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Paper Tigers

Posted: Apr 08, 2008 11:50 AM by James Brumley

Tickers in this Article: IP, WY, UFS, PKG, KPPC, MWV, TIN, C, SSCC

If you closely follow the paper industry, then you already know several reams would be required to sort out all the recent activity among these stocks. Specifically, we've seen a significant number of acquisitions in just the last few weeks.

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And why not? If there was ever a time to load up on (or be forced to unload) a paper enterprise, now's that time. Based on the Dow Jones Paper Index, the average paper stock is down 35% from last July's peak. The index hit new multi-year lows just two weeks ago. The silver lining from a wave of consolidation is simple enough - one or more of these companies will have to survive. Those are the ones I'm interested in. (To learn more, check out The Advantages Of Investing In Aggressive Companies.)

Industry Outlook
The heart of this discussion stems from Citigroup's (NYSE:C) recent upgrade of Temple-Inland (NYSE:TIN) to 'buy' from 'hold'. The underlying rationale is likely to impact all the players in the arena.

The report suggested containerboard (materials used in the production of cardboard boxes) prices wouldn't peak until 2010, and prices of general wood products wouldn't peak until possibly as late as 2011. In the near-term, the analyst doesn't expect any more containerboard pricing pressures until 2009.

If the forecast is accurate, all paper companies could continue to struggle for the next year or so. That's a window of opportunity for those who can weather the storm. (For more on analyst recommendations, check out Why There Are So Few Sell Ratings On Wall Street.)

International Paper Buys Part of Weyerhaeuser
The biggest story lately is Weyerhaeuser (NYSE:WY) selling its container/packaging division to International Paper (NYSE:IP) for $6 billion in cash.

Who wins this one? In the short run, Weyerhaeuser wins. In the long run, International Paper will come out ahead. International Paper is much better suited to run this business. Weyerhaeuser's strength is in raw timber, while International Paper was largely built on production of paper products for the end-user. More than that, the move adds a large amount of market share to International Paper's already-large piece of pie. The company now controls 30% of the market; Smurfit-Stone Container (Nasdaq:SSCC) owns about 19% of it. That's a lot of pricing power.

Next on the Block: Weyerhaeuser's Polymer Composite Unit
Shedding its container and packaging division wasn't enough for Weyerhaeuser; its oriented polymer composite unit is for sale as well. Oriented polymer composite (OPC) is the technical name for wood-plastic composites. The product is growing in popularity as it is considered eco-friendly.

There's no word yet on the asking price, or who Weyerhaeuser's marketing the unit to. So, it's difficult to say who's going to come out ahead on the deal. Based on the International Paper deal though, it doesn't appear Weyerhaeuser will demand a hefty premium. So, the buyer is likely to have the winning hand, as long as they know how to run an OPC business.

MeadWestvaco Sells Mills to KapStone
KapStone Paper and Packaging (Nasdaq:KPPC) recently shelled out $485 million to purchase of six mills from MeadWestvaco (NYSE:MWV) in South Carolina. KapStone benefits from increased cash flows and synergies, meanwhile MeadWestvaco plans to pay off some debt, according to MarketWatch.

The consensus (based on the rally in their stock's price) was that KapStone found a bargain. I'm not so sure though. The synergy-based savings are forecast to be about $2.5 million per year for the now-combined unit that should do about $780 million in annual revenue. That's not a lot. Add in the fact that the purchase was for six different mills (and three different kinds). The synergy could be lost due to lack of initial coordination.

KapStone's "upside" is a concentration in paper produced by the Kraft process called Kraft paper and saturation Kraft. Again, I'm not sure that's a good thing. When you can dominate the market the way International Paper bullies its market, that's one thing. When you're putting most of your eggs in a basket you don't control, that's something else.

Scorecard
The acquisitions and divestitures above are only a smattering of ones we've seen already, and more are likely on the way. So, what will the industry look like a year from now? I think the small companies with good assets (mills, plants. etc) but unable to reach an economy of scale will "win", even if only by being bailed out by a big player. (To find out how the little guys are often the big winners, check out Selecting A Second-Tier Company.)

The losers are the companies caught in the middle: too big for most to buy, but too small to take advantage of size in this incredibly competitive industry. Domtar (NYSE:UFS) is a good example. As for the true winners, International Paper tops my list, even though the stock may not bear fruit immediately. Packaging Corporation of America (NYSE:PKG) also comes to mind, even though the company has yet to show any interest in shopping. Any other big name in a position to gobble up relevant competition could eventually be rewarded as well. One thing is certain: We can expect to see fewer players in the industry a year from now. That's good news for the survivors.

To learn more, check out Trademarks Of A Takeover Target.

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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