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It’s déjà vu all over again

On September 7, Australia voted to change the Federal Government, well at least at one level. There was a decisive victory in the House of Representatives, but the government is unlikely to have a majority in the Senate with Independents and Greens likely to hold the balance of power. This may prevent or certainly delay the implementation of some of the promised policy measures to reduce business costs, such as removing the carbon tax and the minerals resource rent tax. Nevertheless, the change in government is likely to see a significant lift in business confidence, which hopefully will translate into at least some resurgence in manufacturing.

Business cannot wait for election outcomes, so Amcor used the recent reporting of its positive annual results (profits after tax up 8.6% and EPS up 9.4%) to announce that it will spin off its paper and paper packaging business. This marks the beginning of the end of Amcor’s transition from a paper manufacturing company to a pure packaging company. The decision to spin off Amcor’s non-packaging paper assets into PaperlinX in 2000 is usually seen as the commencement of that process, but looking back, the decision was clearly made somewhat earlier. The close of this year will see the evolution completed.

Given the parlous current condition of PaperlinX, while the directors of Amcor in 2000 might be credited with great wisdom for excising those paper assets from Amcor, many would also argue that the spiel to investors that the sum of the parts was greater than the whole rings rather shallow now. Small investors in Amcor who have stayed with both Amcor and PaperlinX for many years may be suspicious that the directors are jettisoning the paper packaging business for similar reasons as they spun off PaperlinX – a belief that the business can only go backwards. If that is the way they think, it may not bode well for the stock price of the spin-off entity. For PaperlinX, it seems the Amcor directors of the day had good advice about the demand trends for communication papers over the decade ahead when they decided to spin off that business. Sadly (if understandably) that foresight was not shared with investors. Of course, PaperlinX’s dreadful financial situation was significantly a consequence of adopting a strategy to be Paper Merchants to the world, which history has demonstrated to be a poor decision. How poor can be seen in the latest annual results (to June 30, 2013). The company lost A$90M, but that was seen as really positive in the light of the prior year loss of A$267M!

The parallels are interesting. PaperlinX was spun off only a short time after commissioning PM5 at the Maryvale Mill to manufacture essentially cut size copy paper. With a nominal annual capacity of 160,000 metric tons (now estimated to be about 185,000 tpa) critics even then argued that it would struggle to be internationally competitive. With the plethora of behemoths in China and elsewhere with annual capacities around 500,000 metric tons, it is even more challenged today. (As an aside, Australian Paper and the union that covers the production workers at the AP sites have taken to direct action to appeal to the Federal Government – the biggest purchaser of paper in Australia – to support and protect the local paper industry by amending its paper procurement policy. This followed the awarding of a paper supply contract to a Thai supplier earlier in the year. A petition was lodged in the Federal Parliament to this effect with more than 4,000 signatures from Maryvale Mill workers and local residents).

Now history repeats. Having just commissioned a new containerboard mill in Sydney, Amcor has decided to divest the assets. Although the mill is below the capacity of some of the new machines in China, at 400,000 metric tons per annum, it is more in the internationally competitive range, but it has to make a much wider range of products than is the case in China or, indeed, its local competitor, Visy (which operates as Pratt Industries in the USA). It was a mill that Amcor seemingly did not want to build, with a gestation of over 10 years, during which time numerous studies were made to establish viability. In the context of what has now been announced, the new mill was essential to underpin the spin-off proposal. Stripped of cartonboard capability with the imminent closure of Petrie Mill, it remains to be seen how competitive the new company (yet to be named) can be. The closure of Petrie can also now be seen as part of the plan to ensure the new company is in good shape when it starts to trade independently. The new company is also the repository of glass containers, metal beverage cans, wine closures, paper sacks and carton packaging. Along with fiber packaging, these could be seen as mature or even “yesterday’s” technology, although all businesses have a competitive market share. The fiber box business, on the other hand, has seen its market share reverse from around 60% of the market a decade ago to significantly below that of Visy in what is essentially a duopoly.

Returning to the proposition that this transition predates the PaperlinX divestment, the real genesis can be seen in Amcor’s retreat from its orgy of overseas expansion in the early 1990s.  The lead article headline in Board Converting News on April 13, 1992 was “Amcor Destined to be Powerhouse in World Market.” Then CEO Stan Wallis played down that aspiration, but the reader would have been left in no doubt that it was a company on the move. All the pieces seemed to be in place. Amcor had acquired Sunclipse, a California-based independent corrugated box manufacturer, it had established modern corrugated box facilities in the UK and France. Subsequently, it acquired Holfelder with paper and box assets in Germany and grew a corrugated box business in Asia and entered China. Paper making followed with the Greenfield construction of McKinley Paper in New Mexico and a raft of other facilities were in the pipeline. So what happened?

There has never been any public revelation about the unwinding of the paper business in favor of alternative packaging, but it is clear that by 1996, there was a revelation about the future of paper and the immense amount of capital that would be required to grow, let alone maintain a seat at the table of the international paper business. At the same time as McKinley Paper was starting up in 1994, Amcor was committing to the PM5 machine at Maryvale Mill and expanding its box business. By 1996, the harsh reality was that the German business was struggling, and McKinley Paper was experiencing difficulties due to the double whammy of historically low linerboard prices and high recycled fiber prices, exacerbated by the challenges related to the unique zero effluent discharge technology employed. As Chairman of McKinley Paper at the time, these challenging negative confluences are seared into my psyche. Although the McKinley mill was turning around nicely and the technology was proved to be robust, the decision was made to sell the mill and also to exit the German business, both of which were sold in August 1997. Bit by bit, the global fiber packaging empire was divested. The European box business was sold in January 1999, the Asian box business was sold in January 2006 and now the journey is almost complete.

Sentiment aside, the “new” Amcor looks to have a good future as the world’s largest manufacturer in the flexible and rigid plastics market segment. In fact, Amcor describes itself as the world’s largest packaging company. The unnamed spin-off company (currently with the clumsy Australasia & Packaging Distribution (AAPD) moniker) operates in the fiber, glass and beverage can packaging markets in Australasia and packaging distribution in North America and Australasia. Analysts have long argued that AAPD drags down the group returns as Amcor trades at lower PE ratios than its competitors. The carve-up will see Amcor with annual sales of around A$9 billion and AAPD with around A$3 billion of sales. The downside for AAPD is that it will take on A$750 million of debt, largely due to the new paper machine and a new glass furnace. It will also take with it the stigma, if not the financial penalties, resulting from its cartel activities with Visy. Amcor received immunity from prosecution from Australian and New Zealand authorities for reporting the cartel behavior and cooperating with the investigation.
Visy Board continues to be penalized for its part and recently was fined NZ$3.6 million by the New Zealand High Court, which is in addition to the A$36 million in penalties it incurred in Australia six years ago.

On the subject of penalties, the fallout from the Gunns failure continues. Former Executive Chairman John Gay was recently convicted of insider trading and fined $50,000. He pleaded guilty to a charge that a 2009 stock sale that netted him around $3 million was illegal. Apart from reputational damage, the fine seems modest in the context of his financial advantage and the fact that his investment in Gunns would now be worthless, with the final chapter about to be written! The last assets of the failed company – including the Bell Bay pulp mill site, attached permits and the plantation forests grown to feed the mill – should be on the market by Christmas. The sale process is expected to take about four months.

The shape of the Australian industry by year end will indeed look very different than it started the year, but the new son of Amcor will look much more like Amcor of 20 years ago and just might be the catalyst for a revived industry, especially if the economy shows renewed confidence as a result of the election outcome.


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