Pulp & Forest Products Merger: Strategy, ROI, and Structure

Industry Overview and Market Conditions

There are significant pressures on the pulp and forest products industry at present, making prediction difficult. Some of the harsh effects of the 2001 recession began to ease in the second half of 2002, when paper prices began to firm. This segment is the largest revenue producer for the industry, so the relief was widely welcomed. However, any extraordinary gains are likely to be mitigated by the oversupply in the wood products sector (Standard & Poor's, "Current Environment").

International Paper is considered the largest pulp and forest products company in the U.S., followed by Georgia-Pacific (GP) (Hoover's Online). A quick look at their financials, however, demonstrates that they are not equally successful, although both serve virtually the entire range of possible market sectors. International Paper (IP) also serves additional niches, producing wood-derived chemicals including crude tall oil and crude sulfate turpentine, as well as a variety of inks, thereby covering markets throughout the possible uses of tree-based products (Hoover's Online).

Financial Comparison: International Paper vs. Georgia-Pacific

In 2002, Standard & Poor's reported negative net income for Georgia-Pacific at −$190.0 million, while it reported net income of $295 million for International Paper.

The reason for this disparity, despite GP's number-two spot in the industry, might be laid at the feet of its product mix. GP sold 60% of its Unisource Worldwide distribution segment in 2002. That segment, along with GP's building products, accounted for just over half the company's sales (Hoover's Online). As noted above, the market for building products is currently the weakest in the pulp and forest products industry.

It appears that IP properly managed its major strength — ownership of vast timberlands and essentially total market integration — while also meeting outside challenges. Hoover's reported no significant changes in IP's operations, structure, products, or markets. Georgia-Pacific, by contrast, was poised to spin off lucrative (though costly to promote and service) household paper product brands such as Brawny paper towels and Quilted Northern, but cancelled the spin-off, citing poor market conditions for a public offering. It may also have undermined itself by selling off a major component of its most lucrative segment — distribution. Perhaps GP was attempting to return to its core pulp and forest products business, but the timing was poor. GP appears to have ignored its relative strengths and fallen prey to an outside threat, divesting a lucrative component at an inopportune moment (Hoover's Online).

Merger Rationale and ROI Forecast

The merger of Continental Paper Company and Great Northwestern Lumber Company makes an interesting case study, particularly regarding an ROI forecast. In the prior year, Continental's sales of $600 million generated $120 million in net profits. Continental serves the paper segment of the industry, which did rally during that period. Great Northwestern, serving the pulp and building products segments, earned only $60 million on sales of $1.8 billion.

At first glance, there appears to be little reason for Continental to join Great Northwestern — except to add value for stockholders through GN's vast forest holdings. Stock analyst Matthew Berler, who covered forest products and paper for Morgan Stanley, urged investors to be "quite careful" with paper and forest-products stocks, buying only on sharp price drops and selling on rallies. This perspective upholds the Continental viewpoint that adding underlying asset value to what is essentially a finished-goods company would be a sound long-term move, and is unlikely to harm near-term performance either (Wall Street Journal, May 13, 2003).

The combined company — referred to here as C&GN — arrives with many of the same structural components that have made International Paper successful. There will be integration costs and some temporary duplication of functions, particularly given the stated aim of reducing headcount through attrition only. A real challenge may be the contrasting management styles of the two CEOs. Nevertheless, it is reasonable to project that if C&GN adopts a holding pattern for its building products division and devotes its timberlands primarily to serving the paper and packaging business brought by Continental, the company should increase market share — potentially at GP's expense — achieving sales of approximately $2 billion with net profits of $200 to $210 million.

This projection is predicated on a differentiation strategy applied to both products (paper, packaging, and building materials) and to the deployment of timberlands and pulp mills. Distinctive competencies and careful resource allocation will be especially important to achieving these goals (Griffin 72).