Stone Container Corporation
1. How did Roger Stone’s management of the company compare to that of his predecessors? In general, would you judge his leadership to have een successful? !hy or why not? Stone Sto ne "on "ontai tainer ner "or "orpor porati ation on #$S #$Ston tone% e%&& ha has s his histor torica ically lly e een en an ac ac'ui 'uisit sitive ive com compan pany y. However, in the wa(e of the )reat *epression, its founders estalished a longstanding policy to $not to carry any signi+cant det for long periods of time%. rior to 1--, ac'uisitions that served to diversify the company’s product o/ering and geographic presence were typically paid for with a comination of cash and loans that were repaid early. !hile Stone completed an initial pulic o/ering in 1-0, the usiness remained conservatively capitalied capitalied thereafter with family ownership in the majority at 23. Roger Stone, with highly leveraged ac'uisitions of distressed producers, stimulated much higher high er +nancial +nancial and e'uity ris(s with the addi addition tion of laye layere red d det det.. He was ale to e4p e4pand and capacity more than 2 times at one5+fth of the normal cost of uilding new plants6 however the high degree degree of oper operating ating leverage leverage inher inherent ent in the pro product duction ion of pape paper7 r7 paper paperoar oard d e4posed the company to a greater degree of cyclicality and pricing ris(. )iven the high +4ed5cost nature of paper manufacturing, Roger’s aggressive capacity e4pansion left the company particularly e4posed to periods of decline where producers will cut prices efore production. 8urther, 8urther, via additional e'uity o/erings overseen y Roger Roger,, the "ompany’s family ownership was diluted to 9:3 y the late 1-;:’s. Initially Initi ally,, Roger’ oger’s s stra strategy tegy was fair fairly ly succ successfu essfull as he was growing growing the ear earning nings s of the usiness and ful+lling det oligations. !hile the ac'uisition of
he his transition was a turnin tur ning g poi point nt tha thatt se sett Sto Stone ne on a pat path h tow towar ard d +na +nanci ncial al dis distr tress ess #e. #e.g. g. nea nearr ins insolv olvenc ency, y, reliance on the sale of assets, revolver re+nancing accompanied y heave fees, reluctant e'uity issuances li(ely plagued y adverse selection, A>5det7=*B of C;.:4 at 179171& and rendered Roger’s leadership unsuccessful. 8urther, it is possile that Roger was ill5 advised to turn down
. How did Stone "ontainer in recent years +nance ac'uisitions? How did the +nancing evolve after the ac'uisition was completed? !hy might Stone "ontainer +nance ac'uisitions in such a manner, in the language of theories we covered in "lass ? Eear E ear >ransaction >ransaction description Bmount Bmount 1-- =4pansion of South "arolin "aroline e line oard F22 million 1-;1 *ean *empsey "orp. e'uity position undisclosed 1-;9 Bc'uisition of "ontinental )roups. Aong term det rose to -3 of capital 8irst e'uity o/ering #8amily ownership 23 to 0-3& F@:: million 1-;2 Bc'uisition of "hampion International International "orporation )ave "hampion 1 to 103 of StoneGs Stoc( #Aess than 0:3 ownership& F02 million 1-; Bc'uisition of Southwest 8orest F@: million 1-;- Bc'uisition of "onsolidated hese assets, whether formally secured as collateral or availale to senior det holders with priority, reduced agency costs for the det mar(et and allowed the company to ta(e advantage of lower cost +nancing. However, an( loans were eventually re+nanced via the issuance of pulic det with $jun( onds% #higher level of asymmetry& creating a +rm more sensitive to insider information.
*B #utilied as a cash Kow pro4y&, while there is wea( correlation at the other two cross5 sections. Bs indicated y 85tests with signi+cance levels aove -23, the multi variale regression results elow indicate that movements in paper and lineroard pricing as a group have a statistically signi+cant impact on the Met Income and =*B of Stone "ontainer. !hen assumingL i& the 1-- production level of .2 million tons per year6 ii& 1-- costs #with the e4ception of interest e4pense& iii& interest e4pense of F0:: million as implied y the case6 and iv& a 923 ta4 rate, earning and =*B are highly sensitive to price increases of F2: and F1:: as illustrated elow. 8or full Income Statement details, refer to Bppendi4 I. 0. !hat would e e/ect under oth these pricing scenarios if production and sales volume increased to full capacity of ;.9 million tons per year #for simplicity, assume costs per ton remain constant&? Nf note, the calculated =*B forecast for :19 of F1,01 million with a pricing change of F1::7ton #see 'uestion O9& resemles =*B of F1,1 million forecasted for a production increase to ;.2 million tons, holding pricing Kat. >herefore, =*B resulting from a 19.@3 isolated increase in pricing is comparale to an isolated 19.13 increase in volume. 8or full Income Statement details, refer to Bppendi4 I. 2. !h !hat at sh shou ould ld e St Ston one e "o "ont ntai aine ner’ r’s s +n +nan anci cial al pr prio iori riti ties es fo forr 11--9 -9? ? !h !hat at mu must st e accomplished if Stone is to relieve the +nancial pressures aPicting it?
