Business Company DMG s valuation per UFS share

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1 Initial Coverage United Fiber System Limited DMG & PARTNERS SECURITIES PTE LTD 20 Raffles Place #22-01 Ocean Towers Singapore RCB Reg. No E UNITED FIBER SYSTEM (UFS: S$0.225) BUY (Initial) Know what you get 09 November 2006 An investment in UFS gives investor a forestry concession, a soon-to-start wood chip mill, a yet-tobuild pulp mill, and construction business. We value these businesses at 74 cents per share. There is also a chance to own a functional pulp mill at a discount which would add 47 to each UFS share. BUY for a narrowing of discount to fair value and the CHANCE to own Kiani Kertas at a discount. Our price target is 44 cents should the Kiani Kertas deal fall through, and 72 cents if the deal is successfully concluded. Implicit in our price target is a 40% discount for excessive market speculation and unrealistic market expectation in the past. This legacy discount (or problem) may erode when the mills start operating and the purchase of Kiani Kertas is more definitive. We initiate coverage with a BUY recommendation and 12-month price target of 44 cents. (I) These are what you get Too much negative publicity and speculative press coverage have clouded investors perception. It s time for a recap. Investment in UFS nets you the following:- Business Company DMG s valuation per UFS share DMG s discount to fair valuation Forestry concession PT HRB S$0.18 S$0.11 Wood chip mill PT MAL S$0.10 S$0.06 Pulp mill PT MBBM S$0.41 S$0.24 Construction Poh Lian S$0.05 S$0.03 Sum S$0.74 S$0.44 (A) Forest concession PT HRB (Hutan Rindang Banua) This concession covers 268,585 hectares in South Kalimantan, Indonesia. Total area suitable for plantation is 130,000 hectares. Between 1994 and 1998, 76,000 hectares were planted with fast growing Acacia Mangium. This forest asset is valued at US$204m (or US 9.6 cents per share) at end (B) Wood Chip Mill - PT MAL (Mangium Anugerah Lestari) This wood chip mill has an annual capacity for 700,000 tonnes bone-dry wood and is expected to start production in November Construction cost of US$45m is fully financed by loans from China National Machinery & Equipment Import and Export Corporation (US$18m) and Raiffeisen Zentralbank (US$21m). Output from the mill is worth US$80m US$90m per annum. 80% of the output will be taken up by China National Machinery & Equipment Import and Export Corporation at prevailing market price. (C) Pulp Mill PT MBBM (Marga Buana Bumi Mulia) This proposed pulp mill has an annual capacity of 600,000 tonnes Bleached Hardwood Kraft Pulp. Construction is expected to start in 1Q07 with completion in Development cost of US$863m is 80% financed (US$690.4m) by the turnkey contractor, China National Machinery & Equipment Import and Export Corporation. The raw material, logged wood, will be supplied from United Fiber s forest concession. 09 November 2006 Page 1 of 47

2 Annual revenue is estimated at US$310m to US$330m. 90% of the output will be bought by CellMark at prevailing market price. CellMark has an option for the remaining 10%. (D) Construction This legacy business is not to sneer at. Order book in the past 1 year has increased from S$150m to S$220m while projects are being completed. Poh Lian Construction is an A1 class contractor and can tender for public sector projects of unlimited value. Net profit margins have recovered from negative territory. Current range of 2% 5% is boosted by private sector projects which typically carry net profit margin of 5% 10%. But interest and valuation will rise with the construction up-cycle, spurred by 2 Integrated Resorts, the Business and Financial Centre and three mega malls along Orchard Road. (II) This is what you hope to get Since mid-2005, UFS has been eyeing to buy PT Kiani Kertas. The latter is an operationally-ready Bleached Hardwood Kraft Pulp mill with an annual capacity of 525,000 tonnes in Mangkajang, Berau, East Kalimantan, Indonesia. This mill has a 126 MW cogeneration power plant, airstrip, deepwater harbour, water treatment plant, an effluent treatment plant and townsite for 800 workers. Commercial production began in November 1999 but was subsequently hampered by the lack of operation funds. In July 2005, UFS entered into an Operation Management Arrangement (OMA) to manage Kiani Kertas mill. UFS will provide operating capital and take delivery of the produced pulp in lieu of payment. Production resumed in September on an ad hoc basis. In the meantime, UFS began preparatory work to acquire Kiani Kertas, including appointment of financial adviser and arranger, lawyers, accountants and technical surveyors. An intermediary entered into preliminary agreement with the vendors of Kiani Kertas in December Bank Mandiri has started to push the vendor to close a deal as soon as possible as the bank is under pressure to resolve its non-performing loans problems. Recent statements from UFS and Bank Mandiri, which is owed money by Kiani Kertas, suggest that an agreement is imminent. BUT nothing is heard from the vendor. Investors should note that there had been many false starts. UFS similarly implied that it was closed to an agreement in June 2006 when it secured the pre-closing financing. Similarly, UFS announced in February 2006 details of its June 2005 agreement with the intermediary to buy Kiani Kertas. This was preceded in December 2005 by UFS announcement that its intermediary had entered into an exclusive sales and purchase agreement with Kiani Kertas shareholders. Investors must understand that this could be a case of cultural clashes. The UFS-Kiani Kertas saga smacks of Indonesian wayang kulit shadow dancing where the innuendoes are as important, if not more important, than the story. Singapore investors have to appreciate Indonesian undertones, evident in the form of an Indonesian major shareholder, an Indonesian CEO, Indonesian forestry concession, pulp mill, wood chip mill, and now a potential acquisition of a big-scale Indonesian pulp mill, Kiani Kertas. (III) This is what you stand to gain (or lose) We believe that investors are getting a 70% discount for the existing businesses of a forestry concession, wood chip mill, a yet-to-build pulp mill and construction business. 09 November 2006 Page 2 of 47

