Dr. Michael Smurfit selected Pulp & Paper/Pulp & Paper International Global CEO of the Year for his aggressive, innovative leadership in Smurfit-Stone merger

Smurfit-Stone Container’s Blueprint for Success Setting the Standard

Dr. Michael W. J. Smurfit, chairman and chief executive officer of Jefferson Smurfit Group plc, and Chairman of Smurfit-Stone Container Corp.

Dr. Smurfit was announced the winner in October and accepted the award at the Paper/Forest Products Global Outlook conference sponsored by Miller Freeman, publisher of P&P, and held in New York on Nov 16, 1999. Many members of the financial community now see the merger in 1998, of Jefferson Smurfit Corp. and Stone Container Corp to form Smurfit-Stone Container Corp as the model for efficient capacity management in the U.S. It has created the dynamic for the restructuring and recovery of the industry noted a press release announcing the award.

Reflecting the views of many in the financial community, one director of a major investment management firm noted that “Dr. Smurfit had the foresight to create a merger and the guts to close significant capacity. He changed the way the industry looks at the business, from one focused on selling as much linerboard as possible to one where optimum profitability is what counts.”

In the view of many who voted for him, the most notable event of the merger was the removal of 1.1 million tons of capacity from operation. The four-containerboard mills indefinitely shut at the end of 1998 were medium mills in Circleville, Ohio; and Alton, Ill.; and kraft liner mills in Port Wentworth, Ga.; and Jacksonville, Fla.

Dr. Smurfit joined his father’s company in 1955. He was appointed joint managing director of Jefferson Smurfit Group Ltd. 12 years later, becoming deputy chairmen in 1969. In 1977 he was appointed chairman and CEO of Jefferson Smurfit group Ltd.

This article provides a profile of the company and its strategy regarding the merger, capacity reductions, etc. Information is based on comments made by Dr. Smurfit upon acceptance of the award and on a separate Q& A session with Dr. Smurfit, which was conducted by Pulp & Paper.

BACKGROUND TO THE MERGER. In accepting the award, Dr. Smurfit noted that when the merger was put together, the bond market had just disintegrated, problems in Asia were in full swing, and spreading to impact other parts of the world, and containerboard markets were at new lows. Given this, he noted the question was why did we do it? He observed that several factors made the outlook look bright. Among them were: industry demand increased year to year; raw materials were plentiful; the North American packaging market had some security regarding offshore competition. Thus, all of the ingredients that are needed to generate shareholder returns existed, i.e. growing customers, wide spread resources, and no large foreign threat. However, instead of returning value to shareholders, the industry’s shareholders have suffered for years, and companies have failed to earn its cost of capital in most of the last 10 years. He stressed that in his view, shortsighted managers in the past saddled the industry by increasing capacity when it wasn’t warranted and raising production and swamping markets with supply.

As a result of all of this, he noted, JSC had to do it (the merger). Smurfit had provided shareholders with strong returns up through the late 1980s by aggressively acquiring, expanding, and investing in very good assets at fair prices and then running them well. They never built a new paper mill. Furthermore, these investments were based on real, not anticipated demand, however, their growth reached the point where they couldn’t buck trends and that others were driving markets and impacting their business as well. So in order to avoid becoming a “me-too” paper company, they saw that a major change was needed in the big U.S. market.

The merger of Stone and Smurfit provided a first step in this process. The shutdown of 1.1 million tons of high-cost inefficient capacity showed the commitment to change. He noted that in 1999 markets have improved and that capacity growth is the lowest in years. Furthermore, he noted that many now recognize that the incremental ton is the most costly one to produce and that buying capacity rather than building is the approach. He noted that for the first time, capital spending is expected to be less than depreciation, and in his view, it should be considerably less.

In discussing the merger itself he noted that it’s a great strategic fit, with operations balanced in terms of integration and fiber base. Synergies of $210 million year to date have been achieved, and a run rate of $300 million looks achievable by year-end. Over $1.8 billion has been applied to debt reduction.

