Resolute Forest Products Analysis
Board: Value Hounds
Resolute Forest Products (formerly AbitibiBowater)
A screen of stocks with low P/B and low P/E yielded a few other names that were not financials among the large pile of European banks and other financials. One of these that ended up having an interesting story behind it was AbitibiBowater, a forestry products manufacturer based in Montreal, Quebec. The current company arose from a merger of equals between Abitibi-Consolidated and Bowater in 2006. The company is emerging from Chapter 11 and rebranding itself as Resolute Forest Products. AbiBow, as I’ll refer to it, succumbed to high costs and overleverage, after posting large losses in 2008 and 2009 and failing in a bid to restructure its debt through a voluntary tender. They filed Chapter 11 in 2009 and all but one subsidiary emerged in December of 2010. Their financing arm remains in liquidation proceedings. With a market cap of $1.46B, the company trades at 0.4x its current book value of $3.79B.
While still mired in a poor industry environment, reorganization has reduced their operating and interest expense substantially. Their post-bankruptcy long term debt, composed of high coupon 10.25% secured notes due in 2018, stood at $679MM as of 9/2011. Per terms of that indenture, they can call up to 10% of the outstanding notes per year at a price of 103. The company recently called an additional $85MM of that debt in November, demonstrating an aim to retire that obligation as quickly as possible. AbiBow has $295MM in unrestricted cash, and access to an ABL Credit Facility exceeding $0.5B that is largely undrawn. In the 9 mos. post-emergence the company posted a net income gain of $47MM, including the most current quarter’s loss of $44MM. This included one-time charges. Operating profit excluding continued reorganization-related and “other” expense totaled $151MM through 9 mos. In short, despite a still difficult environment, the company as restructured is modestly profitable and has no near term liquidity issues with ample cash and access to an undrawn credit facility.
What’s of interest is the fact that ABH is a large holding of Fairfax Financial, comprising 12.8% of their disclosed 13F holdings. The majority of the current 17.5MM share position first appears in a Q1 2011 13F, shortly after AbiBow’s exit from bankruptcy, at a time when prices were approximately twice current levels. Fairfax was a bondholder in AbiBow ‘OldCo’, so these shares must be part of a recovery for bondholders from the bankruptcy. Current ABH shares outstanding number 97.1MM, so Fairfax holdings are 18% of ABH’s float. Fairfax added smaller amounts to an already large position as PPS has retreated, although these additions have not been large (about 0.5MM shares added to a 17MM stake). This is clearly a significant holding from the perspective of both Fairfax and AbiBow. Its greater significance will be clear later.
The TTM 0.4 PE listed on Yahoo is relatively meaningless, resulting predominantly from large one-time gains associated with the restructuring. Given the large number of one-time adjustments that still continue as a result of reorganization charges, focusing specifically on operating results post-reorganization might be more useful. Nine month EBIT totals $151 MM. Annualizing that approximates full year EBIT of about $200MM. Full year estimated Depreciation expense is $220MM. ABH has a Market Cap of $1.45B, $542MM in long-term debt, and $295MM in cash, totaling a $1.70B market cap. Using these numbers, the current EV/EBITDA multiple is $1,700MM/($201MM+$220MM) = 4. The shares are stuck at $15, down from ~$30 after their exit from bankruptcy.
ABH is a paper and wood products manufacturer incorporated in Delaware and headquartered in Montreal. They operate in Canada, the US and South Korea in five segments: Newsprint, Coated papers, Specialty papers, Market pulp and Wood products. While most bankruptcy related legal proceedings are complete, some residual claims are still being processed by the courts. One subsidiary, a prior financing arm is still in Chapter 7 proceedings, and 17MM treasury shares are awaiting disbursal pending some final claims being heard by the court. Any treasury shares not awarded after completion of the current litigation will be distributed to prior unsecured debt holders, so further dilution does not seem to be an issue for shareholders. The company emerged on a relatively sound financial footing, with significantly less debt, a reasonable amount of cash and access to a substantial revolver. In addition to its paper manufacturing facilities, the company possesses significant hydroelectric capacity within the Canadian provinces of Ontario and Quebec. In addition to its hydroelectric sources, the company uses a variety of renewable energy strategies to reduce its manufacturing costs at its facilities. Paper production is energy intensive and water rights are important in this business.