=ven though there seemed little dout that paper prices would eventually recover, the accumulation of F9.9 illion in det had left the company highly leveraged and was drawing close to the coverage and indetedness covenants on its various credit agreements. >he following tas(s must e accomplished in order to relieve the company from its +nancial crisisL 1. Bvoidance of default via compliance with coverage and total indetedness covenants in its various credit agreements . ;:3 of the revolving credit facilities were scheduled to terminate in the +rst 'uarter of 1--9. Stone would need to e4tend, re+nance or replace those facilities 9. 8ind a way to +nance a capital e4penditure e4penditure of F1:: million as re'uired re'uired y new secondary5 waste treatment regulations in "anada Stone must +nd a way to (eep the company aKoat until an industry upswing allows the company to reduce its det load to a sustainale level #closer to peers Q 02.03 det7total capital& that can handle cyclicality. @. Nf the various +nancing alternatives descried at the end of the case, which would e in the est interest of Stone’s shareholders? !hich would e in the est interests of its high5 yield det #i.e., jun( ond& holders? Nf its an( creditors creditors? ? !hich of the +nancing alternatives alternatives would you recommend Stone "ontainer pursue in 1--9? If you recommend more than one, which do you view as most important and why? !hich would you do +rst, and which later? Ja(e sure to call upon previous lectures when answering this 'uestion. he convertile o/ering, with an implied conversion price of F1;7sh, is perhaps tantamount to a ac(door e'uity o/ering considering Stone’s share price in 8eruary :19 compared to its historical averages. Bssuming that Stone weather’s its crisis and recovers with the paper industry, convertile note holders would almost assuredly convert their onds to common shares to sell them on the open mar(et if Stone’s mar(et e'uity price returns to historical levels.
8rom another paper
Stone Container Corp FI 602 Case 6 Stone Container Corp Case Analysis Write-up Anonymous I. Overview J.H. Stone & Sons a !ar"#oar" !ontainer an" paper pro"u!ts manu$a!turer manu$a!tur er was $oun"e" #y Josep% Stone in '26 an" a$ter Worl" War II
rein!orporate" as Stone Container Corporation. (arly on in its !on!eption Stone was a#le to )row si)ni$i!antly #y way o$ a!*uisition. +%e !ompany %a" %a " a po polili!y !y o$ pa pay yin in) ) $o $orr it its s a! a!*u *uis isit itio ions ns ei eit% t%er er en enti tire rely ly in !a !as% s% or #orrowin) $un"s wit% early repayment. Continuin) to )row t%e !ompany #e!ame pu#li!ly-owne" w%en it issue" its $irst 2,0000 s%ares o$ sto! in '/. A$ter its $irst IO Stone was a#le to wi"en its rea!% "emo)rap%i!ally. "emo)rap%i!ally. +%e !ompany #e)an a!*uirin) even more to #etter "iversi$y itsel$ in t%e paper in"ustry. 1y '/ Stone %a" *uintuple" its pro"u!tion !apa!ity #ut %a" #orrowe" %eavily to "o so. Stone Forest In"ustries a su#si"iary o$ Stone Container was !reate" to relieve some o$ t%is "e#t an" Stone Container was a#le to "iminis% t%e rest. In '' Stone was #a! at it w%en it a!*uire" Consoli"ate"-1at%urst In! in !on3un!tion wit% its 45.5 #illion o$ "e#t. (ven wit% its %i)% stan"in) in t%e in"ustry in ''5 Stone Containers $uture was a s%ain) one one t%at !ame "own to %ow it woul" avoi" "e$aultin) on its 4. #illion o$ "e#t. II. Con"ition o$ t%e In"ustry Summary o$ t%e aper & Forest ro"u!ts in"ustry7 8 In"ustry 9i!%es an" relevant !ompetitive lea"ers7 8 aper an" Woo"- :eor)ia a!i$i! 8 Sanitary +issue ro"u!ts- S!ott 8 So$twoo" +im#er- Weyer%aeuser 8 Container#oar";Corru)ate" Containers- Stone Container Corporation 8 In"ustry Sales :rowt%- 5< revenue )rowt% #etween t%e years o$ '6 an" ''2. 8 '6 =evenue- 46.6 #illion 8 ''2 =evenue- 4,.2 #illion
