Corporations often display rational human behaviour, and thank heaven for that. When humans find themselves mired in boring, unpleasant or unhealthy activities, their instinct is to do something about it. They find new jobs or new spouses. The work hard to get a raise. They go to the gym.
So it is with forestry companies in general and paper companies in particular. They are sick of losing money. They have lost money for years. When a paper company CEO fell in the woods, did he make a sound? No one cared, because the value destroyers deserved to fall in the woods, face first, breaking a femur or two on the way down (or so investors hoped).
Newsprint and printing-paper makers Abitibi-Consolidated and Bowater rank among the sorriest examples of stock market deadwood of all time. That time may be over. Their CEOs -- finally, belatedly -- have concluded that making money is more desirable than not making money, and that companies either earn their cost of capital or disappear. Their merger will create $250-million (U.S.) in annual synergies. All other factors being equal, the new AbitibiBowater will see pro-forma EBITDA (earnings before interest, taxes, depreciation and amortization) go from $876-million to $1.13-billion. Operating profit will rise by almost 150 per cent to $421-million. You have to wonder why the two firms didn't get together a long time ago.
Companies merge all the time. Some of the most productive mergers occur in distressed industries. Synergies, which is the polite term for cost cutting, is only one of the drivers. The other is pricing power -- a polite term for squeezing the customer. It's a simple concept. Fewer competitors mean less price competition. Eliminate enough competition and the buyers' market is replaced by the sellers' market. Profit margins expand, investors smile. Customers might scream and run to the antitrust regulators, who may come to the rescue. Generally they don't.
Steel is the perfect example. North American steel companies went through hell a few years ago. Half the industry went into bankruptcy protection or was liquidated. Many of the survivors merged with rivals or were sold (Mittal bought Dofasco, for example). The survivors were able to force customers to accept higher prices and steel firms went from stock market duds to stars. Analysts now mention "steel" and "cartel" in the same sentence, as a BMO Nesbitt Burns report did last month.
Consolidation and pricing power have worked miracles in the airline industry, too. The healthiest airlines in decades are emerging from the post-9/11 shakeout. If you don't believe that, book a flight on Air Canada. It's hard to find an empty seat.
John Weaver, the Abitibi CEO who is to become AbitibiBowater's executive chairman, and David Paterson, the Bowater boss set to be CEO, yesterday steered well clear of potential market control questions. "Pricing power -- you really can't talk about that," Mr. Weaver said.
They can't, but there is no doubt it's coming. Abitibi alone has eliminated 1.6 million tonnes of annual newsprint-making capacity in North America in the past five years. Industry-wide, the figure is 2.3 million tonnes. Last year Domtar, which is merging with Weyerhaeuser's fine paper business, reduced its Canadian paper capacity by 36 per cent. In the U.S., Bowater and International Paper have cut back capacity, too. They had to shrink to stay alive. Falling newsprint demand and rising energy prices clobbered the industry. The tales of woe were worse in Canada, thanks to the flight of the C-buck.
Product prices, as a result, have improved even if North American demand hasn't (newsprint consumption is more buoyant in Europe and Asia). Production capacity and demand are at long last coming into balance. In 2002, when newsprint makers were on the verge of ruin, the operating rate of the North American mills was 89 per cent. It's now 95 per cent. Now add consolidation into the picture. AbitibiBowater will own 55 per cent or more of North American newsprint capacity. That will put the company in a powerful negotiating position with customers and suppliers. There's more good news. The Canadian dollar and energy prices are well off their peaks.
For the first time in years, the stars are aligning for the paper makers. Profits and share prices are on the move. Abitibi's newsprint operations made $40-million in the third quarter, up from $9-million a year earlier. Bowater and Abitibi shares each rose more than 20 per cent yesterday.
A lot could still go wrong, of course. The dollar and energy prices could reverse course. Newsprint demand could plummet. But this is no time to bet against the industry again.
It's had enough pain and wants to make money.
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