3 Investors are given a FREE OPTION for the CHANCE to own Kiani Kertas at a discounted price. A successful purchase could boost UFS fair value by 47 cents per share. We initiate coverage of UFS with a BUY recommendation. Our fair valuation of existing businesses is 74 cents per share. This will rise by 47 cents per share should UFS succeed in buying Kiani Kertas at its target price. We are applying a 40% discount to fair valuation for our target pricing. This translates to S$0.44 without Kiani Kertas and S$0.72 with Kiani Kertas at UFS pricing. The implicit 40% discount is for excessive market speculation and unrealistic market expectation in the past. This legacy discount (or problem) may erode when the mills start operating and the purchase of Kiani Kertas is more definitive. Year end Dec (S$m) F 2007F 2008F Revenue Profit before tax (34.0) Net (loss)/profit (34.9) Loss per share / EPS (cents) (2.04) EPS growth n.m % -6.7% 200.6% 47.6% 176.0% PE at 22.5 cents (x) (11.0) Lynette Tan (65) Lynette.tan@dmgaps.com.sg 09 November 2006 Page 3 of 47

4 Appendix 1: Key Stock Information Issued Capital (m shares) : m Market Capitalisation : 22.5 cents Major Shareholders : Tektronix Industries 44.22%* Wisanggeni Lauw 13.12%* Bloomberg Code : UFS SP Average daily volume (52 week) : m 52-week high / low : S$0.37 / S$0.195 * direct and deemed interests S$ 0.8 Price Chart of United Fiber System May-97 May-98 May-99 May-00 May-01 May-02 May-03 May-04 May-05 May November 2006 Page 4 of 47

5 Appendix 2: Earnings forecast Year end Dec (S$m) F 2007F 2008F Revenue Cost of sales (145.2) (85.0) (82.0) (133.9) (298.0) (277.3) Gross profit Selling and distribution (1.0) (0.3) (4.3) (5.2) (68.0) (57.4) Administrative (6.7) (5.2) (10.6) (7.5) (93.4) (68.9) Other operating expenses (8.6) (4.8) (3.5) (5.2) (39.6) (34.4) Other revenue EBITDA Depreciation and amortisation (9.1) (8.1) (0.5) (1.9) (2.9) (7.2) Operating profit/loss (8.2) Finance costs (1.2) (1.8) (4.6) (4.9) (105.7) (115.8) Share of associates 0.0 (0.1) Exceptional items (24.6) Profit before tax (34.0) Tax expenses (1.0) (5.8) (4.4) (10.3) (11.5) (59.7) Minority interest (0.0) (0.0) (0.0) (0.0) Net (loss)/profit (34.9) Loss per share / EPS (cents) (2.04) PE at 22.5 cents (x) (11.02) Margins Gross 7.0% 8.1% 13.2% 10.2% 47.4% 51.7% EBITDA 0.5% 17.8% 10.8% 13.2% 21.9% 33.7% Operating -5.3% 9.1% 10.3% 11.9% 21.4% 32.4% Net -22.4% 0.8% 0.8% 1.7% 0.7% 1.8% Growth Revenue -4.9% -40.8% 2.3% 57.8% 279.8% 1.3% Gross profit -28.2% -31.3% 67.4% 22.1% % 10.5% EBITDA -96.0% % -38.2% 93.5% 528.7% 55.9% Operating profit % % 15.7% 83.3% 579.8% 53.7% Net profit % % -1.2% 239.2% 47.6% 176.0% EPS % % -6.7% 200.6% 47.6% 176.0% Revenue by segment Construction & Property Forestry and pulp Others Revenue growth by segment Construction & Property -7.4% -39.4% -25.0% 67.5% -16.0% -56.9% Forestry and pulp 0.0% 0.0% 100.0% 32.5% % 13.4% Others n.m % -25.9% % 0.0% 0.0% Revenue by geography Singapore Other Asia-Pacific Revenue growth by geography Singapore -2.8% -36.8% -24.9% 67.2% -16.0% -56.9% Other Asia-Pacific -26.7% -97.4% n.m. 32.0% % 13.4% 09 November 2006 Page 5 of 47

6 Appendix 3 : Balance Sheet Year end Dec (S$m) F 2007F 2008F Forest assets Goodwill Fixed assets Properties under development Investments Other investments Deferred tax assets Advances to a partnership Non-current assets Assets held for sale Properties under development Completed properties held for sale Construction work-in-progress Inventories Trade and other receivables Cash at bank Current assets Construction progress bililngs Trade and other payables Hire purchase creditors Provision for taxation Amounts due to bankers Current liabilities Net current assets (27.7) (40.2) (20.9) (16.3) (15.6) (29.0) Deferred taxation Non-current payables Hire purchase creditors Long term loans Non-current liabilities Net assets Share capital Reserves Shareholders' funds Minority interest Equity Current ratio Trade receivables turnover (days) Trade payables turnover (days) Gross borrowings Gross gearing (x) Net borrowings Net gearing (x) Return on asset (%) -4.7% 1.0% 0.7% 1.7% 2.0% 8.9% Return on equity (%) -7.2% 0.2% 0.2% 0.5% 0.7% 1.9% Return on capital employed (%) -1.5% 1.6% 1.7% 2.9% 19.1% 29.2% 09 November 2006 Page 6 of 47

