Pa­per­ing over cracks in Europe

Or is M-real the real deal?

Finweek English Edition - - Companies & Markets - SHAUN HAR­RIS

“Those are high-end mag­a­zines, less af­fected by the down­turn,” says Boëttger.

But Fin­week had to ask him, as we have be­fore, whether Sappi wasn’t re­peat­ing its per­ceived mis­take of in­vest­ing in op­er­a­tions in the higher cost base of West­ern Europe in­stead of lower cost but still lo­gis­ti­cally ac­ces­si­ble emerg­ing mar­kets in East­ern Europe.

“There’s a per­cep­tion that costs of pro­duc­tion in Europe are higher but that’s not nec­es­sar­ily the case. In some re­gions and ar­eas – such as salaries – yes, they’re higher. But in terms of dis­tri­bu­tion we’re close to our cus­tomers,” was his re­ply.

It will take a few years to see if the ac­qui­si­tion is work­ing – fi­nan­cially – for Sappi. Share­hold­ers shouldn’t ex­pect a sud­den in­crease in bot­tom line earn­ings: the di­lu­tion caused by its rights is­sue will prob­a­bly see earn­ings per share growth flat for its next fi­nan­cial year, maybe two. THERE’S A NAG­GING CON­CERN about Sappi’s large €750m (R8,9bn) ac­qui­si­tion an­nounced last week. The as­sets the South African-based pa­per and pulp pro­ducer is buy­ing – chiefly four pa­per mills in Europe – made an op­er­at­ing loss of €30m in firsthalf 2008.

And it seems cur­rent own­ers – Fin­land’s M-real OVI – have sel­dom, if ever, made de­cent prof­its from their coated graphic pa­per mills in the past seven years.

M-real CEO Mikko He­lander says the group is con­tin­u­ing its “strate­gic re­view” of its re­main­ing pa­per busi­nesses. The short ver­sion would ap­pear to be: “We want to get out of pa­per.”

M-real is a large player in the in­dus­try in Europe and also one of its ma­jor pulp pro­duc­ers. If it couldn’t squeeze prof­its out of its pa­per busi­nesses how will Sappi?

“We be­lieve it will fix our Euro­pean busi­ness,” says Sappi CEO Ralph Boëttger. “We an­tic­i­pate the ac­qui­si­tion will in­crease prof­itabil­ity, re­sult­ing in bet­ter re­turns and im­proved cash flow for the group.”

Europe has been a bleed­ing wound for Sappi (and other ma­jor pa­per pro­duc­ers) for a long time due to over-ca­pac­ity and ris­ing raw ma­te­ri­als and en­ergy costs. Boëttger says no play­ers have been prof­itable in the fine pa­per mar­ket (where Sappi is dom­i­nant) “for the past seven or eight years”.

The deal looks quite good on pa­per. Sappi pays what seems a com­pet­i­tive price for the mills in Fin­land (two), Ger­many and Switzer­land. It se­cures a sup­ply con­tract with two fur­ther M-real mills that will re­main in its own­er­ship. And M-real agrees to stop pro­duc­tion of coated wood-free pa­per at two mills in Aus­tria and Ger­many.

But deals of­ten look good on pa­per – mak­ing them work is the hard part. Much of the re­turn to prof­itabil­ity for Sappi in Europe and an im­prove­ment in the in­dus­try’s sup­ply and de­mand equa­tion hinges on the 0,6m t of pro­duc­tion M-real will take out of the sys­tem by halt­ing op­er­a­tions at the mills in Aus­tria and Ger­many. That will re­move around 5% of coated fine pa­per ca­pac­ity in Europe. But will that be enough to make a dif­fer­ence?

“We need a struc­tured so­lu­tion for fine pa­per in the Euro­pean mar­ket; we need con­sol­i­da­tion in what’s a frac­tured mar­ket. Our strat­egy isn’t about size but about re­turn on cap­i­tal em­ployed. As a min­i­mum that must be the cost of cap­i­tal, but for years we couldn’t get that in Europe. With this ac­qui­si­tion, we be­lieve we can now achieve it,” Boëttger says.

Kari Jor­dan, chair­man of M-real, agrees. “The op­er­at­ing en­vi­ron­ment of the in­dus­try will im­prove, which will be ben­e­fi­cial also for M-real as a fu­ture share­holder in Sappi.”

Part of the price will be €50m newly is­sued Sappi shares. The bulk will come from a €450m rights is­sue Sappi plans to hold, which has the sup­port at home of in­sti­tu­tional share­hold­ers Al­lan Gray and RMB As­set Man­age­ment, who to­gether hold 34% of Sappi in clients’ funds.

But for the ac­qui­si­tion – and prof­itabil­ity in the in­dus­try in Europe – to work, Sappi is go­ing to have to get price in­creases through. year. One thing the deal does do is put Sappi in a stronger ne­go­ti­at­ing po­si­tion by giv­ing it more clout. Graphic pa­per ca­pac­ity in Europe will in­crease from 2,6m t to 4,5m t/year, mov­ing Sappi’s to­tal ca­pac­ity in the mar­ket to nearly 24% and mar­ket share to around 30%.

The deal also brings spe­cialised skills and knowl­edge and some lead­ing cus­tomers, in­clud­ing Newsweek, Vogue, Cos­mopoli­tan, Reader’s Di­gest, Elle and Na­tional Ge­o­graphic.

Fur­ther in­creases will be needed, prob­a­bly as soon as the

beginning of next year.

An in­crease has re­cently been pushed through that Boëttger says is hold­ing. “It’s a shock to the sys­tem – we haven’t seen that for seven years. Th­ese price in­creases are out of ne­ces­sity – our costs are up. I think the mar­ket un­der­stands that.”

But fur­ther in­creases will be needed, prob­a­bly as soon as the beginning of next

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