A new push overseas offers lots of potential, but investors have yet to be convinced
Despite its name, International Paper (IP) has long been about as American as they come. Founded in 1898 when 17 paper mills in the Northeastern U.S. merged under the leadership of a boyhood friend of Thomas Edison, the company supplied 60% of the newsprint for American papers of the day. In the 1920s and '30s it was the primary supplier of electricity to New England, and during World War II it developed waterproof ammunition boxes for GIs.
But these days, International Paper, which most in the business refer to as IP, is finally living up to its global name. After years of weak financial performance—in 2001 it posted a net loss of $1.2 billion—and facing stiff competition from low-cost rivals in Brazil and China, IP is branching out from its North American roots in favor of developing markets.
IP's latest move is in Russia. In October the company paid $650 million for half of Ilim Pulp, the country's leading papermaker. The partners have pledged $1.5 billion more over the next five years to upgrade the venture's four mills in northern Russia and Siberia. The investment "positions us very well within low-cost, high-growth markets," IP Chief Executive John V. Faraci said in a statement on signing the agreement in August.
That purchase follows other big-ticket deals in developing countries. In Brazil, IP is investing $1.15 billion in a pulp mill in the south-central city of Tres Lagoas, due to begin operation in 2009. The new plant will supply pulp to a new IP paper factory to be built nearby. When the project is completed, IP will own three mills in Brazil and expects to control about half of the office paper market in Latin America. And last year, IP invested $140 million in a joint venture with China's Shandong Sun Paper to produce coated paperboards for milk cartons, cigarette boxes, and the like. The venture expects to sell to existing IP customers such as McDonald's (MCD) and Wal-Mart Stores (WMT) as they expand in China.
Thanks to radical streamlining of its operations back home, IP has plenty of cash to fund its international ambitions. Since 2005 the company has sold off $11.3 billion worth of assets, about a third of its total. These include some 5.4 million acres of forest—roughly 85% of IP's timber holdings in North America—that the company sold to investors and conservation groups last year for more than $6 billion. Also on the chopping block were resin and glue maker Arizona Chemical (sold for $485 million), the company's beverage packaging operations ($500 million), and lumber producer Weldwood of Canada ($955 million). IP does, though, still own 18 U.S. mills and makes more than 70% of its sales there. The company declined to make any executives available for this story.
PILES OF DEBT
The Ilim Pulp deal isn't IP's first foray into Russia. The country's vast tracts of forestland—ranging from the lush Pacific coast through the Siberian taiga and all the way to the Finnish border—offer huge potential. Russia's timber output today is less than a third its level in Soviet times, so there should be lots of growth for investors willing to pump cash into rundown paper and lumber mills. Since 1999, IP has had a plant in Svetogorsk, near St. Petersburg, that produces copier paper for the likes of Xerox (XRX) and Hewlett-Packard (HPQ). But the new venture represents a quantum leap in IP's commitment to the country. Based in St. Petersburg, Ilim is Europe's largest timber producer, with sales last year of $1.6 billion. "The Americans will bring new technology and management," says Anna Krylova, an analyst at Antanta Capital in Moscow. That, coupled with better contacts in China, Ilim's biggest export market, "will bring Ilim to a completely new level," she says.
Analysts have long argued that IP was too big and unfocused, dabbling in businesses ranging from lumber to chemicals. In the early '90s, IP even invested in a company that made graphic design software. By 2000, after a string of acquisitions, the company had piled up $12.9 billion in debt. Those problems have pushed its shares down from a 1997 high of nearly $59 to the mid-30s today.
IP isn't alone in unloading its U.S. forestland. Tax rules make it unattractive for paper companies to own such land, so selling timber holdings "is what everybody did," says Citigroup analyst Chip Dillon. "What everybody did not do was what International Paper did with the money: go overseas."
Now, the company says it will focus on just two core product lines: uncoated stock, such as office copier paper, and packaging materials. The changes, though, haven't really started to pay off. Faraci told analysts on Nov. 2 that margins in key emerging markets are more than double those in the U.S., but analysts expect IP's operating profits this year to tumble 21%, to $1.7 billion, as sales dip by 2%, to $21.6 billion, researcher Thomson Financial (TOC) reports. The real problem, analysts say, is not so much IP's plans for expansion in risky emerging markets, but rather its continued poor performance in the U.S., where demand remains sluggish and costs high. "Going back three or four years, IP was a little more rotten at the core," says Deutsche Bank (DB) analyst Mark Wilde. "Now they've sold all the land, but they need a second step. Most of us are still in show me' mode."