8 In"ustry 9et ro$it - >e!line" #y 6,< #etween t%e years o$ '6 an" ''2. 8 '6 9- 42., #illion 8 ''2 9- 4.'/ #illion 8 Hi)% "e)rees o$ pri!e !y!li!ality "ue t%e operatin) levera)e in%erent in t%e In"ustry?s !apital intensive s!%ema. 8 Hi)% Hi)%ly ly !omp !ompetit etitive ive Cont Containe ainer#oa r#oar";C r";Corr orru)at u)ate" e" Cont Containe ainers rs ni!% ni!%e e wit% Stone $a!in) , "ire!t !ompetitors. III. Con"ition o$ t%e Company >ue to %eavy a!*uisition Stone Container Corporation %as put t%emselves in a ti)%t $inan!ial situation wit% up!omin) "e#t an" interest payments. Ston St one? e?s s pl plan ans s to $i $ina nan! n!e e it its s la lar) r)e e a! a!*u *uis isit itio ions ns su su!% !% as t% t%e e on one e o$ Consoli"ate"-1at%urst went awry w%en its plan to re$inan!e its loans wit% %i)%-y %i) %-yiel iel" " #o #on"s n"s wa was s eli elimin minate ate". ". +% +%is is was par partia tially lly "ue to re re)ul )ulato ators rs $or!in) many savin) an" loans #ans to "ump t%eir 3un #on"s. Stone $oun" a way to relieve some o$ its $inan!ial pressure #y re$inan!in) an" restru res tru!tu !turin rin) ) its "e# "e#tt usi usin) n) se! se!uri uritie ties s su! su!% % as int inter erest est ra rate te swa swaps ps an an" " !onverti !onv erti#le #le e@!% e@!%an)e an)ea#le a#le pre$ pre$erre erre" " sto! sto!. . An inte interest rest rate swap wou woul" l" allow Stone to e@!%an)e a stream o$ interest payments $or anot%er party?s strea str eam m o$ !as !as% % $lo $lows ws.. +% +%is is wou woul" l" alt alter er t% t%eir eir e@ e@pos posure ure to int inter erest est-ra -rate te $lu!tuations #y swappin) $i@e"-rate o#li)ations $or $loatin) rate o#li)ations. Converti#le e@!%an)ea#le pre$erre" sto! is sto! t%at !an #e e@!%an)e" at t%e issuer?s option $or !onverti#le "e#t t%at %as t%e same yiel" an" !onversion terms. 1ot% o$ t%ese options !oul" #e pro#lemati! $or Stone #e!ause it leaves t%em open to interest rate ris. 9ot only "oes Stone Container %ave to #attle repayment stru))les #ut it is also $a!in) a volatile in"ustry. In t%e early ''0?s t%e paper in"ustry saw a rise in re!y!lin) wit% a rate o$ 55.,< o$ t%e paper !onsume" !oul" #e re!overe" $or re!y!le" use. An in!rease in re!y!le" paper woul" in$luen!e pri!e !%an)es in t%e paper in"ustry. +%is !oul" #e !ontri#ute" to t%e pri!e "e!rease in t%e early ''0?s. Stone was $a!in) !%an)es in %ow paper was #ein) pro"u!e" #ut also lar)e swin)s in t%e in"ustries pro$ita#ility. 1etween
'6 an" ''2 t%e paper an" $orest pro"u!ts in"ustry )rew $rom 46.6 #illion in sales to 4,.2 #illion. (ven t%ou)% t%is was a 0< in!rease t%e net pro$it "roppe" $rom 46 #illion in ' to 4.'/ #illion in ''2. Su!% a lar)e "e!rease in a s%ort amount o$ time "i"n?t prove $avora#le $or Stone. +%ese two $a!tors !oul" mae it "i$$i!ult $or Stone to a!!urately $ore!ast its $inan!ials t%us its a#ility to pay #a! its "e#t. I. Issues C%oi!es an" Analysis Fa!in) t%e Company Issue Havin) seen )reat su!!ess wit% a!*uisition in t%e past Stone Container Corporation Corporatio n %asn?t seen t%e results it woul" %ave %ope" $or re!ently re!ently.. Stone "isre)ar"e" its poli!y to only #uy w%en it !oul" pay in !as% or pay t%eir "e#ts #a! *ui!ly. +%is in turn le$t t%em wit% t%e un!ertainty on %ow to pay #a! t%e lar)e amounts o$ "e#t t%at were taen on. 1e!ause t%e !ompany?s ori)inal plan to re$inan!e t%eir loans wit% %i)%-yiel"in) #on"s went sout% t%ey now $a!e t%e pro#lem o$ w%i!% o$ t%e $ive alternatives availa#le to t%em is t%e #est plan o$ a!tion to tae to arrive at a soun" $inan!ial plan. +%is plan will nee" to relieve t%e immense "e#t t%at is pla)uin) t%em %elp it )et t%rou)% t%e paper pri!in) trou)% an" also restore t%e !ompany to its $ormer )lory o$ $inan!ial sta#ility. C%oi!es >e#t =elie$ Avenues Availa#le to Stone Container Corporation7 . +%e terms on t%e #an loans !oul" #e rene)otiate" to e@ten" t%eir matu ma turi riti ties es an an" " ea ease se so some me o$ t% t%e e #i #in" n"in in) ) !o !ove vena nant nts. s. Fe Fees es $o $orr t% t%is is transa!tion woul" ran)e $rom 4/0 to 40 million. 2. Assets or e*uity interest in a Stone Container Corporation su#si"iary !oul" #e sol" $or a !as% $low o$ 42,0 to 4,00 million. 5. +%e #an "e#t !oul" #e repai" #y sellin) interme"iate-term senior notes to t%e pu#li!. 4500 million o$ ,-year notes #earin) a !oupon in $rom 2< to 2 B< !oul" #e sol".
