Monday, January 13, 2014

Untangling the Verso-NewPage Deal

Somewhere there must be a person who fully understands all aspects of the proposed combination of NewPage and Verso Paper, North America’s two largest makers of magazine-quality paper. But mostly there is confusion and debate and even misinformation about the marriage and what it would mean for the paper industry and its employees, for magazine publishers, and for catalogers.

Such a pre-nup! What Verso and NewPage have worked out is far more complex than described in the companies’ announcements or even in stock analysts’ reports. Included are some odd provisions that have gone mostly unnoticed.

Here is Dead Tree Edition’s attempt to explain the structure and implications of the impending union, which was announced a week ago after a stormy, three-year courtship:

Why is the proposed deal important?: The two companies control roughly half of the North American market for glossy papers (coated freesheet, coated groundwood, and high-quality supercalendered papers). In theory, a company with that much market share has the power to drive up prices, or at least to keep them stable by preventing gluts in the market. NewVerso (my name for the new company) could also throw its weight around among suppliers and merchants, creating both winners and losers.

Will the marriage be consummated? There seem to be two main hurdles:

1) Anti-trust approval: The Justice Department, goaded perhaps by major paper buyers, may block the deal on grounds that NewVerso’s huge market share would be monopolistic. A more likely scenario is that the company would be forced to sell (or close) a mill, as Abitibi and Bowater were required to do when the two newsprint giants merged.

2) Verso noteholders: For the deal to be consummated, holders of $538 million in Verso debt must agree to exchange their notes for ones worth only $267 million. “This implies debt forgiveness of $271.1 million,” wrote Paulo Santos for Seeking Alpha. “Debt forgiveness is usually attained through a pre-packaged bankruptcy or regular bankruptcy.” Bondholders may chafe at taking such a huge haircut without the stockholders taking a hit. But many had paid less than 50 cents on the dollar for Verso’s distressed debt, and they may decide the NewVerso deal is better than the most likely alternative, a Verso bankruptcy.

Who will the winners be if the deal goes through? Lawyers and investment bankers, of course. Perhaps Verso stockholders, who have seen the price spike six-fold in just a week. And probably competitors like Resolute, UPM, and SAPPI, who would benefit from NewVerso using market discipline to keep prices high.

And the losers? Customers. Either Memphis (Verso’s home) or Dayton (NewPage’s headquarters), at least one of which will lose a corporate headquarters. Probably some supplier and paper merchants. The big losers would be employees and towns of the mill or mills that will be closed.

But didn’t Verso promise it wouldn’t close any mills? No, it said it had no plans to close any mills. Translation: “Nothing in the legal documents requires us to close any specific mills.” Analysts seem to be unanimous in their view that the merger would lead to capacity reductions.

In fact, one of the deal documents even provides incentives for NewPage or Verso to reduce their production capacity by more than 10%. (See the discussion of “triggering events” in the Services Agreement Term Sheet. I’m not aware of any analyst or journalist who has addressed the meaning or significance of the Shared Services Agreement, but I find it intriguing – and confusing.)

That doesn’t sound like a straightforward purchase of NewPage by Verso. What gives? Technically speaking, a Verso subsidiary will merge with a NewPage entity. But each company has several subsidiaries that are involved in related transactions with the others’ subsidiaries, making the NewPage takeover anything but straightforward.

For example, the Shared Services Agreement indicates that Verso will be supplying administrative and marketing services either to NewPage before the takeover occurs or to a separate NewPage entity that will continue to exist after the takeover occurs. (Update: As explained in Odd Verso-NewPage Structure Eyed Warily by Wall Street, NewPage would continue as a separate operating company after the merger.) That agreement addresses how certain costs of the merger, such as severance payments, will be allocated between NewPage and Verso. It also calls for Verso to invoice NewPage each quarter for “realized synergies” resulting from the services that Verso provides to NewPage.

How did nearly bankrupt Verso, whose stock-market value was barely $30 million a week ago, pull off a deal that’s been valued at $1.4 billion? Short answer: OPM (Other People’s Money). Longer answer: Good question.

The Verso-NewPage deal is “sort of like two very weak companies holding each other up,” Vertical Research Partners analyst Chip Dillon told Reuters. “Essentially the deal is all debt, there is no real equity involved here.”

The $1.4 billion figure is based on NewVerso giving NewPage stockholders $250 million in cash and $650 in NewVerso first-lien notes, plus taking on $500 million in existing NewPage debt. NewPage stockholders would also end up with 20% to 25% ownership of the merged company.

But how did a financially troubled company like Verso find backers for such a deal? The deal would create value in two ways: 1) Debt reduction: The proposed debt exchange with Verso noteholders would eliminate $271 million of the company’s debt. 2) Synergies: Verso says the deal will yield at least $175 million in pre-tax cost savings during the first 18 months. Besides economies of scale in administration, marketing, and purchasing, having more machines means each can operate more efficiently by making a narrower range of products.

How did Verso go from being worth $35 million to $200 million in barely a day? That’s the subject of some debate in the markets. Until last week, a Verso shares was basically a cheap (as in 65 cents) lottery ticket, apparently destined to be worthless but potentially valuable if the company could avoid bankruptcy. When news of the NewPage deal broke, some traders figured Verso now had a future and jumped in with both feet. There are somewhat disputed reports that Verso short sellers were scrambling to cover their shorts, driving share prices up even further. And the proposed debt forgiveness was viewed by some as “free money” that added to Verso’s stock value.

Whatever the reason, share volume jumped more than 14,000% on Jan. 6 and nearly doubled again the next day.

Is Verso stock a good investment? It's still more like a lotto ticket than an investment. If the deal doesn’t go through, bankruptcy seems likely. And even if the marriage is consummated, NewVerso could end up like the old Verso – too saddled with debt to have much value when demand for its products is in long-term decline. Then again, if NewVerso emerges as even a moderately healthy company, the Verso stock could see huge gains.

