore any mineral value of the land the company owns.

KEWL owns mineral rights on 406,200 acres of land in Michigan, a huge potential given the history of mining in the area. In the 1950's a study was done on two deposits, and it was determined that the company has significant deposits left of iron ore, silver and copper. It was decided to wait until technology allowed better opportunities to exploit these minerals. Certainly now, 50 years later and with a much higher commodity price, it is now feasible to develop these minerals commercially.

The market cap of the stock is $169 million, higher than the appraised value of the land, but maybe a value play if you put some future value on the minerals. There is also another mineral play, although I don't know enough about KEWL's land holdings to know if this adds value to the company. There are significant natural gas reserves in Michigan in a play known as the Antrim Shale, which is located in Northern Michigan.

Keep this company on your radar during 2008.