. +%e !ompany !oul" sell up to 4500 million o$ !onverti#le su#or"inate" notes. +%e notes woul" %ave / year li$e #ear a !oupon o$ < an" #e !onverti#le into Stone?s !ommon sto! at a 20< premium over t%e maret pri!e o$ Stone?s !ommon sto! at t%e time o$ t%e o$$erin). ,. Common sto! o$ up to 4,00 million !oul" #e issue" to t%e pu#li! w%i!% woul" pro"u!e net pro!ee"s $or t%e !ompany o$ ',< o$ t%e o$$erin) pri!e. Analysis Dultiple assumptions %ave #een ma"e t%rou)%out t%e analysis o$ t%e Stone Container Corporation !ase. Some o$ t%e $inan!ial assumptions in!lu"e7 8 EA wei)%te" avera)e avera)e o$ t%e past t%ree years will #e use" $or net sales $or t%e year en"in) >e!em#er 5 ''5 (@%i#it G. 8 ESellin) )eneral an" a"ministrative e@penses are last year?s e@pense plus t%e avera)e o$ t%e !%an)e in e@pense over t%e past t%ree years (@%i#it G. 8 >epre!iation an" amortiation e@pense is !al!ulate" t%e same as sellin) )eneral an" a"ministrative e@penses (@%i#it G. 8 Sales ta@ rate o$ 5,< (@%i#it 2G. =elevant >ata In or"er to $ully analye Stone Container Corporation?s $inan!ial situation some relevant "ata was nee"e" in or"er to )et a #etter pi!ture o$ w%at it was $a!in). >urin) t%e year o$ Dar!% ''5 to Dar!% '' t%e !ompany woul"7 8 E !ontinue to pay 400 to 42, million in interest on its "e#t 8 E mae "e#t repayments o$ 456, million 8 E e@ten" re$inan!e or repla!e anot%er 400 million in revolvin) !re"it t%at was s!%e"ule" to terminate 8 E #e re*uire" to mae 400 million o$ new !apital e@pen"itures
8 E $a!e pre-ta@ losses o$ 4,0 to 4,00 million Analysis In an anal aly yin in) ) t% t%is is !a !ase se on one e e ey y $i $ina nan! n!ia iall t% t%eo eory ry wa was s us use" e" $i $ina nan! n!ia iall leve le vera ra)e )e.. +% +%is is t% t%eo eory ry ta tae es s t% t%e e "e "e#t #t o$ a !o !omp mpan any y an an" " re rein inve vest sts s t% t%e e pro!ee"s $rom t%at "e#t in or"er to earn a )reater rate o$ return t%an t%e !ost o$ interest. W%en levera)in) is su!!ess$ul t%e $irm?s return on assets =OAG is %i)%er t%an t%e interest on t%e loan as a result its return on e*uity =O(G will #e %i)%er t%an i$ it %a"n?t #orrowe". +%e ne)ative is w%en t%e $irm?s =OA is lower t%an t%e interest rate its =O( will #e lower t%an i$ it %a"n?t #orrowe". evera)e allows a !ompany to see t%e potential $or a )reater return t%an woul" %ave #een availa#le wit%out it. 1ut t%ere is ris invo in volv lve" e" #e #e!a !aus use e t% t%e e po pote tent ntia iall $o $orr lo loss ss is al also so )r )rea eate terr. I$ t% t%e e !% !%os osen en investment #e!omes wort%less wort%less t%e !ompany woul" still #e o#li)ate" to pay pa y t%e prin!ipal on t%e loan an" all o$ t%e a!!rue" interest. Wit% a wi"e assortment o$ avenues Stone Container Corporation !oul" tae to improve its "e#t ratio ea!