Fortress Paper Limited (FTP-TSX)
July 9, 2012 Issue
The Most Powerful Name In Corporate News and Information
Fortress Paper Limited is Focused on Acquiring Mills that They Can Turnaround with a Goal of Generating $100 Million a Year of EBITDA Per Mill, with Three Business Segments Already in the Portfolio: Dissolving Pulp, Specialty Papers and Security Paper Products
Fortress Paper operates internationally in three distinct business segments: dissolving pulp, specialty papers and security paper products. The Corporation operates its dissolving pulp business at the Fortress Specialty Cellulose Mill located in Canada, which is also in the process of expanding into the renewable energy generation sector with the construction of a cogeneration facility. The Corporation operates its specialty papers business at the Dresden Mill located in Germany, where it is a leading international producer of specialty non-woven wallpaper base products. The Corporation operates its security paper products business at the Landqart Mill located in Switzerland, where it produces banknote, passport, visa and other brand protection and security papers, and at its Fortress Optical Facility located in Canada, where it manufacturers optically variable thin film material.
Interview conducted by: Lynn Fosse, Senior Editor, CEOCFO Magazine, Published – July 9, 2012
Mr. Wasilenkoff: My background is that of a contrarian type of investor, and that is how I started Fortress and built it over the last six years. Prior to that, I was looking at basically just industries that were out of favor and built gold companies, oil, gas, copper, and uranium. We had success with those, and then we were looking at the next industry which is what led me to forestry. The forestry sector has experienced significant erosion of capital over the last several decades, and most of the media coverage talks about mills being shut down and going through cost cutting initiatives. That is what interested me. I got involved about six years ago with four forestry related assets. Even though the overall forestry sector was performing poorly, I was confident there would be some smaller niche mills making niche products that would meet my investment criteria, which are high barriers to entry, significant growth profile, and company’s that lack growth capital to take them to the next level. Back in 2006, we bought our first two mills over in Europe. One is in Switzerland where we are the sole maker of the Swiss Franc and we make the Euro for ten different countries. Since 2006, we have expanded capacity by over ten times the original capacity when we bought the mill. Our second mill is located in Germany and specializes now in a non woven wall paper, which is a very strong dry strippable type of paper that is easy to get off the walls and is unique for the wallpaper industry. We have grown that company since 2006 from approximately $1 million a year in dividends to over $40 million a year run rate right now, transforming it into the world’s leading producer globally, almost sixty percent market share of this particular product. As we expand further, we look for interesting assets. We found some pulp mills located in Canada, and have now closed on two of them so far. These mills were making commodity paper products using expensive wood and having a challenging cost structure, so both of the mills were actually shut down and closed at the time we bought them. In general, they are about a $1 billion asset each, the first one we paid just over $1 million for it, and the second we paid $1.00. They were going through very tough times. Because they were shut down, it was the time to get involved and change the cost structure so we implemented a 15% discount on wages across the board. We did not have to bring back as many people. We got huge concessions from the government in the form of long-term debt below market rates. We had the government take most of the environmental issues and liabilities in one of the particular mills, which were quite significant, as well as other financial grants. More importantly within the business plan was not just changing the cost structure, we wanted to go into a completely different product. Rather than making pulp for the paper industry, which is very low margin and tough to compete, we now focus on a very specialized pulp called dissolving pulp, which goes into the viscose rayon industry. It is a replacement for cotton, and the longer term demographics are all lining up. Cotton is going to go through some challenging times over the next several decades, due to the heavy use of herbicides, pesticides, fertilizers, and water and therefore it just will not be able to meet the growth that we are experiencing both in terms of population, and people moving up in income status. Since cotton cannot keep up with that growth, we are quite confident it will be viscose and rayon, and this dissolving pulp that we make will fit into that supply chain. We typically look for mills that have operated at a loss for the last several years before they shut down, then we change their product mix with a goal to generate $100 million a year of EBITDA per mill depending on how the underlying economy performs. Even based on the challenging economy now, we are still achieving very attractive margins.
Mr. Wasilenkoff: Typically what happens is that it starts with finding an industry which is out of favor, then trying to drill down and get the right assets or products within that sector. It really starts with more of an entrepreneurial spirit of trying to figure out what would be a better use for these particular assets, what can be accomplished, and/or where can we identify a unique situation such as a larger company with non-core assets that just want to get rid of them. It makes for an interesting entry point and good valuations. We also look for a government that is motivated to create some jobs, and is willing to assist in the overall economics of the project. Once we secure the assets and formulate the business plan, then I go out and seek industry experts who become partners. Trying to get a partner based on just a business plan is hard. Most very good talented people are gainfully employed on a regular basis, so you never end up getting the timing right, and you really do need to attract the best people away from somewhere. I can only do that once I have secured these types of assets, and put the business plan together and the financing in place. I really do view the new management teams as partners, they come in and have quite a bit of autonomy. They get to run these mills, go through the conversions, and shift it into new products, but we do find experts in everything that we do. We are willing to provide significant or meaningful financial packages to attract the absolute best, which allows us to sleep at night and do what we have had some success with, which is building and growing these companies. We then pass them on to these partners to operate, and these gentleman and ladies come in and take on the CEO role of each of these divisions, so in our Fortress Paper, we now have five different companies with four different CEOs running the different operations with a lot of autonomy.