7 Appendix 4 : Cash flow forecast Year end Dec (S$m) F 2007F 2008F Profit / (Loss) before tax (34.0) Adjustments for:- Deprn & amortisation Exceptional items 24.6 (0.1) Gain from increase in fair value (3.0) (19.1) (15.5) Gain from disposal of interest in JV (0.1) Loss/(gain) on disposal of fixed assets (0.1) Interest expense Interest income (0.0) (0.0) (0.3) (0.1) (0.1) (0.1) Impairment in value of assets Reversal of impairment (2.4) Fixed assets written off Share of associates (0.0) Net exchange differences (0.1) 0.3 (0.2) Operating (loss)/profit before working capital changes (3.2) (1.9) (5.7) Decrease in properties under development Decrease/(increase) in completed properties (11.8) Decrease/(increase) in construction WIP 10.3 (0.8) (2.3) (0.5) (0.1) (0.1) Decreae/(increase) in inventories (2.3) (Increase)/decrease in trade and other receivables (40.2) (3.7) (3.9) (1.6) Increase/(decrease) in trade and other payables (7.2) (8.1) (3.6) Cash generated from/(used in) operations (42.2) Interest paid (1.4) (1.3) (3.4) (4.9) (105.7) (115.3) Income taxes paid (0.3) (0.0) (0.6) (0.2) (0.7) (1.0) Net cash generated from/(used in) operating (46.2) Acquisition of subsidiaries Addition in cost of forest asset (1.0) (0.9) (1.1) (1.2) (1.3) (1.3) Down payment for construction of wood chip mill - - (8.3) Interest received Proceeds from disposal of fixed assets Proceeds from disposal of assets Proceeds from disposal of subsidiaries & associates Purchase of other investments (0.0) Purchase of investment properties (2.0) Purchase of fixed assets (0.4) (0.7) (1.9) (8.0) (15.0) (30.0) Net cash (used in)/generated from investing 1.9 (1.0) (10.8) (9.1) (16.1) (31.2) (Repayments of)/proceeds from bank borrowings (36.8) (2.2) 1.3 (7.6) Repayments of HP liabiilities (0.6) (0.1) (0.1) (0.0) (0.0) (0.0) Expenses incurred on issuance of ordinary shares - - (0.8) Proceeds from issuance of shares Increase of pledge in fixed deposits - - (4.2) Advances to a partnership (0.1) Net cash used in financing (37.5) (2.2) 1.3 (7.6) Net increase/(decrease) in cash and cash equivalents (4.8) 10.1 (1.8) Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year November 2006 Page 7 of 47

8 Appendix 5 : Corporate Summary BUSINESS OF UFS Overview UFS was originally a construction and property company that diversified into the forestry and pulp businesses in June Its operations are currently organised into two core business divisions: (i) the forestry and pulp division, and (ii) the construction and property division. UFS holds a forest concession right for an industrial timber estate of 268,585 hectares in South Kalimantan, Indonesia, through its wholly-owned Indonesian subsidiary PT HRB. The concession right entitles it to plant, maintain, process and market products extracted from the concession area for a period of 43 years, which runs from 27 February 1998 until 26 February UFS plans to manufacture pulp (which is the basic raw material needed to produce paper) through the operation of the MBBM Mill to be situated within its forest concession area. The MBBM Mill is being developed and will operate through PT MBBM, a wholly-owned Indonesian subsidiary. The MBBM Mill has a planned production capacity of 600,000 tons of BHKP per annum. For a total development cost of up to US$45 million, UFS has also begun the development and construction of a wood chip mill in South Kalimantan, which has a planned annual production capacity of 700,000 (bone dry) tons of wood chips. As part of its regional expansion plans, UFS proposes to acquire the entire issued and paid-up share capital of PT KK. PT KK owns and operates a modern BHKP pulp mill situated on a 3,400 hectare site located in Mangkajang, Berau District, East Kalimantan. The KK Mill and its supporting infrastructure and facilities are technologically competitive and have a design capacity of 525,000 tons of BHKP per annum. (I) UFS Competitive Strengths Forest concession right in Indonesia Subsidiary PT HRB, holds a forest concession right of 268,585 hectares situated in South Kalimantan, Indonesia, which entitles it to plant, maintain, process and market products extracted from the concession area up to 26 February Since 1995, UFS has planted approximately 76,000 hectares of its concession area with Acacia Mangium, a fast-growing leguminous species, which can be processed into market pulp of high quality for the production of tissue and printing and writing grade papers. The average maturity period for an Acacia Mangium tree is six to eight years. In addition, UFS has identified approximately 50,000 hectares available for planting within the concession area. The size of its plantation and ongoing investment in tree planting is expected to ensure a sustainable supply of wood raw material for MBBM Mill. However, in order to support the development of the local economy, UFS plans to buy at least 20 per cent. of the wood raw material from forest plantation owners in the vicinity. The constant and stable supply of raw material will help ensure that MBBM Mill remains at optimum utilisation. The forest asset had a book value of over US$204 million at end 2005, based upon a valuation report prepared by Pöyry, a reputable international third party consultant Advantageous position in relation to the supply of wood raw material Wood raw material costs make up the bulk of the cost of production of market pulp, accounting for approximately per cent. of the total manufacturing costs. The remaining components comprise mainly of labour costs, chemicals for bleaching the pulp and energy costs. Variations in 09 November 2006 Page 8 of 47