% one %a" to #e !are$ully !onsi"ere". Option num#er one was to rene)otiate t%e terms o$ its loans. +%e e$$e!ts o$ t%is woul" #e 4/0-0 million in $ees. +%is option is t%e only solution t%at "oesn?t involve t%e Stone?s $amily?s interest in t%e !ompany to lessen #ut "oesn?t %ave an upsi"e o$ tain) in money. Option num#er two was to sell o$$ some assets or e*uity interest in t%e !ompany t%at !oul" raise 42,0-,00 million. +%is option woul" "e!rease t%e Stone $amily?s interest in t%e !ompany #ut woul" still #rin) in t%e $un"s nee"e" to %elp "e!rease t%e !ompany?s "e#t. Option num#er t%ree was to sell a senior interme"iate-term note wit% a ,year term an" a !oupon o$ 2 to 2 B<. +%is is a #on" t%at taes priority over t%e ot%er "e#t se!urities sol" #y t%e !ompany. I$ Stone were to )o #anrupt t%is "e#t must #e repai" #e$ore ot%er !re"itors re!eive payment. Option num#er $our was to 4500 million in !onverti#le su#or"inate" notes wit% a li$e o$ / years an" a < !oupon. +%ese options woul" allow t%e !ompany to re!eive $un"s up $ront wit% !oupon payments pai" in t%e $uture. A $inan!ial levera)e analysis was !ompare" #etween option t%ree an" $our (@%i#it 5 & G. Option num#er $ive was to issue up to 4,00 million in !ommon sto! wit% net pro!ee"s e*ualin) ',< o$ t%e o$$erin) pri!e. +%is option !oul" potentially allow t%e !ompany to put 4/, million towar"s its "e#t.
. =e!ommen"ations A$ter analyin) ea!% alternativ alternative e Stone Containe Containerr Corpora Corporation tion !oul" implement in or"er to relieve its "e#t pressures t%e #est option woul" #e to tae a two si"e" approa!%. I$ Stone were to rene)otiate t%e terms o$ its loans as in option one t%ey !oul" tae a smaller %it t%an i$ t%ey were to pay out t%e interest payments outline" in option t%ree (@%i#it 5G. =ene)otiatin) t%ese terms will also allow t%e !ompany more time to restru!ture its "e#t port$olio an" )ive t%em a !%an!e to "epen" less on an alternative t%at "e!reases t%e $amily?s s%are in t%e !ompany. +%is option outwei)%s t%e alternative to sell e*uity in t%e !ompany or its su#si"iaries #e!ause t%ere t%ere is no loss o$ $amily stae in t%e !ompany. I$ I$ t%e !ompany were to also )o wit% option num#er $our t%ey !oul" see a )oo" return on t%eir e*uity. Wit% t%is option t%e !ompany woul" see a =O( o$ .6< an" only pay interest o$ 4/, million over t%e seven year li$e. +%is alternative outwei)%s t%e option to issue senior notes #e!ause t%e =O( is %i)%er an" t%e total interest pai" is less (@%i#it 5 & G. +%e lon)er li$e o$ t%is option woul" allow Stone to sprea" out its "e$ault ris $art%er t%an any o$ t%e ot%er options. +%is option woul" also eep t%e Stone $amily?s interest in t%e !ompany t%e )reater t%an !ompare" to option num#er $ive. I$ Stone Corporation wants to stay out o$ #anrupt!y it nee"s to restru!ture its "e#t. +%e !ompany %a" a lon) time stan"in) o$ not nee"in) "e#t or pai" it o$$ *ui!ly #ut t%at !%an)e" an" it *ui!ly )ot in over its %ea" #e!ause lar)e a!*uisitions. Five "e#t re"u!in) alternatives were presente" to t%e !ompany wit% two options "eemin) t%e #i))est rewar"s. +%e !ompany s%oul" s%o ul" re restr stru!t u!ture ure its loa loan n te terms rms an an" " iss issue ue 45 4500 00 mil millio lion n in !o !onve nverti rti#le #le notes in or"er to relieve t%e immense "e#t t%at is pla)uin) t%em %elp it )et t%rou)% t%e paper pri!in) trou)% an" also %elp restore t%e !ompany to its $ormer )lory o$ $inan!ial sta#ility.
