ODLUMBROWN.COM
ODLUM
BROWN
REPORT
11 2016
The ABCs of Matchmaking
Speed dating is an unusual matchmaking process. People meet at an event and rotate through a
number of potential mates, typically only having three to five minutes to get to know someone
and determine if there is any interest. At the end of each event, participants submit a list of who they
would like to see again, and couples who match will exchange contact information. According to The
New York Times, matches occur on average two or three times for every 10 dates.
The auction process by which companies put themselves up for sale has similarities with speed dating, except
it’s called “exploring strategic alternatives.” Recently, Twitter decided it was time to find a buyer, and, according
to sources, met with a number of potential suitors, including Alphabet, Disney and Salesforce.com. Unfortunately
for Twitter, the dating process failed to result in a match. #StillSingle
INSIDE THIS ISSUE
Page 1
The ABCs of Matchmaking
Page 2
Timber! Don’t Get Hit by a Trade
War
Page 4
Odlum Brown in the Community
Odlum Brown Limited
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Odlum Brown Limited
@Odlum_Brown
Odlum Brown Community
As Alphabet (NASDAQ: GOOG) shareholders, we have an interest in the way the company chooses to spend
capital. We think Twitter is a unique product and a great tool for consuming information; however, the company
suffers from a number of issues. First, CEO Jack Dorsey runs two public companies: Twitter and Square. For most
executives, the challenges of running one company are plenty. Second, Twitter’s cost structure is massively
bloated; the relaxed attitude toward excessive spending, especially with respect to stock rewards, is notable
when compared to its peers.
While it is difficult to say whether Twitter would be a good fit for Alphabet, we know that Alphabet’s approach
to capital allocation and decision-making is solid. Co-founders Larry Page and Sergey Brin have made reference
to Warren Buffett and Berkshire Hathaway’s “An Owner’s Manual” in the past, and their focus on business
durability and long-term value creation was undoubtedly behind the decision to transition Google into a holding
company in August 2015.
Naturally, Alphabet will look to acquire companies to supplement its internal research and development efforts.
What stands out to us is the way Alphabet manages its earlier-stage technology experiments, such as driverless
cars and glucose-sensing contact lenses, as well as the company’s venture capital portfolio. As part of the
Alphabet restructuring, these investments are now managed independently from the company’s core Search
business. Alphabet’s commitment to operating in this manner is important in that decentralization and the
placement of responsibility and ownership further down the ranks tend to distinguish the great capital allocators
from the rest of the field.
Technology investing can be challenging because successful newcomers are often susceptible to an inertia
that prevents them from continuing to adapt. Yesterday’s disruptors become the next incumbents, ready to be
disrupted. Alphabet has cultivated a company culture determined to avoid this all-too-common outcome. The
company spent roughly $4.5 billion on experimental projects and investments over the last year, and, perhaps
more importantly, it remains focused on closing down projects that fail to deliver results. While it may still be
too early to pass judgement on Alphabet’s capital allocation track record, we believe that their endeavours,
including acquisitions, internally developed projects and the avoidance of ill-suited businesses, make the
company a perfect match for patient shareholders.
STEVEN ZICHERMAN, MBA, CFA
Equity Analyst
@OBDifference
“
Timber! Don’t Get Hit by a Trade War
With a much weaker housing backdrop
this time around, the U.S. industry appears
more focused on achieving a hard cap on
market share. In contrast, Canadian
For the last decade, there has been peace between Canada and the United States on the lumber
trade front, and 2x4s have crossed the border with relative ease. Unfortunately, we think that is
all about to change.
The Softwood Lumber Agreement between the two countries expired on October 12, 2015. Since then, the
industry has operated under a one-year grace period designed to allow negotiations to continue without trade
action. That window is now closed. As Canadians, we are hopeful that cooler heads will prevail. However, it’s
likely only a matter of time before punitive duties will be imposed on Canadian producers, leading to another
costly trade war.
producers would prefer a straight fee
structure, which leads us to the current
stalemate.