9 the price of wood will therefore generally have the biggest impact on total manufacturing costs and profitability. However, as UFS plans to source a large proportion of its wood raw material from its own forest plantations, its exposure to changes in the price of wood should, to some extent, be mitigated. MBBM Mill and Wood Chip Mill sites are strategically located in South Kalimantan. As there are no other nearby mills, plantation owners in the vicinity are expected to sell their harvested trees to UFS mills than to sell them elsewhere. UFS will have a reliable source of raw material from the surrounding plantations. This strength is complemented by UFS plantation as an alternative source of wood, providing UFS with significant bargaining power. Proximity to fast growing Asian import market, in particular China According to Pöyry, the demand for BHKP is expected to grow by 8.1 per cent. per annum in China through However, China s lack of wood fibre domestically means that it has to continue to rely on imported pulpwood and pulp to meet this demand. UFS mills will provide a gateway to Asian pulp and paper demand, with China being a major producer of paper and paperboard products and expected to remain a major net importer of pulpwood and pulp. UFS mills will enjoy cost advantages relative to North and South American producers through lower freight costs, due to their proximity to China and other Asian markets. UFS will have a cost advantage over competitors in many countries Indonesia is one of the world s most cost-competitive countries for the production of pulp. Due to the lower cost of production in Indonesia, coupled with lower transport costs attributable to proximity to Asian markets such as China, Taiwan, Japan and Korea, UFS has a distinct advantage over its non-indonesian competitors. Guaranteed revenue streams from offtake agreements In April 2001, PT MBBM entered into an exclusive offtake agreement with CellMark, under which CellMark agreed to offtake up to 90 per cent. of the annual BHKP production of the MBBM Mill. CellMark, headquartered in Sweden, sells pulp, paper, packaging paper and board, and recycled fibre in more than 90 countries. The offtake agreement is for a period of 10 years from the date of commencement of commercial production at MBBM Mill. UFS has a similar offtake agreement with CMEC in which CMEC will offtake 80 per cent. of the Wood Chip Mill s annual production for up to three years after commencement of commercial production. These agreements will provide UFS with long-term guaranteed revenue streams, optimise inventory management and generate surplus cash flows after repayment of approximately US$690 million of supplier s credit financing for the construction of the MBBM Mill and approximately US$39 million of financing for the construction of the Wood Chip Mill. Track record as a construction company UFS is a major construction company in Singapore. The construction division, Poh Lian Construction (PLC) has more than 30 years of experience in the construction industry and prides itself for its quality, reliability, safety as well as its environmental innovation in project management. PLC is a certified A1 contractor and is able to tender for public sector projects of unlimited value. Over the years, PLC has worked on numerous HDB Design and Build projects, institutional projects, factory projects, upgrading projects as well as prestigious private housing projects. 09 November 2006 Page 9 of 47

10 (II) UFS Strategy UFS aims to maintain its construction business and become a major player in the international pulp industry, with a focus on quality, cost efficiency, safety, sustainability and environmental responsibility. Vertically integrated business model UFS strategy in the forestry and pulp businesses is based on a close integration of all production stages from the tree seeds to the final BHKP product. This will allow UFS to optimise and control all factors in the production of BHKP, which may influence the quality and overall manufacturing cost of the pulp. In conjunction with the existing forest concession and reforestation programme, the construction of the MBBM Mill and the Wood Chip Mill and the KK Acquisition will complete its vertically integrated business model. In December 2002, PT MBBM entered into a turnkey contract with CMEC for the construction of the MBBM Mill, which is a 600,000 tons per annum BHKP pulp mill for up to US$863 million in South Kalimantan, Indonesia. BHKP, the sole product of the MBBM Mill, is the basic raw material used in the production of fine papers, tissue and other related products. BHKP is a commodity that is freely traded in the international market, and the pricing of BHKP is dictated by the supply and demand situation globally. Commercial operation of the MBBM Mill is expected in On 22 April 2003 and 24 December 2004, PT MAL entered into a turnkey contract with CMEC for the construction of the greenfield Wood Chip Mill in South Kalimantan, Indonesia, with an annual production capacity of 700,000 (bone dry) tons of wood chips. The total development cost of the mill is up to US$45 million. The wood chips will be sold to existing pulp mills as fibre raw material. Construction of the Wood Chip Mill is completed and production is expected to start in November UFS proposes to acquire the entire issued and paid-up share capital of PT KK. PT KK owns and operates a modern BHKP mill situated on a 3,400 hectare site located in Mangkajang, Berau District, East Kalimantan. The KK Mill is self-supporting in relation to energy and key chemicals, and has existing infrastructure required to support operations including a co-generation power plant, a deep-water harbour, a road network to the mill and facilities to accommodate its employees. The KK Mill and its supporting infrastructure and facilities are technologically competitive and have a design capacity of 525,000 tons of BHKP per annum. Forest plantation In order to ensure effective control over wood raw material supply and cost-efficiency in its forestry business operations, UFS has adopted the following strategies: Continue to develop additional pulpwood plantations within its forest concession area. To date, a total of approximately 76,000 hectares have been planted and an additional approximately 50,000 hectares of suitable land have been identified for plantation. During 2005, UFS restarted its plantation programme, which was halted during the financial crisis in the late 1990s. During 2006 plantation period, UFS plans to plant some 10,000 hectares. Beginning in 2007, UFS plans to plant some 20,000 hectares per annum. Continue active promotion of and participation in the People s Forest Programme. Under this programme, UFS will assist the farmers in the following: identifying suitable land areas; preparing and filing land applications; sourcing necessary financing; providing technical assistance in areas for land clearing, nursery development, planting and harvesting; and 09 November 2006 Page 10 of 47

