Author
In 1840, John Edwards built a sawmill on the banks of the Wisconsin River in central Wisconsin. It soon developed into a paper mill, which he passed on to his son. John Jr. built the business into an economic powerhouse, and, in commemoration, his statue now stands in front of the sprawling mill that dominates the town, Port Edwards. The statue and the large white letters on the mill's brick smokestack—NEPCO, or Nekoosa-Edwards Paper Co.—are two of the town's most visible reminders of paper's deep historical roots and the prominence of local paper magnates in this part of Wisconsin.
But roots are shorter these days, and paper is no longer local. NEPCO was long ago transformed into Great Northern Nekoosa (GNN), and 10 years ago—in the paper industry's first hostile takeover—GNN was bought out by Georgia-Pacific, the Atlanta-based forest and paper giant. Since then, like a slurry of wood pulp coalescing into sheets of paper, the hundreds of small companies that have comprised the U.S. paper industry since the 1800s have been merging with unprecedented speed.
The trend has begun to concentrate a highly fragmented industry. In 2000, the top five paper companies accounted for 34 percent of total sales among the industry's hundred largest companies, up from 28 percent in 1998. And nowhere has this consolidation had greater impact than the Upper Midwest (see sidebar). Paper mills built over a century ago in Minnesota, Wisconsin and Michigan, and run by their founders' families for decades, have been bought by larger corporations. Then, in dizzying succession, the buyers themselves have been acquired by still larger entities.
The latest big deal blended John Edwards' paper mill still further into the world of corporate paper heavyweights. In late November 2000, Georgia-Pacific bought Fort James Corp. for $11 billion, creating the world's largest tissue paper company; Fort James itself was the result of a 1997 merger between the James River Corp. of Richmond, Va., and Green Bay's Fort Howard Corp., another of Wisconsin's oldest paper companies.
This tidal wave of mergers and acquisitions is an effort to combat poor financial performance by the North American paper industry and increased competition from low-cost global producers. But while many corporate strategists and financial analysts believe consolidation will result in better returns to capital, skeptics question whether it will be enough to bring stability to the highly cyclical industry. In addition, labor unions and local communities worry that new owners will have little regard for their welfare, and some mill managers seem resistant to the changes that such mergers seek to achieve. Still, no one doubts that consolidation is likely to continue, and the few Ninth District paper companies that have so far remained independent are positioning themselves with mergers in mind.
Behind the trend
The pace of change has shaken the industry—"breathtaking" as one observer put it—but the trend itself isn't surprising. Some consider it long overdue. One of the primary drivers, according to analysts and industry insiders, is increased competition from abroad: the globalization of the industry.
"What you're facing is long-term new entrants from Asia and Brazil that are much lower cost," noted Anna Torma, senior U.S. paper and forest products analyst for Merrill Lynch & Co. Foreign competitors with lower labor and resource costs create "a much weaker global competitive market position" for paper companies in many grades of paper, said Torma. "The natural response is for producers to try and increase their relative market position in North America, focusing on the largest customers that will be more difficult for foreign providers to target because they won't be able to provide the same level of service." So paper companies acquire one another in order to be able to provide superior levels of service for large paper customers like OfficeMax, for example.
American paper companies also face global competition from regions with similar production costs, like Europe, because of the strength of the U.S. dollar relative to the euro. "We've seen significant increases in imports over the last two years, 25 percent in each of the last two years, because of the strength of the U.S. dollar," noted Mike Birkeland, communications manager for Potlatch Corp., Minnesota's largest paper industry employer. "It creates the opportunity for domestic buyers to purchase foreign products at very, very competitive rates based on the exchange factors."
Paper profits
The other major factor behind consolidation is the need to address investor concerns over poor profitability in the paper industry. "The principal thing behind this [consolidation] trend is the very poor financial performance of the industry over the last 10 years," said John Hanby, vice president of technology for Potlach in Cloquet, Minn. "I think that's really the driver."