Would NewVerso be a successful company? The precedents are mixed. The widely cited model is the North American uncoated freesheet market, where consolidation has yielded two giants that can keep prices stable in the face of declining demand by judiciously reducing their output. But there’s also the case of Abitibi and Bowater, the two largest makers of newsprint in North America when they combined in 2007. High debt and rapidly declining demand pushed them into bankruptcy reorganization only 18 months later.

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Anonymous said...

Goodbye Rumford! If you work there put the house up for sale and polish up the ole resume - you're going to need it.

Anonymous said...

The employees of Newpage should be saddened to realize that they exist solely to drive massive payouts for NY bankers, lawyers, and a few privileged insiders. There is no money in selling paper...the real game is all about collecting fees and trading in high yield (junk) debt.

Anonymous said...

The leaders of NewPage have much to answer to their employees who will be hurt by this. They are extremely top heavy and corporate focused. The mills are thought of as an necessary evil. Many younger leaders have grown within the irresponsible management "style" and will struggle to find a place in a "normal" organization in the future where a good PowerPoint presentation is a means to and end rather than the pinnacle of their existence.

Anonymous said...

At one point in my life I spent time working for New Page. What struck me most was how short sighted and reactionary everything was. Little to no emphasis was placed on planning strategically to improve efficiency and increase value. Emphasis was always on slashing costs to increase the bottom line in the short term - even if it meant costing more for the company in the long term. Anyone with talent and mobility has already fled the company. It was the most chaotic, strange work environment I have ever been privy to. No merger will ever improve that company. In my opinion , the merger will only drag Verso down quicker

Anonymous said...

I'm disappointed, but not surprised by this turn of events. If you go back to the appointment of Mark Angelson as Chairman of the Board, it was evident to me that the low-debt NewPage was not long for this world. One of Angleson's last big stints was to steer World Color Press out of bankruptcy and into acquisition by Quad Graphics. I was hoping NewPage might get taken over by a papermaker. Verso is like the old NewPage and probably headed for the same fate whether or not the NewPage deal goes through - although Chapter 11 might be easier the second time since everyone knows the drill.

Anonymous said...

I've been watching this since private equity investors purchased MeadWestvaco's paper division and renamed it NewPage in 2005. Private equity has destroyed numerous industries and is responsible for the economic disasters that have ravaged companies and communities across the country. The story is always the same. A single-minded focus to saddle organizations with highly-leveraged debt, flip it to some sucker and take whatever value can be extracted. This so called business investment model has systematically funneled any real cash to the "partners" at the top. But don't take my word for it, many have written about this scourge. (Matt Taibbi, of Rolling Stone for one.)

Anonymous said...

While I agree whole-heartedly with most of the points shared here and have never been happy with the way New Page has dismantled their paper group and tanked the overall market price for CFS, they are not fully responsible for the situation the market is in. The demand is declining and closing of 1 - 3 sites is inevitable and NEEDED. IP showed their leadership by taking the difficult step of closing Cortland and this will keep the UCF world healthier short and long-term. It is sad that a few more paper mill communities will be affected so catastrophically, but that is the way of certain paper brands these days. The best we can hope for is that NewVerso is able to focus on streamlining their organization and stablizing prices asap. Something NewPage was unable to accomplish during their dismal foray into this business.

Anonymous said...

It will be interesting to see who ends up running the operations of the combined company. The uncontrollable drag of the market decline is a fact that can be dealt with but not affected in a significant way. The efficiency of their operations and the quality of their products are the only things that will make them profitable. This would mean questioning their basic methodologies for, and interactions between, the operations, maintenance, and engineering functions. That is the only place where the money is. The history of focusing on making and shipping as many tons as possible "at all cost" has saddled the now declining paper industry with operating and maintenance systems that are incapable of doing this. Can they bet the farm on improving or will exist practices continue and focus on trying cost cutting to profitability until they fail? History says it will be the latter.

Anonymous said...

This is what you get when you take some Mead Westvaco rejects and combine them with private equity. Failure on a massive scale. Talk to any of the old Stora Enso employees. Good ideas had no place in the NP agenda. They are ruthless, vindictive, and shot sighted. They bought the Stora mills and found they needed to close Niagria, Whiting, PH, and Kimberly. Notice the trend. All former Stora mills. They protect there own and treat everyone else like 2nd class. I hope they get what they have coming. Hopefully they can't raid the retirement fund because they won't hesitate to line their own pockets. Good riddance.

Anonymous said...

One of the favorite parts of my dead tree experience is when an issue such as this comes into play and the passionate and anonymous papermakers come out of the woodwork!! Great comments by all and will certainly be interesting to see how all this plays out. I just read one of the best breakdowns of the merger in an ERA Forest Products Research analysis. A great summary by their analyst Kevin Mason that was on point and substantiated some of the concerns out there. Good luck to all the mills involved and while the outcome is sure to be ugly either way, everyone in my world believes the Verso management team is far better suited to handle the transition than the New Page team - George Martin and his crew need to take their undeserved millions and leave this industry to those will more foresight to the future.

Anonymous said...

This would be a marriage of two very poorly managed companies. Why would anyone in their right mind invest in stock knowing they have no net worth? I bet there is something in it for upper management? Wouldn't be surprised if to management have some very attractive golden parachute contracts? These people don't have brains and they don't have a conscience. I guess they forgot to read the Printing Impressions article that stated 95% of the printed published magazines in this country will go digital within the next 20 years. I personally do not think it will take nearly this long. Digital publications will be able to offer advertisers an interactive age where customers can view a short video and be able place orders immediately on line.