He also shared his views on the future by noting that unless companies have a 20 million ton system or more and command 20% of the market, they won’t be able to compete effectively. Commenting on the threat of competition from other products such as returnable plastic crates (RPC), he noted that industry has responded by forming a task force of the eight largest integrated companies to design and launch a corrugated design standard for produce. Other steps include work by the industry to develop software to allow customers to compare the costs of RPC and corrugated. The produce market represents 6% of the U.S. box market, and just 30% of this is potentially replaceable. However, these initiatives show the power of an end-user strategy.

In regards to fiber supplies and fiber resources, the U.S. is currently the breadbasket for recycled fiber, but in the next 10 years, the world containerboard industry may need 30 million tons of good new fiber, as most new growth will be based on recycled grades he noted. This may not be possible, or even a good thing. The urban forest may be inexpensive on transportation initially but it can be expensive on the distribution side. Furthermore, despite high economic growth, U.S. box growth has been weak. Also, as the U.S. imports more lower quality fiber, this needs to be monitored carefully.

Despite these issues, he noted the corrugated box is viewed as the best product for transporting and protecting goods, is cost effective and readily available.

INTERNET AND BOXES? He believes the Internet will have a very positive impact on his company’s business. For example, e-commerce products presumably will incorporate high quality graphics, and these goods may even be boxed three times—an inward box, the distributor or sellers box, and then a delivery box such as for overnight express.

In commenting how their customer’s customer business is changing, he noted that the growth of mega-stores wouldn’t be confined just to the U.S. These stores are at the cutting edge of packaging developments and use corrugated boxes and folding cartons to provide point-of-purchase promotion. Thus, their emphasis is on high-graphics appeal, functionality, and multi-packs. SSCC is working to meet these needs via micro-flute products and lightweight papers that provide value to the customer via weight savings.

Dr. Smurfit noted that traditional kraft liner exports in the medium- to long-term may not be an option for U.S. mills. For example, the European kraft liner market is contracting, and local mills—such as JSG—will eventually be able to meet demand. Similarly, other regions such as South America can serve their own needs. He noted further that the export market for U.S. linerboard hasn’t been a good one in terms of profitability except in the boom of 1995.

INCREMENTAL CAPACITY GROWTH. Regarding his company’s capacity in North America, by making simple improvements at existing mills, capacity can be significantly increased if demand requires it. He went further to note that any increase in latent capacity will be based on real demand and will be done incrementally and without impacting any existing business.

He summarized by noting that Jefferson Smurfit Group’s secret is acquire, rationalize, repeat. Opportunities to apply this will continue to exist outside of North America and they will look for further growth.

Q& A SESSION. Pulp and Paper also conducted a Q&A with Dr. Smurfit and the following summarizes this.

Pulp & Paper: Jefferson Smurfit is now one of the world’s largest paper-based packaging companies. Was this your plan from the outset, or when did becoming so large become a goal?

Dr. Smurfit: The Jefferson Smurfit Group never set out to be the largest of anything and it has never been our goal. Rather our goal has always been to be the best at what we do and that remains our primary target and focus. It may be as a result of this target and focus that we have become the largest, but scale itself does not imply success.

P&P: What are your strategic long-term goals for the company?

The long term strategic goals for our company remain the same, to generate superior shareholder value by penetrating new markets, servicing our global customers, and continuing to acquire and develop our business towards a target of some 20 million tonnes.

P&P: How can the pulp and paper industry—which has generated very poor returns in recent years—regain the confidence of financial investors?

Regaining the confidence of financial investors is not something that will happen overnight. It took us 15 years or so to dig ourselves into the hole we are in, so the odd good year or two is not going to regain the confidence of the financial community. A sustained and strict discipline in both production and capital will, I believe, help regain confidence.

P&P: Smurfit Stone (SSCC) has reduced long term debt considerably but it remains large at about $5 billion. Do you have a debt target in mind, and over what time frame?