Merrill Lynch's Torma concurred. "One of the overriding factors" behind consolidation, she said, "is the cry by investors to have more profitable long-term outlook if [the industry] is going to have ongoing access to capital."
For years, paper companies have had low returns to capital relative to other industries, averaging just over 7 percent in the last five years, according to a recent industry analysis, compared to over 9 percent in food, drugs and tobacco, and 12.5 percent in chemicals. Competition from low-cost foreign producers has simply exacerbated the problem.
The industry's hope is that through consolidation, paper manufacturers can shut down less efficient mills and manage capacity more effectively—something the fragmented industry comprised of small producers has been reluctant to do. Historically, paper mills have seen maximum tonnage as their goal and have run mills at the highest possible operating rates. To improve returns, consolidated paper companies intend to bring supply into better balance with demand at prices set by the global market.
In essence, to make itself more attractive to investors, the industry needs to become more profitable, and the only way to do that in the face of global competition is to seek greater efficiencies by cutting costs.
"We're changing at IP from a belief that every machine and facility must be operated at 100 percent capacity," said International Paper CEO John Dillon, at an October 2000 paper conference in Appleton, Wis. "We call this making more money, not making more tons." For years, said Dillon, industry earnings have been highly cyclical "because we choose to operate beyond customer demand, thereby building inventory and lowering revenue." The industry now hopes to focus on reducing costs and "finding that 'sweet spot' where production is most profitable."
"The hope of the industry, and the financial community that supports the industry, is that by consolidation, these larger groups of companies with large capacity will be able to manage these supply/demand swings," said Dan Temple, a senior consultant at Jacobs-Sirrine Consultants.
In addition, consolidation can lower costs by eliminating labor made redundant when one company buys another. Marketing, sales and engineering payrolls can be trimmed in the new corporate entity, one of the money-saving synergies that mergers and acquisitions hope to deliver.
Pink slip synergy
In just such an effort, International Paper, the world's largest paper company and new parent of Wisconsin-based Champion International, announced in October 2000 (just two weeks after Dillon's Appleton speech) that it would close three U.S. mills employing 2,500 workers. Wall Street was delighted, rewarding the company with a 9 percent jump in share price. "IP shutting down 5 percent of white paper production permanently—this is what great companies do," remarked Bear Stearns analyst Linda Lieberman.
The downside of such synergies, of course, is that people lose their jobs, and while the IP closures occurred in Alabama, Arkansas and Pennsylvania, Ninth District workers have also paid a price when Upper Midwest paper companies have trimmed their workforces. A number of these reductions have taken place through voluntary retirement or attrition, and some were under way prior to the mergers, but the layoffs have had a significant impact in small communities that have long relied on good-paying paper mill jobs. Overall, from 1995 to 1999, employment in paper and allied industries declined 3.9 percent in Minnesota, Wisconsin and Michigan combined, according to Bureau of Labor Statistics data. Minnesota saw the biggest decline (10.2 percent), followed by Michigan (down 5.6 percent), while Wisconsin had a slight increase (0.8 percent).
"The paper industry has been known [to provide] good jobs, some of the higher-paying jobs, including salary and benefits, and when these jobs leave a community that is where the real devastation can come in," noted Leon Towne, vice president of the Paper, Allied, Chemical and Energy (PACE) Workers International Union, for Region 10, which includes most of the Upper Midwest. Average hourly wages for paper and allied industries jobs range from $16.53 in Michigan to $18.76 in Minnesota.
Culture shock
A more subtle concern is the cultural change created by consolidation—a fear that new owners won't have the same commitment to community welfare that homegrown owners did. "A less obvious impact of this trend toward large corporate ownership is the effect on community organizations and what is often termed 'community spirit,'" noted the Northwest Regional Planning Commission (NRPC) in its recent profile of the paper industry in Wisconsin and Upper Michigan. "Plant managers and senior staff are often very active in their communities, but frequent ownership change often results in frequent changes in personnel."
