Papering over cracks in Europe
Or is M-real the real deal?
“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