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:

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.
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

[su_pullquote]The integration process that began after AP Paper Mills acquired International Paper three years ago will continue for a longer time for tangible result[/su_pullquote]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 .