An excerpt from the 10-K outlining the product segments, details regarding capacity and customers follows:
In 2010, excluding BPCL, we produced newsprint at 13 facilities in North America and South Korea. We are among the largest producers of newsprint in the world by capacity, with total capacity of approximately 3.1 million metric tons, or approximately 9% of total worldwide capacity. In addition, we are the largest North American producer of newsprint, with total North American capacity of approximately 2.9 million metric tons, or approximately 35% of total North American capacity. We supply leading publishers with top-quality newsprint, including eco-friendly products made with 100% recycled fiber. We distribute newsprint by rail, truck and ship. Our newsprint is sold directly by our regional sales offices to customers in North America. Export markets are serviced primarily through our international offices located in or near the markets we supply or through international agents. In 2010, approximately 50% of our total newsprint shipments were to markets outside of North America. We sell newsprint to various joint venture partners (partners with us in the ownership of certain mills we operate). During 2010, these joint venture partners purchased approximately 407,000 metric tons from our consolidated entities, which represented approximately 14% of the total newsprint metric tons we sold in 2010.
We produce coated mechanical papers at one facility in North America. We are one of the largest producers of coated mechanical papers in North America, with total capacity of approximately 651,000 metric tons, or approximately 15% of total North American capacity. Our coated papers are used in magazines, catalogs, books, retail advertising, direct mail and coupons. We sell coated papers to major commercial printers, publishers, catalogers and retailers. We distribute coated papers by truck and rail. Export markets are serviced primarily through international agents.
We produce specialty papers at 10 facilities in North America. We are one of the largest producers of specialty papers in North America, including supercalendered, superbright, high bright, bulky book and directory papers and kraft papers, with total capacity as of December 31, 2010 of approximately 1.9 million metric tons, or approximately 34% of total North American capacity. Our specialty papers are used in books, retail advertising, direct mail, coupons and other commercial printing applications.
We sell specialty papers to major commercial printers, direct mailers, publishers, catalogers and retailers. We distribute specialty papers by truck and rail. Export markets are serviced primarily through international agents.
Wood pulp is the most common material used to make paper. Pulp shipped and sold as pulp, as opposed to being processed into paper in one of our facilities, is commonly referred to as market pulp. We produce market pulp at five facilities in North America, with total capacity of approximately 1.0 million metric tons, or approximately 6% of total North American capacity. Market pulp is used to make a range of consumer products including tissue, packaging, specialty paper products, diapers and other absorbent products. North American market pulp sales are made through our regional sales offices, while export sales are made through international sales agents local to their markets. We distribute market pulp by truck, rail and ship.
We operate 18 sawmills in Canada that produce construction-grade lumber sold in North America. In addition, our sawmills are a major source of wood chips for our pulp and paper mills. We also operate two engineered wood products facilities in Canada that produce products for specialized applications, such as wood i-joists for beam replacement, and four remanufacturing wood products facilities in Canada that produce roofing and flooring material and other products.
One problem with trying to value ABH is the absence of any meaningful earnings history. Legacy costs are significantly reduced and fixed asset values have been restated relative to its predecessor. As a result, costs of goods sold, SG&A and depreciation levels will not follow prior patterns, per company guidance. That gives us only three quarters of performance to evaluate. Looking at past volumes can however, give some appreciation of relative sales performance in the recent past, pricing trends and a better appreciation of the relative importance of the different segments at least in terms of volume. The first thing that jumps out is that while ABH does produce lumber and other wood products, this is a paper company first and foremost. For that matter, newsprint and specialty papers are the bulk of their business. It’s easy to understand why the newsprint business is in difficulty, and given their revenue distribution between segments, it’s also easy to understand how AbiBow ended up run-aground on a sandbar.
The following is a summary of revenues by segment for the pre-bankruptcy company. Note that results prior to 2007 are pre-merger Bowater results and even 2007 includes only a partial year of combined operations. Unfortunately, that means that only 2008 provides a good comp for the full corporation pre-collapse:
[See Post for Tables]
Since AbiBow is incorporated in Delaware and files with the SEC, all numbers are in millions of $USD.