11 offtake of the harvested trees. Acquire and/or form partnerships/strategic alliances to obtain additional concession areas for further plantation development proximate to UFS planned operations in East and South Kalimantan. Increase R&D activities for the following purposes: Improvement in the wood yield per hectare of plantation: The R&D team will continue to perform tests to determine the optimal spacing for trees in order to achieve maximum wood harvest. Trees have been planted in rows at various intervals to optimise the diameter, volume, growth and height of the trees from the various sample plots. Pruning is performed on the Acacia Mangium trees in order to maximise the wood yield from the trees. Improvement of immature Acacia Mangium trees resistance against diseases: Various degrees of disease have been simulated in various sample plots. The R&D team will continue to apply different dosages of various fungicides such as benlate, bavistin, alto, antracol and vitigran to the different sample plots. The plant within each sample group is then compared with trees grown under normal conditions to determine the effectiveness of fungicides as well as the resistance of the plants to the diseases. As mature trees are more resistant to disease, R&D efforts are focused mainly on the immature Acacia Mangium trees. Development of seed stand: develop more high quality seeds and shorten the growth cycle of the plantation to five to six years compared to provenance planted now, which requires six to eight years to mature. Improvement in the soil fertility after harvest: introduce a gentle harvesting method, which should reduce the logging impact, and leaves as much logging residue, mainly consisting of small branches and leaves as possible in the field. This will help each growth cycle to improve the soil fertility. Environmental and social responsibility UFS will manage its forest assets and industries in compliance with Indonesian, and to the extent possible, international environmental standards. As a forestry and pulp company, UFS long-term survival depends upon the sustainability of its wood resources and forest operations, as well as industrial activities, development of the local economy and social environment. Construction and Property Division UFS will seek opportunities in high-end condominium construction, where margins tend to be higher, and HDB work. UFS has no current plans to acquire land bank for further development projects. (III) UFS History The company was incorporated in December 1995 as Poh Lian Holdings, a private limited investment holding company. In conjunction with its initial public offering, the company was converted into a public limited company in May 1997 and changed its name to Poh Lian Holdings Limited and was listed on the main board of the SGX-ST. In April 2002, shareholders approved a plan to diversify into the forestry and pulp businesses. Pursuant to this plan, the company acquired the entire issued and paid-up share capital of Anrof Singapore Ltd which, through one of its subsidiaries, held a forest concession right in South Kalimantan, Indonesia. Through this acquisition, the company also acquired a licence to build and operate a pulp mill in South Kalimantan, Indonesia with an annual production capacity of 600,000 tons of pulp. In 2002, the company name was changed to United Fiber System Ltd to reflect its new core businesses of forestry and pulp production. (IV) Principal Products and Services UFS operations are organised into the following two core business areas: 09 November 2006 Page 11 of 47

12 forestry and pulp division; and construction and property division. Forestry and Pulp Division Forestry Business UFS holds a forest concession right for an industrial timber estate of 268,585 hectares in South Kalimantan, Indonesia, through wholly-owned Indonesian subsidiary PT HRB. The concession entitles UFS to plant, maintain, process and market products extracted from the concession area for a period of 43 years, which runs from 27 February 1998 until 26 February The map below shows the locations of the concession area and the sites of Wood Chip Mill and proposed MBBM Mill. Within the concession area, UFS has planted approximately 76,000 hectares of Acacia Mangium, a fast-growing leguminous species, which can be processed into market pulp of excellent quality for the production of tissue and printing and writing grade papers. The average maturity period for Acacia Mangium is six to eight years. UFS has established a reforestation programme for its plantations that involves planting of Acacia Mangium on available grassland, bush and scrub land. A total of 120,000 to 130,000 hectares of the forest concession area are suitable for forest plantations, including 76,000 hectares that have already been planted. As part of reforestation programme, UFS has mapped out plans identifying the areas to be planted annually to ensure that there are sufficient mature trees available for harvesting annually to serve as raw material for the planned MBBM Mill. The reforestation programme will provide a sustainable source of wood raw material for the MBBM Mill. The forestry assets are valued annually by Pöyry, a reputable international engineering and consulting group specialising in forestry-based industries. UFS forest asset had a fair value (less estimated point-of-sale costs) of approximately US$204 million. In 2005, the forestry and pulp division contributed positive results of S$15.3 million (US$9.2 million) on gain arising from increase in fair value less point-of-sales costs of forest asset. 09 November 2006 Page 12 of 47

