Morgan's Soaring Debt Fuels Speculation in Hamakua Area

posted in: May 1992 | 0

It is difficult to tell from the public record just how much Francis Morgan paid to acquire Hamakua Sugar from Theo. H. Davies & Co. Ltd. in 1984. At the time, newspapers reported the purchase price as at least $69.6 million. Elsewhere, in “Hawai`i’s Sugar Industry and Sugarcane Lands,” a report prepared in 1989 for the Department of Business and Economic Development by Bruce Plasch of Decision Analysts Hawai’i, Inc., the figure of $90 million is given. Morgan gave Theo Davies a note for $20 million, as well as a cash payment of about $50 million. The remainder, if any, may have been satisfied by terms of a land swap between Morgan’s Kualoa Ranch and Theo Davies.

Terms of the swap are partially disclosed in records at the Bureau of Conveyances. From those records, it would appear that more than 10,000 acres of the Theo Davies’ Hamakua land was deeded over to Kualoa Ranch in exchange for 183 oceanfront lots owned by Kualoa Ranch in Ka`a`awa, O`ahu. The sugar company has a long-term lease with Kualoa Ranch, allowing the sugar company to cultivate cane on Kualoa Ranch’s Hamakua acreage. Ranch lands as well as Hamakua Sugar Company lands have been used as collateral to secure the Western Farm Credit Bank loan and other notes.

In any case, it is a matter of record that a loan of $61 million from the Western Farm Credit Bank (or, as it was known then, the Federal Land Bank of Sacramento) provided the bulk of the financing for Morgan’s acquisition of the plantation.

Altogether, it would appear that about 34,000 acres of cane land and improvements (including two sugar mills, plantation camps, roads, and the like) on the Hamakua Coast came into Morgan’s hands, along with a number of long-term leases allowing the plantation to cultivate cane on land held in fee by private parties as well as the state. The improvements are ancillary to sugar production; inasmuch as they are needed for the remainder of the land to be cultivated in cane, their value rides with the land. Or, to put it another way, if the improvements were not part of the package, the value of the land would be reduced.

Using the $90 million figure cited in the DBED report as authoritative, it would appear that Francis Morgan paid $2,500 an acre for the Hamakua land.

Weighing Sugar’s Worth

To arrive at cane land’s value, several approaches can be used. The most conservative values the land according to ability to generate steady income based on agricultural sales. The most radical and also the most risky would assess its value on the basis of its potential for non-agricultural development. This approach allows appraisers to look to the highest sale price for comparable land in the neighborhood and to set a similarly high value on the land in question.

To determine the income-producing value of Hamakua land, Environment Hawai`i undertook the following analysis, using as a basis 1987, the year for which the most complete figures exist:

In 1987, Hamakua’s yield was 9.93 tons of raw sugar per acre. With 42 percent of its 34,560 total cultivated acreage harvested lands are generally harvested only every other year in Hawai’i because of its two-year sugar crop. Hamakua’s sugar production generated income of $50.8 million.

If the production costs per acre (roughly $2,900) are subtracted from the dollar value of the crop (about $3,300), one arrives at the net income, which would be about $400 an acre. However, this figure represents harvest of a crop that takes two years to mature. To arrive at the annual average income of an acre of land, the $400 needs to be halved, to $200.

If one wants a 10 percent return on investment, say; the capitalized value of the land would come to $2,000 an acre. On that basis, the 34,000 acres of Hamakua Sugar lands (along with the improvements needed to make them productive to the tune of at least $200 per acre per year) would be assigned a value of $68 million.

Other Views

On several occasions, appraisals of Hamakua Sugar Company’s worth have been made. One of the most recent is to be found in a December 1991 memo to Yukio Kitagawa, chairman of the Board of Agriculture. That memo, prepared by the Agricultural Loan Division of the Department of Agriculture, seeks Kitagawa’s approval of the continued deferral of payments on the suite loan to Hamakua Sugar Company.

Total assets of Hamakua Sugar are reported in that memo to be precisely $142,456,427. The loans of the Western Farm Credit Bank and the Hawai’i Production Credit Association are given as $68,977,756. Discounting this debit, the net worth of Hamakua Sugar is, therefore, placed at $73,478,671. The state’s collateral (essentially a third mortgage on Hamakua lands) is described as “good.” (Kitagawa approved the deferral, part of several forbearance agreements extended to Hamakua Sugar.)

Fueling Speculation

By any standard, the greatest asset of Hamakua Sugar is its land. To assign to the company a value of $142 million – and to allow the burden of debt anchored by that land to approach that mark – means one is giving the land a value that is more than double what can be justified on the basis of its agricultural income-producing potential. (According to Hamakua Sugar Company’s benefits proposal, prepared in October 1991, the principal and interest on the Western Farm Credit Bank loans totaled $95 million; “combined with other creditors, and capital gains taxes, the overall obligation totals over $130 million,” the document reported.)

To sell the assets at a price that allows one to retire the debt, one must find a purchaser who is willing to pay enough not only to cover the inflated value of the assets-in this case the land being sold, but also to pay the difference between the production-based value of the remaining land and its inflated value.

It is not sufficient, in other words, that Francis Morgan find a buyer for his so-called “surplus” lands willing to pay what he paid. To the contrary; his bailout plan requires that he find buyers who, in the aggregate, will pay enough both to retire the debt on the parcels purchased and to bring down the indebtedness on the remainder of his property to the point where that debt can be paid off with the agricultural income from the retained land.

Tax Liabilities

Adding to the price Morgan needs to get from potential buyers are tax liabilities he faces. There are two types: first, there are the capital gains taxes to be paid should he sell the property for more than he paid for it. Those taxes may add up to several tens of millions of dollars, if Morgan gets what he is asking.

Then there are back property taxes owed to the county or the so-called rollback taxes. Most of the land slated for development was placed under a 20-year agricultural dedication in 1974. Such dedication allowed the owner to be taxed at a favorable rate, but when the parcels so dedicated were no longer inactive agricultural use, the owner (or successor in interest) would be liable for back taxes calculated at the highest and best use for the property; starting from the time the agricultural dedication was put into effect. Apart from that, a 10 percent per year penalty would be imposed.

Hamakua Sugar may already be liable for rollback taxes on a number of parcels. In the area of Kukuihaele, for example, cane has not been harvested for years. Rollback taxes on one 230-acre parcel may approach $110,000, according to preliminary calculations at the county real property tax office. Total rollback tax liability for all the dedicated acres Morgan would take out of cultivation could be in the range of several million dollars.

Volume 2, Number 11 May 1992