Stone Container Case Discussion

Stone container Case discussion discussion Question 1:

What was the basis of Stone Container’s successful successful growth during its first fifty years? What was its product market strategy? What was its financial strategy? Industry: Cyclical nature of the industry along with high degree of operating leverage, capital intensive industry !achines run close to full capacity When demand fell, prices were cut "asis of Stone’s successful growth #snapshot of the marketing and the financial strategy as given below$ • • • • • •

%rowth by ac&uisitions 'c&uisitions paid by the combination of cash and loan which were repaid early Conservative capital structure with debt repaid early (etained family ownership )*pansion of product lines and more speciali+ed products )*pansion of various geographical locations internationally Widened geographically by buying and building regional plants

!arket  -inancial Strategies: •

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.igh &uality product at reasonable prices with minimal capital tied up to its inventory during initial stages Introduction of new products and e*pansion of product lines/ 0 Shifted its focus away away from ordinary cardboard containers towards the production production of more speciali+ed containers that provided advertising on the e*terior as well as simply a means of  conveyance 1 )*pansio )*pansion n into conta containers iners made made from from 2raft 2raft linerb linerboard oard )*pansion of various geographical locations internationally Widened geographically by buying and building regional plants

Great depression1. Cha Change nged d sto stone ne fr from om job jobber bers s to man manufa ufactu cture rers. rs. The Na Natio tiona nall re recov covery ery ct outla!ed price cutting ". #r #reviou eviously$ sly$ %tone %tone had ac&uire ac&uired d the merchand merchandise ise at a discount discount and passed passed on the savings to their customers.

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%rowth by ac&uisition Went for I34 in 0567

#rior to 1'('$ ac&uisitions that served to diversif diversify y the company)s product o*ering and geographic presence !ere typically paid for !ith a combination of cash and loans that !ere repaid early

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Conservative Conservative capital structure and retained family ownership of 879

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+ts founders established a longstanding policy to ,not to carry any signicant debt for long periods of time.

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uestion 1: .ow did (oger Stone’s management of the company compare to that of his predecessors? In general, would you ;udge his leadership to have been successful? Why or why not? .ighly leveraged strategy, growth by ac&uisitions, and increase in capacity 6 million debt So his leadership was successful during the earlier years which was dependent on the favorable market conditions but later his leadership was a failure since the company had accumulated lot of debt by then and it was struggling to repay the same during the later years
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.ighly leveraged strategy, continued to increase the capacity rapidly

+nitially$ /oger)s strategy !as fairly successful as he !as gro!ing the earnings of the business and fullling debt obligations. /oger)s strategy !as predicted on the notion that greater value could be created by buying up capacity from distressed producers during troughs in the industry cycle.  This !ould enable %tone to ac&uir ac&uire e assets at favorable prices !hile avoiding the additional e0pensive ne! capacity to the industry. c&uisitions !ere a faster means of e0pansion$ as construction of the ne! facility could tae 2 years to complete. s a res esu utt be stim stimulat ulated ed much higher nancial nancial and e&uity riss !ith the addition of  layered debt.

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3e !as able to e0pand capacity more than 4 times at one-fth of the normal cost of  building ne! plants5 ho!ever the high degree of operating leverage inherent in the produ pr oducti ction on of pap paper6 er6 pap paperb erboar oard d e0 e0pos posed ed the com compan pany y to a gr grea eater ter deg degre ree e of  cyclicality and pricing ris. 7ailure of /ogers)s %trategy

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Given the high 0ed-cost nature of paper manufacturing$ /oger)s /oger)s aggressive capacity e0p 0pan ansi sion on le lefft th the e com compan pany y par partic ticula ularly rly e0 e0pos posed ed to per period iods s of dec declin line e !h !her ere e producers !ill cut prices before production.

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7urthe urther$ r$ via additional additional e&ui e&uity ty o*er o*erings ings over overseen seen by /o /oger$ ger$ the Compa Company)s ny)s family

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1. dded signicant nancial ris by increase in debt and additional reliance on  jun bonds for nancing nancing.. ". This transit transition ion !as a turni turning ng point that that set %tone %tone on a path to!ard to!ard nanci nancial al distress distr ess cing> rendered /oger)s leadership unsuccessful. •

=*ect of increase in the debt due to strategy and company struggling to repay the same posed failure of his strategy 1. ?ver the the years$ years$ become become highly depend dependent ent on high yield yield debt. debt. to nanced its large ac&uisitions. @anted @anted to renance the loan !ith high yield debt. Anfortunately the high yield debt maret had developed serious li&uidity problems. This depressed /ogers)s intentions of renancing them into high yield debt. ". 3ad to pay a lot of fees to renanc renance e its revolvin revolving g credit credit agreeme agreement nt !ith the ban 2. 3ad to sell sell its assets assets to meet its debt debt obligatio obligations. ns. 3ad to sell sell shares shares to tae tae care of debt obilgations B. /e /enan nanced ced its debt !ith comple0 comple0 convertibl convertible e e0 e0chan changeab geable le preferred preferred stoc stoc and interest rate s!aps