Yes, SSCC’s debt still remains considerable at $5 billion but I anticipate that the debt will drop quite dramatically over the next 4 to 5 years.

P&P: Given the pressure to produce value for stockholders, how do you invest sufficiently now to keep your mills competitive over the long term?

We should always invest whatever is needed to keep not only our mills but our converting companies competitive both in the short- and medium- term and we have the resources to do that.

P&P: How is the amount of capital to be invested annually in the U.S. determined? For example, does SSCC have a target such as a specific spending to depreciation ratio?

Yes. The Jefferson Smurfit Group will probably spend 50% to 60%.

P&P: Given your current debt levels, could you make additional acquisitions?

SSCC could finance further acquisition by issuing paper, should the opportunity and need arise, whereas Jefferson Smurfit Group would have the option of using either debt or equity.

P&P: If containerboard prices reach $450/ton, will your mills re-open?

It is not anticipated that any of our mills will be re-started due to ample supplies being available. This is especially true as U.S. producers withdraw from export markets, which have been extremely unprofitable for a long period of time.

P&P: Do you view competitive packaging materials, e.g. plastic, as a major threat to paperboard packaging?

Plastic returnable crates are the biggest single threat the industry has facing it, and these will undoubtedly take a percentage of our business going forward, particularly in the produce area. Therefore, we must plan accordingly.

P&P: The use of E-commerce—the buying and selling of products—is in the beginning stages in the paper industry. What’s your general view on this as far as the pulp and paper industry is concerned?

It is too early to determine whether pulp and paper will be traded in any real quantities on the Internet. We will however, have a much better handle on this in about a year, as we have recently appointed two full-time executives to explore the impact of the internet on our business.

P&P: How will the Internet and e-commerce impact SSCC?

We believe that the impact of e-commerce on corrugated containers will be positive, as people use extra boxes to ship materials.

P&P: Do you see SSCC selling boxes and paperboard online to a significant degree?

At this moment in time, we don’t see either SSCC or Smurfit Group selling too much of our product online but again, we will keep an open mind and continue to explore all opportunities.

P&P: Were environmental expenditures that would have been needed a factor in closing down capacity in the U.S. and Canada? Please elaborate.

Environmental compliance really only requires significant capital expenditure on the white side. Yes, environmental expenditures would be one of the factors we take into consideration when examining any facility that is a candidate for closure.

P&P: Your company has indicated to analysts that a more stable market is a goal. How do you accomplish this when major customers such as retailers are always pushing for lower packaging costs?

I do not know of any business that does not continually push for lower costs and improved ways of doing things. We are the vanguard of trying to save our customers money, while at the same time generating adequate returns for our shareholders. Up to now, the industry has been running significant losses for too many years and customers who study the industry carefully will fully comprehend that in the long term, no industry can survive if it continues to sell product below the true cost of production.

P&P: Will high-end-graphics (e.g., using white top substrates and micro-flutes) continue to be the highest growth area?

Yes, we anticipate that high-end graphics and micro-flute will be a growth area and will compensate for business lost to returnable plastic crates.

P&P: In the future do you foresee that a greenfield containerboard mill will ever be built in North America?

With regard to greenfield containerboard mills, yes, I believe a number of mini-mills will be built in the future, particularly by independents as they wish to integrate backwards for more secure supplies of raw materials. However, it is hard to see the justification for a new kraft liner mill given the return on such investment over the last fifteen years or so.

P&P: What person has had the greatest influence on your business life and why?

The person who had the greatest influence on my business life was my father. He was an extraordinary man. He built his own paper machine, corrugators, and printer slotters from studying books. He was quite something to behold, a giant of a man, not only as a businessman but also as a father.

P&P: What are the major changes in paperboard packaging that you see going forward?

The major changes in paper packing going forward will be reduction in waste, better performance materials, and rapid growth in micro-fluting as it penetrates the folding carton market.