October 29, 2010
Hon. Judge Kevin J. Carey
United States Bankruptcy Court
District of Delaware
824 N. Market Street. 3rd Floor
Wilmington, Delaware 19801
Re: AbitibiBowater Inc, et al. Case No. 09-11296 (KJC)
Honorable Judge Carey:
I am a common shareholder of AbitibiBowater Inc. (henceforth, ABH), and would like to take this opportunity to present a succinct, cogent argument as to why the Plan proposed by ABH management should not be confirmed.
1. Dramatically restructured operations
ABH today is a much-improved company compared to when it entered bankruptcy. ABH significantly transformed its business while in bankruptcy: closing high cost mills, shifting focus to more attractive paper grades, and slashing operating costs. As an example, ABH closed in excess of 900k tons of newsprint capacity (representing 20% of ABH’s capacity and in excess of 10% of North American capacity) since January 2010. I anticipate only 36% of future EBITDA will be generated from Newsprint, with the other 64% coming from coated paper, specialty paper, pulp, and wood products. Additionally, the company reduced fixed costs by $925mm and will benefit from an agreement with the union upon confirmation of the Plan Of Reorganization, which will further reduce COGS (Cost of goods sold) and SG&A (Selling, general and administration) by $115 millions.
2. Overly pessimistic outlook for newsprint and under-appreciated sustainable export storyAs a result of the secular decline in North American newsprint demand accompanied by the step-function loss of demand experienced during the financial crisis, much of the North American newsprint industry found itself in financial distress over the past couple of years. The industry responded by dramatically reducing North American capacity by in excess of one forth since 2009. This reduction of capacity has caused a spillover effect which has increased the cash costs for newsprint manufacturers outside of North America and thus, shifted the cost curve in favor of the North American producers (who are currently the low cost producers in the world). This dynamic stems from North American producer’s outsized reliance on virgin wood fiber as its key raw material, relative to Asian and European producers who rely much more heavily on recycled newspaper (ONP - Old Newsprint). Historically, ONP was in plentiful supply and thus, its cheap cost accompanied by a production process that was less energy intensive allowed ONP mills to produce newsprint on the lower end of the global cost curve. As a result, almost all of the European and Asian mills built over the past two decades have been ONP-based and most do not have the equipment or the wood supply to produce newsprint using virgin wood fiber. This has come back to bite them, as ONP can only be recycled 4 times before the fibers breakdown and Asian producers must source ONP in North America (which they then have to ship back to Asia) because of its high virgin fiber content. Due to the rapid decline in North American production of newsprint, unsurprisingly recycled newsprint has become increasingly tight (and is expected to remain tight) – driving up the cost for ONP to in excess of $100 per ton relative to $50 two years ago. Additionally, the current low cost of natural gas in North America has reduced the energy cost advantage of the ONP production process. As a result, North American producers currently have over $150 cash cost per ton advantage over Asian producers. Meanwhile, European producers would not be competitive until the Euro was sub $1.20, a situation which seems less likely every day. All of the aforementioned factors have created a huge export story (ABH is currently exporting over 50% of its production and is turning down export orders) allowing North American producers to operate at 100% utilization ratios and thus, creating pricing momentum. Despite the continued secular decline in North American newsprint demand (which is expected to continue to decline at 5-6% per year), the rest of the world is actually growing - Asian demand is expected to increase in excess of 500k tons per year through 2014 (more than offsetting the decline in North American demand, as the base of North American demand is already extremely low) as literacy rates increase in emerging markets. Therefore, ABH is expected to maintain its ability to generate meaningful cash flow from newsprint operations into the foreseeable future, as it exports more of its production into the Asia and Latin America.
3. Near-term upside in coated & super-calendar paper
ABH has in excess of 1mm tons of capacity of coated paper and super-calendar paper, representing in excess of 15% of North American production. Due to a dramatic reduction in capacity and inventories, accompanied by a second half recovery in magazine and catalog circulation, coated paper manufacturers have recently announced $100 per ton of price increases. Despite these price increases, I believe there is room for additional price increases, as prices remain near historic lows on a real basis. Additionally, the US ITC (United States International Trade Commission) ruled on October 24th 2010 that domestic coated paper makers are being harmed by low-cost imports from Indonesia and China. This was the last of 4 decisions that was necessary for tariffs to be imposed on imports and is expected to keep the Chinese out of the domestic market for the next 5-years, which should further support price stability.1
4. Pulp – A long-term secular story
The recent run-up in pulp prices in 2010 to in excess of $1,000 highlights the long-term story for pulp, as consumption per-capita increases in the developed world, as more and more people in emerging market use tissues, toilet-paper, diapers, etc. and and areas of North America are the only place in the world that produce long-fiber NBSK ( northern bleached softwood kraft) pulp. Also recent industry pulp data has indicated no decline, as demand in China continues to support pricing. In addition, current prices are in excess of the Plan assumptions.
5. Upside from monetization of wood products and other assets are not reflected in the Plan
The wood products division is currently generating virtually no EBITDA. This division of ABH has generated as high as $110mm of EBITDA in the past and I believe for next the 5 years EBITDA for this business will be $100mm/year. Assuming 6x, this business could be worth $600 million alone and is not reflected in the Plan. ACH sale: ABH is in the regulatory process of selling its one of the Hydro Power Asset. This asset have 230 million of non recourse debt associated with them (Over $220 million in equity value). I expect the asset will be sold for in excess of $450 million by first quarter of 2011.
I currently ascribe no value to other assets including timberland and closed mills (which they have been selling to scrape steel companies for $18-20 million)NOL's: ABH has retained significant NOL's and I do not expect them to be a tax payer for an extensive period of time.
Business Overview/Paper Grade Exposure:
Newsprint: 3.3mm tons of capacity representing 9% of worldwide capacity and 37% of North American capacity
Coated papers: 658k tons of capacity representing 15% of North American capacity
Specialty papers: 1.8mm tons of capacity representing 36% of North American capacity (note: roughly 1/3 of this capacity is supercalendar capacity, which trades like coated, 1/3 trades like uncoated, and 1/3 trades like newsprint)
Market pulp: 1.1mm tons representing 7% of North American capacity
Wood products: the company operates 18 sawmills in Canada that produce construction grade lumber sold in North America.
For a large, multinational corporation as ABH, there are many factors that can drastically affect its EBITDA. Below are some of these key sensitivities.
-/+ $25 newsprint = -/+ 85mm of EBITDA
-/+ $30 CPP = -/+ 65mm of EBITDA
-/+ $25 Pulp = -/+ 26mm of EBITDA
+/- .01 C$/US$ = -/+ 20mm of EBITDA
+ / - 10% natural gas = -/+ 11mm of EBITDA
A change of $25 in the cost of newsprint per ton affects the EBITDA by $85million, whereas a change of penny in value of the Canadian Dollar against the US Dollar can affect it by $20 million. Hence, it is imperative that we use the most current rates (and not the stale data used in the Plan) and account for the near-term projections in determining ABH’s value.
Conclusion
In light of all the arguments presented above, I would like to request this Court to dismiss the proposed Plan and ask for one that includes a more thorough and accurate valuation. Such a valuation would show that the company is in good enough shape to partially compensate the existing common shareholders. Meanwhile, the 8.5% compensation for management is patently ludicrous and yet another reason to reject this Plan.
Respectfully,
