International Paper Maps Massive Shakeup

For years, International Paper Co. has led its industry in size and lagged its peers in generating shareholder value. That disparity, in a mature, capital-intensive industry where even the best performers don’t rank as headliners, is a primary driver in International Paper’s massive restructuring, which will cleave off businesses generating 30% of sales and 40% of operating earnings and focus the giant firm on two paper segments where it enjoys leadership positions. Bob Neapole, an industry expert at L.E.K. Consulting, notes that International Paper consistently has finished at or near the bottom of the paper group in the firm’s annual Shareholder Scoreboard. Returns were -0.2% for 2004, 4% on a three-year basis, -3.3% over the last five years, and 3.5% for the latest 10 years. The track record, according to Neapole and other industry observers, reflects the great, often anomalous difficulties in managing modern paper companies and impels significant changes in configurations, product mix, and strategic focus. Whether other companies will follow International Paper is hard to tell, analysts say, not because they aren’t suffering similar pressures but because the paper industry has been in a long-term state of flux, with some noting that restructuring and consolidation have been going almost non-stop for a century. Key players, says Richard Balaban of Mercer Management Consulting, “have for the last 15 years been getting bigger without getting better.” International Paper’s streamlining plan calls for selling or spinning off its coated papers, beverage packaging, and kraft papers businesses along with its Arizona Chemicals and wood products operations and all or parts of its U.S. timberlands. In addition, the company recently agreed to sell its 50.5% stake in Carter Holt Harvey Ltd., the biggest forest products concern in Australia and New Zealand, to Rank Group Investments Ltd. The surviving focus will be on the company’s uncoated papers business, the world’s largest in that segment, and industrial and consumer packaging, which includes corrugated containers and containerboard. International Paper aims to raise $8 billion to $10 billion in divestiture proceeds, which will be earmarked for paying down debt to retain an investment-grade credit rating, investing in a proposed plant realignment, and using 25% to 30% of the take to “return value to shareholders,” probably through share buybacks or special dividends. Balaban says that a major problem for the industry is that unlike other industrial businesses, paper is driven by supply instead of demand. This is the unwitting result, he says, of consolidation, which saddled the industry with fewer but bigger machines that are hard to operate in a cost-efficient manner. They cannot be easily shut down or slowed down when demand ebbs, for example. “Downtime is very expensive,” notes Neapole. That provides an incentive to keep the machines running but it also means that continued production in a soft market reduces prices. “Paper is one of those industries in which the lowest cost of production is when the machine is running at its highest level of efficiency, which, because it is a continual process, means it’s running all the time,” he says. Mergers may have helped reduce capacity but they haven’t improved performance because of the basic cost/production dilemma, which Balaban calls “the industry disease.” “You have a supply-driven cycle, which means that no matter how much the industry grows in terms of total consumption – which has been steady – supply grows faster.” These problems have helped drive an across-the-board series of mergers and restructurings that have been executed through a number of formats. Among the higher-profile actions are the formation of broad-based MeadWestvaco Corp. through the merger of the former Mead Corp. and Westvaco Corp.; Weyerhaeuser Co.’s acquisition of Willamette Industries Inc.; Georgia-Pacific Corp.’s excising of its building materials operation; the going-private LBO and restructuring of Boise Cascade Corp.; and actions by several companies to split manufacturing from their forestlands. International Paper itself warmed up for the big dance by selling off Weldwood of Canada Ltd. along with its smallish industrial papers, fine papers, and foodservice bag businesses. There also have been reshufflings to emphasize core operations in the consumer products, or tissue, segment, which the experts regard as a different part of the industry because of differences in production processes and customer base. For example, Kimberly-Clark Inc. last year spun off its writing paper business as Neenah Paper Inc. Slimming down to two businesses should allow International Paper to get a better handle on managing production, but Balaban says that solving the industry’s basic problem requires a strategic change of mindset to plug the producers in with their customers. Selling a commodity on price is “a very tough way to make money,” he states. “The different approach is to figure out how your product is used in the value chain of your customer and build your business model around that,” Balaban comments. “It’s more complicated and harder to do but it’s more profitable.” Analysts say it’s hard to figure which of International Paper’s expendable businesses will be sold and which will be spun off to shareholders, although the goal of raising multi-billions and maintaining credit ratings suggests cash divestitures are preferred. Most are of good size but a few may be hard sells because, observers say, the company hasn’t kept its equipment up to the most optimum levels of efficiency. Private equity buyers might figure strongly in the buyer mix along with smaller paper firms that seek buying opportunities and larger players that want to build share in specific segments. Take Over Defenses Packaging a Pill With Merger Approval When shareholders of Entegris Inc. and Mykrolis Corp. approved the merger of the two technology firms in early August they in effect also sanctioned installation of a poison pill at the combined company. The defensive mechanism was provided for in the merger agreement between the companies, which supply materials and services for making semiconductors and other technology-based products. It was unveiled in late July when the partners announced that a shareholder rights plan – a preferred share purchase program with flip-in and flip-over features – was adopted by directors of Entegris DE Inc., a subsidiary of Entegris that was the surviving entity in the deal. The pill was timed to take effect when the merger closed and Entegris DE was renamed Entegris Inc. As a result, shareholder approval of the deal extended to the pill, which is to be in effect until August 8, 2015. Other companies voting in stock purchase rights in July included: Alnylam Pharmaceuticals Inc.; Capstone Turbine Corp.; FEI Co.; Knology Inc.; Mattson Technology Inc.; and Navigant International Inc. Firms that scrubbed their pills included Exar Corp.; McGraw-Hill Cos.; PhotoWorks Inc.; and SPACEHAB Inc. (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com