Building the Blocks

In order to expand its paper business, US-based International Paper (IP) acquired 75% stake in Hyderabad-based AP Paper Mills for up to $423 million (Rs 1,888 crore) in October 2011. The deal included:

1. Purchase of a 53.46% stake from the company’s promoters—L.N. Bangur and his family for $257 million (Rs 1,145 crore) and $62 million (Rs 276 crore) for payment of non-compete to the company.
2. Open offer for 21.54% (85.67 lakh shares) of shares in APPM for $104 million (Rs 466 crore)

The average valuation of Indian paper companies is about 7 times earnings, while IP has paid about 32 times APPM’s 2010 earnings.The price of the acquisition was Rs 670 per share including the complete fee for the promoter stake resulting in  136% premium paid over the market price then of Rs 283 per share.

REASONS FOR APPM’s ACQUISITION AT HUGE PREMIUM

APPM offered the following benefits :

• Strategically located plants & proximity to fast growing pulpwood plantations
• Scalable business model
• First mover advantage in adopting sustainable farm forestry program
• Leading supplier of premium grade products in the domestic market
• De-risked its business through backward integration
• Established distribution network
• Adoption of pulpwood plantation practices attractive to foreign players
• Raw material procurement was obtained from the company’s own farm forestry initiative
• Adequate availability of coal as the company had tie-ups with producers
• Low debt

The acquisition allows International Paper to hedge for growth with many of its current markets stagnant or in decline

APPM   – PLATFORM FOR ENTRY STRATEGY

Core areas identified by the acquirer for augmenting operational excellence at APPM over the last 4 years:

• Enhance production processes & captive production
• Optimize resources to meet the needs of the market
• Reduce cost of production by adopting the latest technology
• Improving the quality of its end product/enhance product mix
• Introduce new value added products & strengthen branded presence
• Apply IP’s operational, technical, & project management capability to create value

FINANCIAL PERFORMANCE

Income statement – International Paper APPM
Particulars	FY11	FY12	FY13	FY14	FY15	FY12-FY15 CAGR%
Net Sales	782	893	931	1,092	1,135	8.3%
YoY Growth (%)		14.2%	4.3%	17.2%	4.0%
Other Income	17	11	19	13	18
Total Revenue	799	904	950	1,104	1,152	8.4%
EBIDTA	164	197	102	74	106	-18.6%
EBITDA Margin (%)	21.0%	22.0%	11.0%	6.8%	9.4%
YoY Growth (%)		19.9%	-48.0%	-27.6%	43.5%
Depreciation & Amort.	67	67	72	87	69
EBIT	97	130	30	-13	37	-34.1%
EBIT Margin (%)	12%	15%	3.3%	-1.2%	3.3%
Finance cost	40	57	42	43	45
YoY Growth (%)		43.6%	-26.5%	3.0%	2.8%
PBT	57	72	-12	-56	-6
Provision for Tax	12	99	-4	-15	-7
Profit After Tax	45	-26	-7	-42	0.2	NM
PAT Margin (%)	5.7%	-2.9%	-0.8%	-3.8%	0.02%
Financial Year ended March (Figures in INR Cr) (Source: Annual Reports / Quarterly Financial Statements) NM – Not Meaningful

Note: For comparing & analysing the Historical financials over the last 5 Years, we have ascertained the financials for FY12 & FY13 for 12 months period ending 31 March as against 15 Months FY13 & 9 Month FY12 Data available.

International Paper APPM- Raw Material & Fuel cost
	FY11	FY12	FY13	FY14	FY15	FY12-FY15 CAGR%
Net sales	782	893	931	1,092	1,135	8.3%
Raw Material Cost	370	482	505	728	701	13.3%
>Raw Material cost YoY growth (%)		30.3%	4.8%	44.2%	-3.8%
Raw Material cost % of Sales	47.3%	54.0%	54.3%	66.7%	61.8%
>Fuel Cost	94	100	93	87.7	86	-4.8%
Fuel cost YoY growth (%)		6.3%	-7.4%	-5.3%	-1.7%
Fuel cost % of Sales	12%	11%	10%	8%	7.6%
Total Fuel & Power Cost	464	582	598	816	787	10.6%
Total Fuel & RM Cost %	59%	65%	64%	75%	69%
Amounts in INR Crores (Source: Annual Reports / Quaterly Financial Statements)

KEY FINANCIAL HIGHLIGHTS

• Net sales witnessed CAGR growth of 8.6% over the last 4 Years
• Sales volume was 215,846 MT in FY15 as compared to 208,089 MT in FY14
• EBIDTA margin was higher, up by 43.5% at Rs 106.1 crore as compared to Rs 73.9 crore in the previous year. EBIDTA as percentage of revenue increased to 9.3% in 2014-15 from 6.7% in 2013-14.
• Capacity utilization climbed to 90.2% during FY15, from 87.7% in the previous year
• Raw material & fuel costs as % of sales for the last 4 years has been around 70% despite taking initiatives for cost control

CONCLUSION

The past four years have witnessed significant challenges for the paper industry in India due to demand-supply mismatch in raw materials, resulting in higher cost of production and declining margins. Wood prices have shot up by over 200% in the past 24 months and accounts for almost 50% of total production cost. Added to this, there is sluggish demand for paper. Amidst a challenging environment, APPM has struggled to cope up with rising input cost pressures (70% of sales) despite de-risking its business through backward integration & adopting measures to improve its operating efficiency.

Also, despite APPM having a scalable business model and having access to a range of global technologies and practices, IP has struggled to enhance APPM’s market share in the domestic market significantly. As a result, the market capitalization of APPM is at the same level as it was four years back.

Given the above concerns, the transformation process that began three years ago at APPM following its acquisition is likely to continue for a longer period of time, before we could see the operational strategies adopted by the company translating into higher earnings & enhance Value.