Who Owns Whose Trees?

Dec. 21, 2004
The global makeover of the forest products industry has only just begun.

In dramatic fashion last month, the boundary lines of the global paper and forest-products industry disappeared in the aftermath of five mergers, takeovers, and acquisitions in 13 days, including the industry's first two significant transatlantic mergers. Finnish paper companies UPM-Kymmene Corp. and Stora Enso Oyj -- themselves the result of mergers in the last four years -- reached across the ocean to buy, respectively, U.S. firms Champion International Corp. and Consolidated Papers Inc. In addition, U.S. giant Smurfit-Stone Container Corp. gobbled up Canada's St. Laurent Paperboard Inc.; Canada's Abitibi-Consolidated Inc., the largest newsprint producer in North America, bought Canadian newsprint company Donahue Inc. from Quebecor Inc.; and International Paper Co. purchased containerboard firm Shorewood Packaging Corp. in a merger of two U.S. companies. "Once one occurs, the others fall into place," says John Linehan, analyst with T. Rowe Price Associates Inc., Baltimore. "There is a natural domino effect because other companies want to make sure they have someone they can be comfortable with." The paper industry's global makeover "has only just begun," says Kathryn McAuley, analyst with Brown Brothers Harriman & Co., New York, the largest privately owned bank in North America. "There is an awful lot of consolidation ahead of us." Much of that consolidation will be in the U.S. -- for two reasons. First, it's the most important printing market in the world. Second, two-thirds of the European paper companies, most of them in Scandinavia, disappeared when the industry shrunk to half a dozen players as the companies consolidated over the last decade. "The U.S. is where the consolidation game is going to reside for awhile," says Linehan. "It is much more fragmented." But not for long. McAuley anticipates that within five years, "you will probably see only a few global players for each industry segment." That would be a stark contrast to the more than 100 companies that exist today, even in the aftermath of an 18-month period (before last month's merger blitz) that saw a flurry of mergers between U.S. and Canadian companies. "Forest products is still an incredibly fragmented industry worldwide," especially when compared with other commodity industries, says Marc Wilde, New York-based analyst with the Baltimore firm of Deutsche Banc Alex. Brown. "International Paper is the largest paper company in the world and it has only a 5% market share. You still have scads of players in North America alone" -- upward of 20 in Canada and 30 in the U.S. Part of the urge to merge now is an increasing need to become global in what was strictly a regional industry until a little more than 10 years ago. "End-use customers want fewer suppliers, and they want them to be global but supply locally," asserts McAuley. Another factor: The current low valuations of cash-rich U.S. companies has made them more attractive and affordable to European firms, especially since there appears to be a relatively stable growth curve for earnings in the near future. "The paper sector is in a bear market and valuations have come down dramatically (25% from the beginning of the year to mid-February) even though earnings are expected to increase dramatically, if not double," says McAuley. "That has opened the window of opportunity for mergers." Wilde adds that competitive pressures from new production regions such as Latin America and Southeast Asia and U.S. paper companies' financial returns, which for most of the 1990s were "pretty much an unmitigated disaster," are causing them to "think differently" about how they manage their businesses. For example, "There is a much more disciplined approach to new capital investment," he says, with many companies limiting such expenditures to 50% of depreciation costs compared with years past when they routinely spent as much as four times depreciation to add new capacity. McAuley agrees. "In the last two years, companies have ratcheted down capital spending in North America, Europe, and Asia. Instead of spending cash on new equipment or capacity, they are using cash to increase dividends, repurchase shares (Weyerhaeuser Co., began such a plan last month), and to make acquisitions. That is how they are now growing their market share." Thus, analysts believe the merger craze can only help the industry because of the synergies and capacity rationalization that can occur. "It is positive for the companies and it is positive for the industry," says Linehan. "It should take capacity out of the industry, improving efficiency, and the more concentrated the industry becomes, the more pricing improves." Last year Abitibi shut down 450,000 tons -- or 3% -- of its North American newsprint capacity and this year the company plans to shut down another 515,000 tons -- or 2.5% -- of capacity as it integrates the Donahue newsprint operation. Weyerhaeuser, which bought Canadian corrugated paper manufacturer MacMillan Bloedel Ltd. last fall, said last month that it will close four corrugated-paper plants this year. International Paper eliminated excess paperboard capacity when it bought Union Camp Corp. 18 months ago and Smurfit-Stone shut down over 1 million tons of containerboard capacity after it digested Stone Container Corp. "Global companies can allocate capacity better and be more efficient in production," says McAuley. Equally important, as the industry becomes more global, the likelihood of overcapacity should decrease. "With more of a global view, companies should be more sensitive to how capacity additions in one region of the world would affect their business around the world," says Wilde. What's more, if European companies continue to acquire U.S. companies, product pricing should stabilize. "They have always been much better at balancing supply and demand than U.S. companies," says Wilde. "That's why pricing in Europe has always been much more stable." What's the short-term impact of the most recent merger wave? First, U.S. companies such as Temple-Inland Inc., Louisiana-Pacific Corp., and Boise Cascade Corp. will need to assess "whether they are positioned to compete in a global market," says Linehan. Others, especially giants such as International Paper, will try to become even larger through acquisitions in Latin America and Asia. Second, the mergers will force $12.5 billion Stora Enso and $14 billion UPM -- both of which had more than 80% of their sales from Europe before last month's acquisitions -- to think differently. "They now have to take the impact on the U.S. market into consideration," says Linehan. Third, just as the International Paper-Union Camp and Jefferson Smurfit-Stone Container mergers made the containerboard industry more efficient, Wilde expects the same to happen in newsprint with the Abitibi-Donahue linkup and in coated papers with the Stora Enso-Consolidated and UPM-Champion mergers. (UPM will change its name to Champion upon that merger's completion.) "There is very little doubt in my mind that the acquisitions by these two Finnish companies will help the coated-paper business in North America," even though three of the four largest coated-paper operations in North America will be foreign owned, says Wilde. "There will be a much more global view of the business." And while Stora Enso gets the biggest and "the best house on the block" in the North American coated-paper business, Wilde says that if the UPM-Champion deal goes through "they've hit a home run." The reason? Whereas Smurfit-Stone and Stora Enso paid premiums of 70% for their acquisitions, the $60 per share purchase price UPM paid was only a 30% premium over Champion's share price. Besides, says Wilde, Champion was worth $40 to $50 per share just for its timberlands. "UPM obtains a big, asset-rich (but underachieving) company with good mills, one of the best paper businesses in Latin America, and 1.5 million acres of timberland in Brazil," says Wilde. "It gives the company entry into the U.S. as well as the Latin American markets and fortifies its position in the magazine and fine papers businesses." Similarly, Donahue should give Abitibi, which restructured and lost money the last two years, an enormous boost. Donahue, which two years ago bought Champion's newsprint operations, is considered to be the lowest-cost newsprint manufacturer in the world, with a well-integrated pulp and lumber business.

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