Private equity investors stalking debt-laden companies have found the paper industry an intriguing place to gamble.

by David Price

Consider the following “players”: Koch Industries, (US), Madison Dearborn Partners (US), Cerberus Capital Management (US), EQT (Sweden), and CapMan (Finland). They are not paper makers, they are private equity investors—emerging financial players at the paper industry table.

Between them they own all, or parts of, Georgia-Pacific, Boise Cascade, Graphic Packaging Corp., Jefferson Smurfit Group, Buckeye Cellulose, Packaging Corporation of America, NewPage (formerly MeadWestvaco's paper business), Smurfit, Munksjo, along with Metso Drives and the Helsinki building in which Kemira has its headquarters.

In addition, Carl Icahn and Swedish fund manager Christer Gardell together built up a 4 percent stake in Metso Oyj. Last May, Icahn instigated talk of breaking up the company.

Family-owned Koch Industries of Wichita, Kansas has the highest profile because it has just bought GP for $21 billion. In doing so it has parachuted in its own Koch management team and sidelined that of GP. Outgoing CEO, Pete Correll, at the height of the purchase, said, “This is a tough industry to make a profit in and some sectors are hopeless. In those cases the best solution is to get out. It's better to go into those sectors where making money is easy.”

Last year Correll was commended by this magazine and RISI for turning GP into a consumer products firm from a cyclical commodity producer. But it has clearly come at a cost.

The new owners of GP are big players in the oil and gas industry, and chemicals and energy. So why would they want GP? And why do the other private equity firms want to invest in this industry?

The first thing they look for is debt and “distressed investment.” Cerberus of New York, for example, buys the debt, invests money and provides cash flow. Cerberus has at its disposal $14 billion of capacity investment. The firm's vice chairman is former US vice president, Dan Quayle.

Madison Dearborn of Chicago… “invests in a broad range of companies where strong cash flow or business portfolio repositioning permits the creation of equity value through the reduction of acquisition indebtedness.” In other words, they buy debt. But they have investments in five pulp, paper and packaging companies.

EQT of Stockholm has Euros 6 billion invested in various companies, two of which are Munksjo and Smurfit. Again, they buy up debt, inject money and restore cash flow.

CapMan of Helsinki focuses on Scandinavia and last March bought Metso Drives from Metso Corporation. Last November it bought the Helsinki headquarters of Kemira which has a leasable area of 16,000 square meters. Kemira will remain as a long-term tenant in the building.

WHAT WILL HAPPEN?
It is important to understand how these firms operate. Mark Connolly of Credit Suisse First Boston (CSFB), speaking at PRIMA in Hamburg last year, highlighted how traditional pulp and paper business models have failed to generate the kind of returns that investors seek. He believes the new financial players, or private equity funds, will move further into the industry in North America and Europe.

Connolly suggests that these players are more likely to make money from the industry since they are interested, first and last, in financial returns rather than growth. They will seek to sell overvalued assets and get out of unprofitable markets before cutting costs or reinvesting, which was the traditional approach.

In my experience, the investors usually acquire companies by borrowing huge sums against future earnings. The first thing that happens is a vicious round of job cuts, intended to boost profits by trimming costs. Assets are sold, operations outsourced and then a few years later, what's left of the company, is sold on for a fat profit.

In my view, the industry in North America will be further transformed by private equity activity. It will change and its ownership will be diverse and remote. I think the state of the US film (movie) industry is an instructive example for our own. Studios are no longer individually owned. The famous brands of Paramount, 20th Century Fox, Universal, RKO and MGM are owned by Sony, Vivendi, News Corporation, Time Warner, Zivaldi, Seagram and Matsushita. Some of their business is film-making, but most of it is elsewhere. The bottom line managers who run these companies are not interested in filmmaking, but in selling a big-name product that might have spin-offs or merchandizing potential.

For my generation nothing is more quintessentially American than Hollywood. But in the 21st century, Hollywood's products are now commodities, owned by transnational conglomerates, which are bought and sold in global markets.

Is this the emerging pattern for the US paper industry?

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