(The following was the cover story in a B2B forestry management newsletter which I designed, wrote and produced)

The Urge to Merge

By Joe Bergeron

Consolidation has become the growth strategy of choice in the forest products industry

M&A. That's MBA speak for "mergers and acquisitions." Lawyers define it more verbosely: "The absorption of a lesser estate, liability, right, action or offense into a greater one." But you don't have to be an MBA or a lawyer to know that mergers and acquisitions are a common financial strategy in every industry from manufacturing to financial institutions. It seems most companies are either buying, or hoping to be bought. And while the AOL/Time Warner merger may grab all headlines, the forest products industry is hot with a merger fever of its own.

With 26 transactions totaling $60 billion since 1997, few industries have experienced the merger and acquisition activity of forest products companies. And, according to one industry insider, it's far from over. "Surviving companies tend to be healthier and able to provide more stable employment. Better capital decisions will improve overall returns and poorer competitors will be forced out more quickly."

The most significant consolidation was undoubtedly International Paper's $9.9 billion acquisition of Champion International and its $7.9 billion purchase of Union Camp. "IPA is greater than the sum of its parts," says one industry observer. "Their previously distinct and diverse opinions about forest management are now one voice with one agenda. You'll see it manifest itself in industry association meetings, procurement policies and land management strategies." The melding of these three industry giants was preceded by an IPA buying-spree, which included Federal Paperboard, Carter, Hold Harvey,, Zellerbach, Festoon,, Ganders, Aussedat Rey, and Shorewood.

IP isn't the only forest product company in the acquisition mode. Weyerhaeuser's acquisition of MacMillan Bloedel and TJ International for $3.4 billion gives the company a major presence in solid wood. One Industry analyst believes that Weyerhaeuser may soon add Willamette to its stable of companies. "If the Willamette hostile take-over occurs, it will show that even the healthiest companies are subject to be being bought up."

Another significant deal is Plum Creek's acquisition of The Timber Company, owned by Georgia-Pacific. It shows that GP - one of the giants of vertical integration - is willing to sever its ownership of the forest, and move to a non-cyclical business strategy. Although supply agreements are currently in place, they will eventually expire and G P will have to rely upon the open market for its wood supply.

The Sappi purchase of SD Warren and Stora Enso's acquisition of Consolidated Papers make it clear that forest products is a global industry. U.S. companies are no longer immune to the buying habits of foreign corporations. Says one industry insider, " Global consolidation will eventually provide opportunities for manufacturing organizations to be merged and managed globally, versus regionally."

Wood is Split

The picture has been changing, particularly in North America, with market share of the top 5 paper and paperboard producers increasing 24 percent, from 31 to 55 percent since 1990. However, market share of the top 5 producers of wood products (lumber, plywood, OSB) has actually fallen, from 74 percent to 63 percent. With the increasing need to be global, there is an urge to merge according to Kathryn McAuley, analyst with Brown Brothers Harriman & Company, New York. "End-use customers want fewer suppliers and they want them to be global, but supply locally.”

Synergies

Beyond sheer size, there are mutual advantages in virtually every merger or acquisition. One example is transport economies, such as a pulp plant supplying raw material to a recently acquired, adjacent paper plant. And there are other benefits. First, the price paid by the acquiring company is less than replacement cost of the equipment, inventory and other assets. Operations can be made more productive by extending machine runs. The product mix of the two joined companies can be optimized, and duplicate selling, marketing, general and administrative costs can be eliminated. Cash flow can be captured and redirected. And the acquiring company's customer base is expanded.

These synergies can be significant; the acquisition of Champion International and Union Camp represented $850 million in merger cost savings and synergies to International Paper.

Assets of the combined companies, like land holdings, are viewed with a critical eye. ''Acquired land is being looked at closely for its strategic fit, and areas not deemed strategic are sold off. This is creating opportunities for potential land buyers," says one industry official.

Mo' money, mo' money

On Wall Street, size matters. Mutual funds and institutional investors make it that way - a company has to be big in order to get picked up by their investment radar. A low return on capital in the industry has been a major driver of the consolidation trend, according to Morgan Stanley Dean Witter. The 10 year average return (market capital) in the paper sector has been just 8.6 percent. Since 1995, indexed prices of the S&P 500 have risen 219 percent. In that same period, stocks in the paper sector rose just 33 percent.

The capital markets are pressuring publicly traded forest products companies to ramp up their return on investment. "Returns on capital have been miserable over the last 15 years because of cyclical supply and pricing. Industry leaders have surmised that, unless some discipline is established concerning capacity and pricing, future capital will be hard to come by," says one industry insider. "Consolidation allows strength to influence capacity and pricing decisions. With size comes significant influence in supply chain management and leverage of purchasing practices."

In addition to benefits to shareholders, consolidation should be good news for consumers, too. "Consumers are getting a more efficient, albeit, sterile marketplace. The larger companies are more environmentally responsive, but they're also bigger targets for attack by the environmental movement. Certification programs - like the Sustainable Forestry Initiative (SF!) - are being driven through at light speed by the big companies," says an industry observer.

Impact on timberland owners

According to Rob Morrow, VP of Business Development at Resource Management Service, Inc., and a specialist on private landowner issues, consolidation of the industry is presenting new challenges for private, non-industrial timberland owners. "Bottom-line, there will be fewer buyers for your timber. That will drive down prices, at least for the short-term. But, as in virtually every sales situation, the buyer/seller relationship is extremely important.

Landowners who don't have the time or tendency to develop relationships with buyers should think about aligning themselves with a strategic partner who already has the buyer-relationships. A good strategic partner can find buyers for your wood and generally get you a better price. They can also help you deal with certification issues that could otherwise hinder the sale of your timber," he says.

What's down the loggin road?

Further consolidation of the industry is inevitable. In addition to mergers and acquisitions, new, strategic alliances of forest products companies will playa role in global marketing of wood products. An online paper and forest products marketplace, jointly developed by International Paper, Georgia-Pacific and Weyerhaeuser, is a clear indication of things to come. By working together to establish an electronic marketplace, the companies believe they can benefit customers by simplifying transaction processes, improving information flow and increasing speed of delivery. The companies say that by providing both procurement and sales functions, the online marketplace will enable participating companies to streamline purchasing operations, reduce inventories, cut internal costs and increase efficiency in the industry.

Doug Hayhurst of PricewaterhouseCoopers says that institutional investors believe that companies focused mainly in one product area are more likely to succeed. "The push is there from big investors for pure plays. So a lot of M&A activity comes from forest product organizations buying and selling assets to one another as they slim down their product line to concentrate and specialize in one or two areas."

According to Brown Brothers Harriman & Company's Kathryn McAuley, the industry's global makeover has only just begun. "There is an awful lot of consolidation ahead of us."

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