Be careful with consolidation

For paper and paperboard producers, the world has changed significantly in the past 10 years. In the late 1980s, the paper and paperboard sector was highly fragmented, with many small and mid-sized companies. The global top five paper and paperboard- producing companies accounted for only about 10% of global capacity. The combined capacity of the 10 biggest producers only amounted to some 15%.

At this time in the sector it was very common to grow via huge capacity expansion programs with brand new production facilities and/or machines. Often, when the market outlook was promising for some pulp, paper or paperboard grade, many producers announced major capacity expansion programs at about the same time. As can easily be imagined, such behavior destroyed the outlook for some grades for years to come. With such a fragmented market and such uncontrolled expansion behavior, it is easy to see that it was the producers themselves who usually spoiled the party.

The situation is entirely different now; there are fewer players on the market. By the end of the 1990s, the world's top five producers' share of global capacity had increased to 16%, while the top 10 increased their stake to almost 25%. The year 2000 was a very frenetic time for mergers and acquisitions in this segment: the figure for the top 5 producers today is above 20%, while for the top 10 producers it is above 30%.

Fewer and fewer

Previously, there were many local producers, but now there are a few giant players on each continent. As the next step in this evolution, observers will start to see the first truly global players in the pulp and paper industry. The first steps have already been taken, as merger activity has accelerated, particularly between North American and Western European players.

What, then, can pulp and paper companies gain from this consolidation process? The benefits of a more consolidated market are as follows:
•  with fewer players, market predictability could improve. In an environment with fewer and bigger players, we can assume that investment allocations could be better managed. Thanks to their bigger balance sheets, the larger players have the strength to shut down obsolete and unprofitable capacity when necessary
•  a big player is able to optimize its production better than smaller players. It is possible to increase production capacity by reconsidering the production mix per machine. By dedicating fewer grades per machine it is possible to increase production capacity without any major capital injections
•  savings could also be made through more cost-effective logistical processes. For instance, the location of production close to a raw material base or customers could bring gains for a consolidated company
•  savings from reduced corporate and marketing costs. Overlapping operations in organizations should be avoided.

However, even though consolidation is the present trend in the pulp and paper industry, companies should not jump on this bandwagon if they cannot be sure that they can increase the value of their company. When calculating the impact of such a deal, all the relevant costs of this action (the transaction price and all the non-recurring items from restructuring measures) should be taken into consideration. The transaction price should be calculated very carefully. The buyer or bidder should always keep in mind the highest possible price that it is willing to accept. If it is not possible to close the deal at a financially acceptable level, forget it. The cardinal sin is agreeing to pay an excessive price. Therefore, withdrawing from such a deal should always be an option. Financing alternatives should also be carefully considered and negotiated, so that a company does not end up with a disastrously heavy burden.

As the pulp and paper industry is still a volatile business, managers should always bear in mind that there will be lean years. "Cost savings from synergies" is a common argument for mergers and acquisitions. However, afterward it is very difficult, or almost impossible, to prove what the impact of synergies has been. This is because company structures change, and cyclical economic fluctuations make it difficult to gauge the sustainable savings impact.

There is always the risk that the only ones in this game who win will be the consultants. But players can hope that this time around, there will also be winners in the pulp and paper industry.