”
The last time the industry operated without a trade agreement, a 27% tariff was levied against Canadian lumber
exports. At the time, demand for lumber was on its way to a multi-decade high, and there was an elevated
need for Canadian wood products. Yet, it took five long years and US$5.4 billion in duties before a deal was
reached.
The signing of the 2006 Softwood Lumber Agreement coincided with the peak in U.S. home construction. It
was structured with a sliding tax based on the price of lumber. In good markets, the tax would fall to zero, and
in poor markets it would rise to 15%. Of course, this seemed like a bargain relative to a flat rate of 27%.
With a much weaker housing backdrop this time around, the U.S. industry appears more focused on achieving
a hard cap on market share. In contrast, Canadian producers would prefer a straight fee structure, which leads
us to the current stalemate.
Complicating matters is the fact that the market is not static. Canada’s market share averaged roughly 33%
for the five years prior to the signing of the last agreement. Since then, it has averaged 30% and even dipped
below 26% following the financial crisis of 2008/2009. Canada’s share of the lumber market is now back to
approximately 33%.
The U.S. Lumber Coalition has suggested that Canada deserves just 22% market share. While that proposal is
undoubtedly a negotiating ploy, it highlights how far apart the two sides are in terms of expectations. Government
agencies can’t even agree, with Statistics Canada and the USDA Foreign Agricultural Service reporting vastly
different market share statistics over the past year. Nonetheless, it is clear that Canadian producers ramped up
exports to the U.S. during the one-year grace period at a growth rate of somewhere between 20% and 40%,
depending on the source. This has not been lost on U.S. producers and has likely strengthened their resolve to
regain market share.
We shouldn’t be surprised by the controversy regarding softwood lumber exports. Disputes over timber have
been going on since the 1930s, and this will be the fifth lumber trade war between Canada and the United
States.
The underlying argument made over and over again by U.S. producers is that Canadian lumber is unfairly
subsidized by the government. This is because most Canadian timber is logged on crown lands, whereas logging in
the U.S. is primarily done on private timberlands. Private land owners sell timber at the market price, which is
typically higher than stumpage paid to the Canadian government to access crown lands. While this is a valid
point, the issues run much deeper.
There are three contributing factors making negotiations particularly contentious:
1) Canadian producers enjoy a much more favourable exchange rate today than was the case for much of
the last decade.
2) Falling demand from China has increased the flow of lumber from Canada to the United States.
3) Rising protectionism has created a toxic environment in which to negotiate a trade agreement.
2
The Canadian dollar was near parity in the fall of 2013. The depreciation of our currency since then has meant
a 25% lift in lumber prices in Canada because prices are set in U.S. dollars. This is an intolerable competitive
advantage from the perspective of American lumber producers. Ominously, the last lengthy trade dispute
occurred when the loonie was similarly depressed.
One of the big stories for B.C. forestry in recent years has been the rise of Chinese lumber imports. Local companies,
such as Canfor, were quick to address the market and eagerly shipped lumber overseas. However, that market
has softened and demand has declined in recent months. The timing couldn’t be worse. A shrinking export pie
hurts everyone and puts the focus squarely back on the U.S. market.
“
Within the forestry sector, there are some
excellent options to participate in
rising housing starts. Our favoured names
in the sector continue to be Norbord (TSE:
OSB) and Weyerhaeuser (NYSE: WY).
Protectionism is a difficult factor to measure but has almost certainly played a greater role at the negotiating table
this time around. Look no further than commentary from presidential hopefuls Donald Trump and Hillary Clinton. It
has become popular to publicly blame trade deals such as NAFTA for lost American jobs. The idea that Canada
is taking a greater share of the lumber market does not sit well with many Americans and their elected leaders.
With a trade dispute looming, the market has already discounted trouble ahead for domestic forestry companies
that sell into the United States. Stock prices for Canfor and West Fraser are down 26% and 17%, respectively,
over the past year (as of October 20, 2016). While such discounts pique our contrarian instincts, it may be too
early to bargain hunt given the likelihood of a protracted dispute.