The recession hit AbiBow hard. Newsprint, which dominates their revenue, was 48% of revenue in 2008. Newsprint revenues fell 44% in 2009/2010 to $1.8B. The second highest segment, specialty papers, comprising 27% of 2008 revenue, contracted 28% through 2010. Low demand severely eroded pricing as costs rose, and both segments flipped to a loss as AbiBow was forced to sell into an upside down market in an effort to raise cash. Unable to restructure their debt and reduce service costs, the company entered Chapter 11 protection in 2009.
Current performance is similarly challenged. While we have only 3 quarters of data available post-reorganization, there are some note-worthy improvements. While volume remains down, both newsprint and specialty papers have slim, but positive operating margins. Unfortunately, the wood product segment remains at a loss as softness in the housing market continues to undercut pricing. Following are segment revenues and margins for current operations: 4.63% 10.84% 3.99% 13.94% -5.72%
[See Post for Tables]
The first thing that stands out is how thin margins are on AbiBow’s main segments, newsprint and specialty papers. The second is how badly the wood products segment is hurting. Finally, the strong margin on one of AbiBow’s smallest segments, Market pulp, is striking. Market pulp pricing is strong due to Chinese demand. Notably, AbiBow recently tendered a hostile bid for Fibrek, a Canadian market pulp producer that would substantially increase volume in this segment.
The Fibrek dustup
AbiBow (Resolute as referenced in the links below), is right in the middle of a hostile bid for Canadian pulp producer Fibrek. As shown above, market pulp is a glaring hole in AbiBow’s product portfolio, being a small segment with disproportionately high margins. So, this acquisition makes sense from an operational perspective. Fibrek produces spruce pulp at one plant in Canada as well as recycled pulp at two sites in the US. Fibrek’s current pulp production is 375,000 metric tons per year, almost 40% of AbiBow’s current production. Fibrek’s recycled pulp facilities produce 385,000 metric tons of pulp per year. Together, they would almost double AbiBow’s pulp segment output, were the purchase to go through. That would elevate market pulp to parity with the specialty paper segment, better aligning segment capacity to current market conditions. With market pulp’s higher margins and greater overseas demand, this seems like a good acquisition. Fibrek’s management is actively fighting the takeover. While the takeover bid makes some sense from a business perspective, there are additional factors in the deal that give it a bit of an unsavory undertone from the perspective of Fibrek shareholders. These revolve around Fairfax, which has a large equity stakes in both companies.
There is a lot of conflict of interest associated with this deal. It’s hard to find anyone that doesn’t have an axe to grind in fact. Fibrek was recently converted from a unit income trust to a corporation in a rights offering financed by Fairfax. http://www.marketwire.com/press-release/Fairfax-Announces-St... It seems that Fairfax was also a unit holder in the predecessor trust, and also a debt holder prior to this rights offering. The predecessor trust, known as SFK Pulp was formed in 1996. The company now operates three pulp producing plants, one of which was purchased from Abitibi-Consolidated in 2002. AbiBow is also its primary supplier of woodchips and bark feedstock for its pulp production. That supply agreement was frozen as a consequence of AbiBow’s bankruptcy proceedings in 2009, leaving Fibrek in a difficult spot, trying to arrange alternative chip supplies. As mentioned above, Fairfax was a bobdholder and provided Chapter 11 exit financing for AbiBow and thus holds large minority equity stakes in both AbiBow and Fibrek. It appears that Fairfax wishes to consolidate these holdings, and that this bid is the instrument of choice. Fibrek is using a poison pill triggered if either AbiBow or Fairfax raises its ownership stake to fight the hostile bid, which AbiBow is currently challenging in court:
How this plays out will be interesting. Fibrek’s management argues that AbiBow is cherry picking at the bottom of the market, and has challenged the legality of the bid, arguing that a formal valuation is required. http://www.fftimes.com/node/248021 They have begun shopping for better offers. Although, one has to question if Fairfax will see it their way even if Fibrek can find a better offer, considering Fairfax is playing both sides of the aisle. AbiBow has stated that “three of Fibrek's largest shareholders, representing approximately 46% of the outstanding shares… have agreed to irrevocable lock-up agreements, with no ability to tender their shares to a competing bid." That’s pretty obviously Fairfax and its aligned interests, and it sounds like they’re committed to kill any other deal. It seems that the little guy may get crushed in this soap opera if he chooses to swim against the tide, with the ultimate outcome being consolidation. AbiBow reports that 57.1% of Fibrek’s float has been tendered in the offer. The offer has now been extended through Feb 13 to allow for Canadian courts to hear arguments. http://www.marketwatch.com/story/resolute-extending-offer-fo... A supermajority of 67% is needed to secure the bid.