13 UFS Pulp Business UFS plans to manufacture pulp through the operation of a BHKP mill in South Kalimantan, Indonesia. The MBBM Mill will be located in Satui, near a plantation site in Kintap within UFS forest concession area. The MBBM Mill is being developed and will operate through PT MBBM, a wholly-owned Indonesian subsidiary, established in year 2000 specifically for this purpose. The MBBM Mill has a planned production capacity of 600,000 tons per annum. UFS has decided to build the MBBM Mill in this location as it is a suitable mill site with access to process water (the Satui River) and a recipient for the used (and cleaned) process water (the sea). Also, it is close to source of wood (UFS forest plantation) and villages with experienced labour. These factors should ensure that business operations are cost-efficient. UFS is in the process of acquiring the land on which the MBBM Mill will be situated, covering a total gross area of 340 hectares within its concession area. After acquiring the land, UFS will need to apply for permission to convert the site into industrial use, prior to beginning construction of the MBBM Mill. The proposed built-up area of the MBBM Mill and adjoining supporting facilities is approximately 200 hectares. The remaining 140 hectares will be used for a possible future expansion of the MBBM Mill. In addition to the production line and a co-generation power plant, the MBBM Mill project comprises an adjoining chemical plant, a water and wastewater treatment plant, a township and related infrastructure to be developed. The MBBM Mill will also have its own jetty to allow for the import and export of goods. Funding the development of the MBBM Mill project will include the development of these adjoining facilities. The entire project cost is estimated at approximately US$1.03 billion (excluding working capital, interest during construction, and infrastructure taxes and duties). It is expected to be financed by a combination of debt and equity. Instead of funding the entire development of the project, UFS is seeking third parties to undertake the development of the adjoining facilities, whilst it focus on the development of the MBBM Mill (pulp mill production line and co-generation power plant). The MBBM Mill and the adjoining chemical plant will share the same water and wastewater treatment plant, resulting in more efficient use of chemicals and power. The breakdown of the estimated development cost of US$1.03 billion for the MBBM Mill and the adjoining supporting facilities is as follows: Estimated Items cost (US$ in million) Pulp mill production line and co-generation power plant Chemical plant Water and wastewater treatment plant Township and related infrastructure ,026 Pulp Offtake Arrangements In April 2001, PT MBBM entered into an offtake agreement with CellMark ( CellMark Offtake Agreement ). CellMark has agreed to offtake up to 90 per cent. of the projected annual pulp production of the MBBM Mill for a period of 10 years from the date of commencement of commercial production. Under the CellMark Offtake Agreement, the quality of the pulp is required to comply with internationally accepted environmental standards. 09 November 2006 Page 13 of 47

14 The price for the pulp, under the terms of the Cellmark Offtake Agreement, will be the current prevailing market price for Acacia Mangium pulp in US dollars or such other price as agreed by the parties. Pulp Mill Turnkey Contract In December 2002, PT MBBM entered into a turnkey contract with CMEC (the Turnkey Contract ) for the construction of the MBBM Mill with an annual capacity of 600,000 (Air Dry) tons per annum in South Kalimantan, Indonesia, for a consideration of up to US$863 million. CMEC is an industrial foreign trade corporation engaged mainly as a contractor of international engineering projects and in the import and export of machinery and electrical products business. CMEC has a track record of international projects that includes thermal power stations in Malaysia and Bangladesh and cement plants in Vietnam and Pakistan. Under the terms of the Turnkey Contract, CMEC will build and deliver the MBBM Mill to UFS on a turnkey basis. CMEC is responsible for the MBBM Mill s design and the supply and installation of equipment for the MBBM Mill production line and co-generation power plant, as well as for procuring spare parts and materials, and for providing training, commissioning and technical support for the commercial operation of the MBBM Mill for one year. UFS target to have the MBBM Mill commence operations in Under the Turnkey Contract, CMEC is responsible for financing 80 per cent. of the development costs and PT MBBM is responsible for the remaining 20 per cent., which is payable on a progressive basis during the construction of the MBBM Mill. The supplier s credit provided by CMEC bears interest at 6 per cent. per annum compounded semi-annually.. The repayment period for the principal amount and the compounded interest of the supplier credit is seven years, payable semi-annually in arrear 36 months after commencement of construction. The Turnkey Contract shall take effect upon fulfilment of all conditions precedent by the relevant stakeholders. The security package for the supplier s credit includes (i) naming CMEC as the first beneficiary under an insurance policy for national political risk; (ii) a repayment guarantee by UFS; (iii) a first lien over the MBBM Mill in favour of CMEC; and (iv) paying part of the receivables from the sale of the pulp produced by the MBBM Mill into an account jointly managed by PT MBBM and CMEC. The following significant progress under the Turnkey Contract has been made: CMEC has executed a purchase contract with a value of more than US$250 million for the main process machinery with Andritz OY, one of the world s leading suppliers to the pulp and paper industry; CMEC has obtained in-principle approval from the relevant authorities for the supplier credit; CMEC has sought internal approval by the Ministry of Finance and the State Council of the People s Republic of China, in support of its supplier credit. Also, final approvals from the State Council of the People s Republic of China and relevant authorities are in the process of being finalised; and CMEC has also confirmed that China Export & Credit Insurance Corporation ( Sinosure ), in conjunction with international insurance underwriters, has agreed to provide the coverage of related insurances for the MBBM Mill project. Feasibility and Environmental Studies Feasibility studies on the MBBM Mill project were undertaken by Pöyry in 1996 and updates on the study were undertaken in December 1999 and November It was concluded that the MBBM Mill was feasible in view of market potentials in Asia-Pacific, in particular China, the availability of low-cost wood raw material from UFS forest plantation and UFS competitive cost structure. An environment study was also undertaken in February 1996 and updated in March 09 November 2006 Page 14 of 47