A rational response to the risk and uncertainty of another softwood lumber dispute would be to avoid forestry
stocks altogether. However, we believe that the U.S. housing market is in the middle innings of a multi-year
recovery and represents an attractive area for investment. The industry has underbuilt for almost a decade,
and we expect significant demand for homes with the rising trend of new household formations.
Importantly, neither business should be
negatively impacted by a prolonged
lumber dispute.
”
U.S. HOUSING STARTS REMAIN BELOW THE LONG-RUN AVERAGE
Thousand Units
2,500 –
2,000 –
Average
Housing
Starts = 1.4 M
1,500 –
1,000 –
500 –
‘66 ‘68 ‘70 ‘72 ‘74 ‘76 ‘78 ‘80 ‘82 ‘84 ‘86 ‘88 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘12 ‘14 ‘16
Year
Within the forestry sector, there are some excellent options to participate in rising housing starts. Our favoured
names in the sector continue to be Norbord (TSE: OSB) and Weyerhaeuser (NYSE: WY). Importantly, neither
business should be negatively impacted by a prolonged lumber dispute.
Norbord is a global panel producer, and panels are not subject to any of the trade restrictions placed on
softwood lumber. Moreover, we believe that the outlook for oriented strand board, the material from which
Norbord’s products are primarily made, is attractive given capacity constraints and our expectation for
improving U.S. building activity.
Weyerhaeuser owns extremely high-quality timberlands and operates predominantly in the United States.
Near-term restrictions placed on lumber imports will provide an immediate benefit to the company. Over the
long term, we think Weyerhaeuser will be able to increase earnings as the value of its land grows and demand
for building products accelerates.
CORY O’KRAINETZ, B.SC.
Equity Analyst
@OBDifference
3
Odlum Brown in the Community
The spirit of philanthropy and community giving has long-standing roots at Odlum Brown Limited, starting
with General Victor Odlum and Colonel Tom Brown. We are pleased to be able to honour these leaders
through the following initiatives.
Juno Beach Centre:
“From Vimy to Juno”
Travelling Exhibit 2016-17
BC Tour
The Juno Beach Centre
General Victor Odlum
Canada will commemorate the 100th anniversary
of the Battle of Vimy Ridge in 2017. One of our
founders, General Victor Odlum, served our country
in both World War I and II. To mark this anniversary,
as well as the 150th anniversary of Canada, the Juno
Beach Centre launched a new multi-year national
initiative called the “From Vimy to Juno Education
Campaign” in March 2016. This bilingual, national
commemorative program explores the connections
between Canadian experiences during the First and
Second World Wars in the lead-up to the centennial of the Battle of Vimy Ridge in 2017.
The campaign is comprised of a national travelling exhibition, an educational website
with pedagogical resources, and a series of pan-Canadian special events at museums
and cultural centres from coast-to-coast. General Odlum will be featured in the exhibit
and profiled on the program website.
Odlum Brown is pleased to honour our founder, General Victor Odlum, by partnering with the Juno Beach
Centre as the Presenting Partner of the British Columbia leg of the tour, with stops in Vancouver, Victoria and
Kelowna, communities in which we have offices.
To learn more about the Juno Beach Centre and the “From Vimy to Juno” tour, please visit
junobeach.org or vimytojuno.ca.
Debra Hewson, President & CEO, Odlum Brown
The Nature Trust of BC:
Odlum Brown Land
Acquisition Fund
This year marks the 45th anniversary of The Nature
Trust of BC. There is a lengthy connection between
Odlum Brown and The Nature Trust of BC, dating
back to 1971. Colonel Tom Brown served on the
board of The Nature Trust for 21 years and was
one of the original directors. He was instrumental in
establishing The Nature Trust as the fiscally
responsible land conservation force that it is today.
Colonel Tom Brown
In recognition of The Nature Trust’s 45th anniversary,
we were pleased to announce at their recent Gala the establishment of the Odlum
Brown Land Acquisition Fund with a gift of $45,000. These funds will be used to acquire
properties in the areas where Odlum Brown has offices: on Vancouver Island, the Lower
Mainland/Fraser Valley and the Okanagan.
For more information on the The Nature Trust of BC, please visit naturetrust.bc.ca.
4
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