Balance sheet assets
As mentioned above, AbiBow’s P/B ratio is 0.4. Since operations remain challenged for the near term, much of the apparent value here is tied to the accuracy of AbiBow’s book value and the quality of its assets. Post-restructuring, the company wrote-off existing Goodwill in total, reduced intangibles to nearly zero, and impaired some of their fixed assets. As a result, their current book is likely to be reasonably in line with true value. Intangibles are minimal. Still, the asset sheet includes a rather large $1.7B in deferred income tax asset that will only be realized if operations turn profitable, and a number of held-for-sale industrial sites could be of questionable value. In addition, AbiBow holds considerable timber and water rights that are hard to value. Is book value as carried a reasonable measure of asset value?
The biggest question marks have to be in Property plant and equipment. Especially fixed assets held for sale. According to their 10-K, PP&E held-for-sale is carried at estimated current market value less estimated costs to complete their sale. Obviously, there’s no way to verify how realistic their asset valuations are outside of realized sales. But, we do have a few sales that have been completed to help in that regard. In December of 2010, AbiBow held several properties for sale:
As of December 31, 2010, we held for sale the following assets: our investment in ACH, our Kenora, Ontario and Alabama River paper mills, our Saint-Fulgence and Petit Saguenay sawmills and various other assets. These assets and liabilities held for sale were carried in our Consolidated Balance Sheets at
fair value (as a result of the application of fresh start accounting) less costs to sell. As of December 31, 2010, we expected to complete a sale of all of these assets within the next twelve months for amounts that equal or exceed their individual carrying values.
During the three months ended September 30, 2010, we sold various assets for proceeds of $2 million, resulting in a net gain on disposition of assets of $1 million. During the nine months ended September 30, 2010, we sold timberlands and other assets for proceeds of $15 million, resulting in a net gain on disposition of assets of $14 million.
During the third quarter of 2011, the Alabama River mill and associated assets were sold for $11MM, resulting in a $1MM loss on the transaction. The minimal loss on this sale, together with the earlier gains from 2010 detailed in the second paragraph above, suggest that PP&E values on AbiBow’s balance sheet are not significantly overstated. In addition, their interest in ACH, the Kenora mill and other assets was sold for $304MM in 2011, resulting in a $4MM gain. This final figure, presented in the financial statements as a single transaction deserves a caveat. ACH was a joint venture in three hydroelectric facilities and their associated water rights, in which AbiBow held a 75% interest. Unlike the closed mills, the hydroelectric operations are operational and have substantial present value. Given the wording of the 10-Q, it’s hard to determine anything with regard to the net gain or loss on the mills alone. In the third quarter, US recycling assets were added to their held-for-sale fixed assets. It does not seem unlikely that additional facilities could be added to the held-for-sale category, or that additional impairments could be incurred as time goes on. However, carrying value does not appear to be out of line with reality, meaning losses here should be small and manageable.
Going back for a second to the ACH transaction is worthwhile, since it in and of itself sheds some light on the potential value of a key asset still held by AbiBow. ACH was a limited partnership, 75% owned by AbiBow that operated three hydroelectric facilities in Ontario. The current LP is a subsidiary of BluEarth Renewables operating under the same ACH LP name. The 75% interest in the combined 137 MW of capacity in the ACH Limited Partnership closed for $300MM net of debt that was assumed in the transaction, valuing the total holdings at $640MM (CD). http://www.globalpapermoney.org/abitibibowater-to-sell-indir... Altogether, AbiBow had four hydroelectric facilities when it emerged from bankruptcy. Three within the ACH LP, and a fourth wholly owned. AbiBow maintains its 100% interest in the remaining Quebec property. This remaining Hydro Saguenay, Quebec facility with its 162 MW of capacity obviously represents a substantial asset. Making some rough assumptions, we can put a dollar value to it based on the ACH transaction. The ACH transaction of $640MM works out to $4.67MM per MW of hydroelectric capacity. With 40% more capacity than the ACH properties, Hydro Saguenay would be worth $760MM ($4.67MM per MW times 162MW capacity at Saguenay). This single facility represents 30% of AbiBow’s reported fixed assets as of Q3 2011 ($2.485B as of 9/30/2011).