15 2003 by AF Industrins Processkonsult AB, Stockholm, Sweden, to evaluate, among other things, the environmental acceptability of the project, the conformity of the proposed pulp mill process concept with international standards and the compliance of pulp mill effluent discharge and atmospheric emissions with existing national standards and regulations and international guidelines (such as those of the World Bank). The MBBM Mill project plans to meet the World Bank s Environmental Guidelines that relate to effluents and air emissions from pulp mills. Construction of the MBBM Mill will commence once final approval for CMEC s supplier credit has been obtained from the State Council of the People s Republic of China and relevant authorities. UFS expects the MBBM Mill to commence operations in The MBBM Mill will source its wood raw material, Acacia Mangium, from UFS forest plantation and neighbouring third party forest plantations outside its concession area. Economics of the Pulp Business The sole product of the MBBM Mill is BHKP, which is the basic fibre raw material needed to produce mainly printing and writing grade papers and tissue products. BHKP is a commodity that is freely traded in the international market, and the pricing of BHKP is dictated by supply and demand. Since 1999, BHKP has traded at an average price of US$518 per ton, up to a high of US$703 and a low of US$392. In March 2006, BHKP (Acacia Mangium) traded at US$530 to US$555 per tons in the Asian market. The following chart illustrates the price trends for Acacia pulp from Indonesia since 2003: 600 Acacia (Indonesia) Price Trend 550 Price (US$/tonne) Month Wood raw material cost will make up the bulk of the cost of production, accounting for 60 to 70 per cent of total costs. The remaining components comprise mainly labour costs, chemicals for bleaching the pulp and energy costs. The cost of wood raw material is generally the most volatile of the cost components. UFS intends to source most of the raw material internally, from the forest plantation owned by subsidiary PT HRB. The forest plantation is expected to provide the MBBM Mill with a sustainable supply of raw material, which should help ensure that the MBBM Mill remains at optimum utilisation. In line with market practice, whilst UFS has not undertaken any insurance on its forest asset, UFS has ensured that the firebreaks and other fire-fighting measures are in place to contain any outbreak of fire and are able to respond to any fire on or near its forest plantation in order to 09 November 2006 Page 15 of 47

16 contain any outbreak of fire. UFS plants trees in plots with surrounding firebreaks to prevent spread of fire should there be an outbreak. Pulp Mill Process Flow The pulp mill process is a fully integrated production facility. The logs will be delivered to the MBBM Mill site. The logs will be debarked, chipped and the chips screened in the woodhandling area. The wood chips will be conveyed to the fibre line area where they will be fed to a digester where pulp is produced. Thereafter the pulp is screened and bleached before it is pumped to the pulp drying and baling areas where it will be dried, cut, baled and prepared for shipment. Water for the MBBM Mill will be supplied from a pump station at the nearby Satui River. The water will be treated prior to use as process and potable water. The chemicals required will be salt as a feedstock to the bleaching chemical preparation plant and make-up saltcake and limestone for chemicals lost in the pulping process. In the recovery area, used chemicals from the fibre line will be reprocessed. A recovery boiler will be used to burn organic material extracted from the wood in the digester when pulp is produced.. High-pressure steam will be produced from this process. The steam will be utilised in the power plant, together with steam produced in a power boiler, to produce electricity. The power boiler will be fuelled by tree bark and waste wood from the woodhandling area. Wood Chip Mill UFS has completed construction of a wood chip mill in South Kalimantan, which has a planned annual production capacity of 700,000 (bone dry) tons of wood chips, for a total development cost of up to US$45 million consisting of a construction cost of US$39 million and other development costs of US$6 million. The raw material, which is 100 per cent. plantation wood, will be provided by neighbouring third party plantations. Indonesian subsidiary PT MAL was established for manufacturing of wood chips. In 2004, PT MAL entered into a turnkey contract with CMEC to construct the Wood Chip Mill for a cost of up to US$39 million. Under the terms of the contract, CMEC s obligations include designing, supplying and procuring all equipment and material, spare parts, transportation, civil work, installation, training, commissioning and technical support for commercial operation of the Wood Chip Mill for one year. UFS has procured financing from CMEC and Raiffeisen Zentralbank Osterreich ( RZB ) for the construction of the Wood Chip Mill. A facility agreement for US$21 million was signed with RZB and UFS will receive US$18 million in supplier credit from CMEC. The repayment period for the US$39 million principal amount of the facility agreement and the supplier credit is three years, starting after completion of the construction of the Wood Chip Mill. UFS is expected to finance other development costs of up to US$6 million from internal funds. PT MAL acquired the land required for the construction of the Wood Chip Mill. Pre-construction work, including a land survey and basic and detailed engineering were completed. The main machinery contract was awarded to Andritz OY of Finland by CMEC. Construction of the Wood Chip Mill began in the second quarter of 2005 and was completed by 3Q06. Wood Chip Offtake Arrangement On 4 March 2005, wholly-owned subsidiary Pacificwood, entered into an agreement ( Wood Chip Offtake Agreement ) with CMEC. Under the terms of the Wood Chip Offtake Agreement, CMEC agreed to purchase 80 per cent. of the annual production of wood chips for up to three years after commencement of commercial production. In each three-month period, Pacificwood must sell and deliver to CMEC at least 105,000 tons of wood chips having the aggregate value of 09 November 2006 Page 16 of 47

