Foreign Direct Investment — The Next Leap of Ownership?

Over the past 15 years, drastic ownership changes in the forest products and timberland industries have taken place. The corporate sell off of timberland ownership into the hands of pension fund investors is well documented. Many manufacturers either bought or were bought, others merged, and some underwent a combination of transformations. Some bear the names of both companies (Smurfit-Stone and MeadWestvaco) and some don’t (International Paper and Weyerhaeuser). Others like Georgia Pacific, fed up with Wall Street, agreed to be purchased by private owners. Still other smaller concerns morphed into major players by going on an asset-buying binge, including Hampton, Riley Creek and the Swanson Group.

The most recent wave of new owners came from the North. As Canadians looked into a bleak domestic future—one of long-term stagnant markets, lumber tariffs and the supply restrictive mountain pine beetle outbreak—they looked South. Canfor and West Fraser bought major positions in the US South when the strong Canadian dollar and the lumber tariff rebate created a once in a lifetime buying opportunity.

Enter 2008! Lumber prices are at historic lows; log prices are too. Pulp and paper prices are just now showing real weakness in the face of what is sure to be a global recession.

Storm in the 2008 financial crisis and the stock market crash! In mid-October, literally trillions of dollars of value disintegrated on Wall Street in the matter of couple weeks. Forest products companies—to no surprise—suffered the same fate. International Paper’s stock, which had been recently trading as high as $37, faded to $19. Louisiana Pacific lost 75 percent of its value, falling from a year high of $17 to $4. Graphic Packaging shrunk from $5 to $1, Smurfit Kappa from $13 to $3. And Chesapeake is now literally a penny stock.

Now, I don’t believe for a minute that the true value of these companies faded so quickly. The market is simply gripped with panic and emotion, which are ruling the day. But, just the same, it doesn’t matter. This is a ripe buying opportunity for a savvy foreign investor. Here’s why.

The market capitalization of International Paper—prior to this crash—was about $16 billion. Now it is $8.2 billion. With the current Euro-to-US Dollar exchange rate of 1.35 (actually strong relative to the last year), a European investor can purchase a 16 percent stake for about €1 billion Euro. Using the same logic, a European investor can purchase all of Louisiana Pacific for a mere €310 million. Furthermore, the dollar is strengthening relative to other major currencies after a long slide. A foreign investor may invest as solely a currency hedge, allowing any stock price appreciation to be icing on the cake.

Now, I am not suggesting that the senior officers of these companies would sell at such a bottom feeding price—they are very capable people—or that enough investors would be willing to sell to a single investor. My point is merely that forces are aligned for more foreign ownership of our US-based forest products industry.

Incidentally, the Scandinavians look like the Canadians did a few years ago. They have a shrinking industry on their hands, a Russian log supply base that is shrinking due to an escalating export tax and the Kyoto’s green albatross tax that has put them at a competitive disadvantage worldwide. So why not the US? It’s a spot to grow, with a traditionally good economic environment, a stable government, and no Kyoto requirements. And it’s where a large part of the world’s wood products are and will be consumed.

Expect events to start unfolding in the fourth quarter and early next year as these forces become too strong to resist and as capital flows back into the US (albeit in a constrained manner). My guess is that closed-door talks are being held right now, and that these talks will significantly change the ownership of the US forest products industry for the next 10 years.