Midwest paper mills tend to have inordinate influence on their local communities, especially in rural areas, where they're often the largest single employers. But the NRPC report acknowledged that "given the global nature of the pulp and paper industry," communities have limited capacity to influence decision-making on paper mill operations. The report suggested that infrastructure improvements and tax incentives might have some effect on corporate decisions, but recommended that communities look to "diversify local economies to reduce dependence on the pulp and paper sector."
Source: American Forest Paper Association,
Statistics of Paper, Paperboard and Wood Pulp
Change inevitable
While job loss concerns are understandable, the fact remains that older, less efficient paper mills will eventually be driven out of business by low-cost paper from elsewhere. Takeovers shift the blame, but they don't change the outcome. And in some cases, the deeper pockets of new corporate owners have helped modernize mills that previous owners couldn't afford to upgrade. In Port Edwards, for example, Georgia-Pacific recently decided to build a new chip mill, creating new local jobs. Local PACE union president Edward Saylor said that over the 10 years since Georgia-Pacific's takeover of GNN, the new management has listened to labor concerns, even though they're no longer next-door neighbors.
"Before we were taken over, we were family-owned. ... All the senior officers were local people," said Saylor. "And now we're operated out of Atlanta. But we've still been able to make contact with the CEOs and the vice presidents for this area. ... It's been a good relationship really because they have stuck money up here."
"They built a great big warehouse after they took us over and they dumped quite a bit of money into us," he added. "And we've also given them quite a bit back, at the same time. They just shut down a mill in Kalamazoo, Mich., and so I guess we had to feel lucky ... that we're still running and being profitable at the same time."
Does size matter?
For industry, the big question is: Will it work? Will all the mergers and acquisitions pay off by cutting costs, reducing capacity and establishing greater control over supply levels? While the theory is appealing, observers note that the long-term impact on financial performance remains uncertain.
"There's been checkered success," said Temple. "The success of merger and acquisition synergies are still not proven." The leading magazine covering the paper industry, Pulp&Paper, noted in its November 2000 issue that "in general, performance for larger companies has lagged that of small- to medium-sized firms, based on return on assets or similar gauges." In that same vein, Michael Shanahan, vice president and managing director of global resource practices at the Arthur D. Little Inc. consulting firm, told a recent paper industry conference that "large consolidations have not improved the outlook for the pulp and paper industry. ... Companies that seek acquisitions and consolidations aggressively tend to underperform."
Moreover, it doesn't appear that capacity management, the oft-stated goal of the consolidation frenzy, has made it through the chain of command. Pulp&Paper's 2000 survey of paper mill managers found that 50 percent of them view maximum tonnage as their primary goal, an increase from 42 percent who felt that way in 1999. Some suggest that a different sort of culture shock may be in play here: Merged corporate cultures may have difficulty with internal communication.
Regardless, the consolidation trend seems certain to continue over the next year, and companies that haven't yet been acquired are either preparing for it or figuring out how they themselves can launch an acquisition. Potlach has already begun a cost-saving program, including layoffs, in what some say is preparation for acquisition. Tiny Badger Paper Mills, the only publicly owned paper company headquartered in Wisconsin, seems a likely takeover target. Analysts also consider Mead Corp., which employs 1,400 at its Escanaba, Mich., mill, a possible acquisition target. But all is speculation until the deals are done, and the fact is, virtually every paper firm should be looking over its shoulder.
"With low-cost entrants coming in, you have two choices," said Merrill Lynch's Torma. "You can either move up the value chain, or you can become the largest." Companies like International Paper have focused on growth, but others may try to develop specialized paper markets. Boise-Cascade, with operations in Minnesota, has been able to extend its life span by moving up the value chain. Other Ninth District paper companies like P.H. Glashalter and Wausau-Mosinee have long-established market niches that have set them apart from the current wave of "capacity rationalization."
But for the industry as a whole, the matter of profitability will remain key to paper's long-term health. "The critical question," observed James Robins, an A.D. Little analyst, "is whether the industry has learned its lesson on supply and demand. Will it refuse to build inventory in soft markets to avoid driving price and profits to the bottom? Only time will tell."