17 US$10.2 million in the first year, and, in subsequent years, at least 122,500 tons of wood chips per annum having the aggregate value of US$11.7 million. No penalty is payable by Pacificwood if it fails to deliver the required amount. During the term of the Wood Chip Offtake Agreement, Pacificwood must give CMEC the first right to purchase the remaining 10 per cent. of the annual production of PT MAL. Competition The international markets for pulp are highly competitive, involving a large number of producers located throughout the world, many of which have greater resources than UFS. UFS production level will be small by comparison to overall world market pulp production, and the prices UFS will be able to obtain for its pulp will depend on prevailing world prices and other factors. UFS will have competitors in many areas of its business operations and markets. Many factors will influence its competitive position including cost, price, product quality and service. Key competitors will be those who are based in Southeast Asia and produce similar type of market pulp (from Acacia Mangium or eucalyptus trees). UFS believes that its main competitors in Southeast Asia are as follows: APRIL, Sumatra, Indonesia, whose annual market pulp production capacity is 1.8 million tons; PT Tanjung Enim Lestari, Sumatra, Indonesia, whose annual market pulp production capacity is 450,000 tons; and Phoenix Pulp and Paper Public Company Ltd, Thailand, whose annual market pulp production capacity is 200,000 tons. Social Environment UFS cooperates closely with the Indonesian Government and with the local communities, and recognises its responsibility to support the development of the local economy and the social environment. The establishment of the MBBM Mill, the Wood Chip Mill and the reforestation programme will have a number of positive environmental and socio-economic impacts: Employment Opportunities Employment opportunities will be created for local people as skilled and unskilled workers in the operation and maintenance of the mills and adjoining facilities. During the peak MBBM Mill construction period, up to 10,000 skilled and unskilled workers will be employed; Upon completion, the MBBM Mill and adjoining supporting facilities will employ up to 1,000 people; About 5,000 people will be involved in the logistics of the forestry operation, i.e. harvesting and transportation of the wood logs to the MBBM Mill; Local contractors under the supervision of PT HRB will perform the harvesting and transport of the logs; Planting of seedlings will provide silviculture jobs for over 4,000 people; and Thousands of others will be employed by various service and supporting industries during the construction period and later by the small and medium-sized enterprises around the MBBM Mill. Improved Welfare Welfare of the surrounding communities will be improved through: participation in the People Forest Programme; improvements in communications through the upgrading of roads and telephone networks; the upgrading of general educational, recreational and health services; and 09 November 2006 Page 17 of 47

18 the establishment of government offices, shopping facilities and other amenities. Local Procurement The local content during the construction period will be significant. The construction company will procure various locally manufactured industrial products and locally available raw materials such as cement, steel and other building material. In addition, locally available services, including engineering, civil work, steel construction and transport, will be procured. Small and Medium Industrial Estate Utilising the electrical power and other utilities provided by the MBBM Mill, there will be opportunities for the establishment of up to 200 small and medium-sized scale enterprises. These enterprises may consist of light and medium-weight industries such as woodworking, food processing, garment, handicraft, assembly, metal, building and similar types of industries. Fully established, these enterprises alone could present job opportunities for up to 20,000 people. In addition, supporting services to cater for daily needs, including restaurants, workshops, small food markets and barbershops, are likely to be established. Agriculture In view of the significant increase in population expected to be brought about by the project, food supply will need to be established. Cash-crop plantations and daily farms will be set up by the local populace to provide vegetables, meat and poultry for the surrounding communities. Subsequently, these facilities may evolve into producing raw material for the food-processing industries to be established in the industrial area. The local fishing communities will be encouraged to develop and establish processing plants for the daily catch from the sea. Town Site Development A town site will be established at the commencement of the project to accommodate some 50,000 employees with families. Normal infrastructure facilities including water, power, communication, schooling, medical and shopping will be supplied. With the establishment of service and supporting industries, the population in the area is likely to increase substantially and the town site may well grow into a full-fledged township. Shops, schools, sports facilities and other service facilities are likely to be established. Both local and foreign investors will be invited to develop the town site together with the other facilities mentioned above. Environment Sustainable development is a vital component of competitiveness and a necessary condition for the progress and existence of UFS business. To achieve sustainable growth, all projects incorporate environmental considerations from the earliest stages. The use of plantation wood, clean processes and an efficient wastewater treatment plant are among the industry s contribution to environmental protection and are what allows the industry to operate in a sustainable fashion. Fast-growing forest plantations are particularly helpful in protecting the environment as they produce, using relatively little land area, very large volumes of wood that are able to satisfy local 09 November 2006 Page 18 of 47