Mr. Wasilenkoff: Technology plays a limited role, we always try to use the latest and greatest technology, improve runabilities and performance, but usually decisions we like to put together are generally based on the fundamentals of the equipment and the unique opportunity. When you start with a billion dollar asset, and you buy it for one dollar, we have a lot breathing room to wrap it up, put in a little bit more capex, and maybe a little bit of technology, but it is definitely not the make or break portion of the projects.
Mr. Wasilenkoff: We see quite a few deals and we have very stringent investment criteria. We are venturing into new areas where we do not have much personal experience, and then we have to build the management teams around them. Because of that, if they do not meet our very strict requirements and/or we end up running into any kind of issues or difficulties where it could be more of a challenge than we anticipated, or it changed the economics where they are not spectacular, then you have to walk away. We have looked at many and passed on a lot, so it ends up being a great amount of work and a great amount of deals to evaluate at all times. We do not close on that many, but go through the process many times.
Mr. Wasilenkoff: It is more opportunistic, if it does get into certain countries, and the political risk is too high, or the corruption is too high, then we would avoid it altogether. Life is too short, and there are enough good opportunities in better political and less corrupt jurisdictions. Otherwise, we would generally look at any industry in any location.
Mr. Wasilenkoff: In our oldest division, which is our wallpaper division, it is going spectacularly well. Record month after record month, even though it is based in the Euro zone. Even though our products are a consumer based product which is sold in Europe with their challenging times, things have never been better. In our banknote division, which is our second oldest investment, it has been a challenging time because of our cost structure. A couple years ago when we made the large investment and expanded our capacity ten-fold, things were going well. Then with the Euro crises, people have been flocking into the Swiss Franc, just seeking safety, and not because it has great GDP or great growth profile, but just strictly for security reasons. We are the only banknote producer in Switzerland where as most of our competition is in other Euro countries. Therefore, they have become a lot more competitive, and we have gone from 20% positive profit margins to ball park negative 10% profit margins. Hopefully, with an easing up in the Euro zone and people getting back down to more fundamentals in terms of currency exchange rates, profitability there should come back in line. Our other businesses and our dissolving pulp are going well, one of our mills is fully converted and ramping up nicely, this mill is really generating quite a substantial margin, and continuing to grow. The other pulp mill that we just recently closed on is pushing forward and starting the conversion now.
No, not at all and I get this question often. What we find is that if you
invest in the hot sector and just try to jump on the bandwagon then you get
a lot of attention. However, this does not fit our contrarian strategy. In
the hot sectors it is hard to find an asset, then once you find the asset
and you pay too much for them, then you cannot attract people away because
they are all gainfully employed and they are also in good growing companies
with stock options, large pay packages, and things like that. Once you put
all that together, it is still very easy to raise the money to attract
investors because it is the hot sector. The way we are doing it is the exact
opposite, we go the out of favour sectors where we can get world class
assets, world class people, and unbelievable valuations. Forestry as an
example has seen a huge erosion of capital for decades. When we talk to
investors, a great deal of them say that they do not even want to hear about
the forestry sector, and nobody ever makes money in that industry. So
getting investor attention is very difficult. So while we do not have much
competition when looking for these assets, we are overlooked on the other
side and many people are not that interested in what we have to say. So we
typically trade at a poor profit multiple compared to other industries in
CEOCFO: What is the financial picture like for Fortress Paper today?
We just completed a large conversion on one of our dissolving pulp mills,
which is now our largest asset, we spent just over $200 million to convert
that mill, and it is ramping up now so we are operating at about 90%
capacity. When it is fully ramped in the next month or two, it will change
the overall dynamic of our company because that mill will generate
approximately $100 million of EBITDA per year. Prior to that, it was shut
down last year because we were going through our major conversion. It is a
transition time right now, and if somebody looks back one or two quarters
historically, they would wonder what is going on and how is it possible this
company could be growing so fast based on previous results. That is because
we buy these major assets, and they have been shut down. Financially, it is
all looking very positive, and on a go-forward, it just starts to ramp up
now. We have six analysts covering the stock, and a majority of them calling
us their number-one strong buy, so at least the analysts like the story and
where we are taking the company. They are confident the risk to reward
profile is good, but unfortunately a lot of investors do not listen to these
analysts either because they are forestry based.
There are forestry companies in general that do offer attractive valuations.
We have seen what has happened to companies like Facebook and things that
could be trading well ahead of themselves, and you have to hope that it
eventually catches up to the valuation, but with these forestry companies
that have been beaten down so badly, generally there is no investor
sentiment around them. They tend to be less liquid, which can scare off some
investors, but their returns can be phenomenal, and you can pick these
things up at pennies on the dollar compared to other industries and sectors.
You need to have a long term time horizon because nothing is going to change
overnight. The sentiment also is not going to change overnight, but there is
more significant wealth that can be created with this long term horizon, by
picking up something in this industry or sector at the bottom of the cycle.
We typically look for mills that have operated at a loss for the last several years before they shut down, then we change their product mix with a goal to generate $100 million a year of EBITDA per mill depending on how the underlying economy performs. - Chadwick (Chad) Wasilenkoff
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