NewCo Value from an Operating Perspective
Given changes in costs and accounting, the operating results of AbiBow OldCo cannot be extrapolated to the reorganized company. So, we have little track record. But, we can generate a crude estimate of future profitability with a few assumptions: (1) reversion to 2008 volumes, (2) maintenance of 2011 pricing by segment, and (3) maintenance of 2011 margins by segment. I selected 2008 because 2007 consolidated numbers are pre-merger and not reflective of full operations. The pricing assumptions are conservative IMO. With the exception of market pulp and wood products, 2011 pricing is largely in line with 2008, with slight deterioration of paper pricing, particularly coated papers. Pulp and wood products prices have actually increased since 2008, but any gains in wood product pricing have been more than offset by rising cost. Here, things should improve when the economy rebounds. The following table outlines projected operating income after recovery given these assumptions:
[See Post for Tables]
It’s also worth considering the potential earnings of a NewCo including Fibrek, if Fairfax and AbiBow are successful in their takeover bid. Adding Fibrek pulp capacity to AbiBow’s current pulp volume gives the following EBIT estimate:
[See Post for Tables]
The $427MM EBIT plus $220MM of Depreciation expense, gives EBITDA of $647MM. The offer for Fibrek amounts to $122MM. In addition, Fibrek has $101MM in long term debt that would be assumed, making the combined EV $1,920MM. EV/EBITDA = 1,920/427 = 4.5. Summary
Resolute Forest Products, formerly AbitibiBowater, is a maker of forestry products, recently emerged from bankruptcy. Funding in receivership was provided in part by Fairfax Capital. The recession, coupled with too high a debt load forced them into Chapter 11 in 2009. Fairfax is now a large equity stakeholder in the reorganized company. The company operates in five segments: newsprint, coated papers, specialty papers, market pulp and wood products. Two of these segments, newsprint and specialty papers dominate revenue. Operating margins on these high volume segments are exceedingly thin, running less than 5%, even after reorganization. Despite this fact, the company is still profitable in a very poor industry market. Market pulp, a segment seeing expansion from demand in China is performing well. The recession has had no effect on this segment’s revenue or volume, pricing has remained stable and operating margins are double digit. Unfortunately, AbiBow has insufficient pulp capacity to take advantage of this trend. The company recently made an unsolicited offer to purchase Fibrek shares for cash or ABH shares at a slight premium to Fibrek’s trading value. Fibrek is a manufacturer of pulp, and its acquisition would help patch a hole in AbiBow’s product offerings. Fairfax holds sizeable positions in both ABH and Fibrek and may be a driving force behind the bid.
AbiBow (Resolute) trades with a total market cap of $1.45B at a significant discount to its current book value of $3.79B (9/30/2011). Shares are 50% off their bankruptcy exit levels. The current valuation of fixed assets seems reasonable, given the fact that recent sales of properties has not resulted in meaningful losses. This is reinforced by a recent transaction of hydroelectric facilities that when used as a comp, would value their retained hydroelectric capacity at roughly $0.75B. That’s approximately a third of the carrying value of their fixed assets as of 9/30/2011. On the downside, $1.7B of their asset value consists of deferred tax assets, which will only be realized if the company remains profitable. Operations are currently marginally profitable, in an environment that remains difficult to say the least.
On a going-forward basis, it is harder to make a value case for the company. The wood products division is still a money loser even after restructuring and the two largest segments have thin operating margins, below 5%. Acquisition of Fibrek would be a positive. A return to normal segment volumes with maintenance of current pricing and margins would predict an EBIT of approximately $350MM after recovery. It’s also noteworthy that tax provisions will be non-cash for quite a while, with $1.7B in deferred tax assets at their disposal. I’m at a loss as to how much value is left in this cigar butt in a dying industry, but Fairfax with its extraordinary value track record has a lot of skin in the game. At the very least, the story is interesting to follow as Fairfax tries to wring some blood from a stone…