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4. ccu ccumula mulated ted lot lot of debt debt to the e0t e0tent ent of B.1 B.1 billion billion 7urther$ it is possible that /oger !as ill-advised to turn do!n ;oise Cascade)s o*er to purchase %tone in 1'(' for "D maret value

uestion @: .ow sensitive are Stone Container’s earnings and cash flow to the paper and linerboard pricing cycle? )stimate the effect on earnings and cash flow of a >8 per ton industry/wide industry/wide increase in prices 'ssume Stone Container’s sales volume appro*imates its 0551 production level of 78 million tons per year, and costs, other than interest e*pense, remain the same 'lso assume a @89 ta* rate

/etaining the present volume of (.41( million and increasing the price per ton from (2B.B2 to (B.B2 and assuming the same costs$ interest costs of B88 million and ta0 rate of 249$ the ne! net income !as arrived as "11.4 as compared the present net income of <1((.B>.
seems to increase by more than 1 times as compared to the previous level

uestion 6: What would be the effect of a >0 per ton industry/wide increase under the same assumptions given above #in @$?

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uestion 8: What would be the effect under both these pricing scenarios #per @  6$ if production and sales volume increased to full capacity of A@ million tons per year #for simplicity, assume costs per ton remain constant$? 6 million, the net income seems to increase by more than 0@ and 0B times respectively for >8 and >0 increase as compared to the previous level

uestion B: What should be Stone Container’s financial priorities for 055@? What must be accomplish accomplished ed if Stone is to relieve the financial pressures afflicting it? -inancial priorities

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continue to pay B88 to B"4 million in interest on its debt

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mae debt repayments of 2E4 million

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e0ten e0 tend$ d$ re rena nance nce$$ or re repla place ce an anoth other er B8 B88 8 mil millio lion n in re revol volvin ving g cr credi editt tha thatt !a !as s scheduled to terminate

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be re&uired to mae 188 million of ne! capital e0penditures

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face pre-ta0 losses of B48 to 488 million

=ven though ther there e see seemed med litt little le doubt that pape paperr pric prices es !ould eventually eventually recover$ recover$ the accumulation of 2.2 billion in debt had left the company highly leveraged and !as dra!ing close to the coverage and indebtedness indebtedness covenants covenants on its various credit credit agreements. agreements. The belo! tass based on a high level analysis must be accomplished in order to relieve the company from its nancial crisis before before taing into account the in depth analysis of nancing alternatives as listed in the case 1. voidance of default via compliance !ith coverage and total indebtedness covenants in its various credit agreements ". 89 of the revolving credit facilities !ere scheduled to terminate in the rst &uarter of  1''2. %tone !ould need to e0tend$ renance or replace those facilities

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%tone must nd a !ay to eep the company aFoat until an industry ups!ing allo!s the company to reduce its debt load to a sustainable level closer to peers so that it can handle cyclicality.

uestion 7: 4f the various financing alternatives described at the end of the case, which would be in the best interest of Stone’s shareholders? Which would be in the best interests of its high/yield debt #ie, ;unk bond$ holders? 4f its bank creditors?

%hareholders: an outright asset sale or o*ering of subsidiary stoc !ould avoid the negative conse&uences of information asymmetry related to a ne! e&uity o*ering and eliminate cash Fo! rights of ne! debt !ith higher priority. %afety to the shareholders. Can received high returns !hen the company is performing !ell. ?ption to cash at the end and the value of the bond cannot fall belo! the par value

I ngener al ,t hough,t he yofferi nv es t or st headv ant agesofabond’ sr el at i v er el i abi l i t ywi t ht heopt i on t oc onv er tt oequi t yandr eal i z eanev engr eat ery i el d. +f the company !ere to also go !ith option number four they could see a good return on their e&uity. e&uity. @ith this option the company !ould see a greate greaterr /?= and only pay interest of  1(4 million over the seven year life. This alternative out!eighs the option to issue senior notes because because the /?= is high higher er and the total interest interest paid is less  The longer life of this option !ould allo! %tone to spread out its default ris farther than any of the other options.  This option !ould also eep the %tone familyHs interes interestt in the company the greater than compared to option number ve. 3igh Iield Jebt 3olders: e&uity issuance !ould bring in cash that !ould not dilute their claim on cash Fo!s and mae it more liely that scheduled 0ed income !ill be received .  The convertible o*ering$ !ith an implied conversion price of 16sh$ is perhaps tantamount to a bacdoor e&uity o*ering. ssuming that %tone !eather)s its crisis and recovers !ith the paperr indus pape industry$ try$ convertible convertible note holde holders rs !oul !ould d almo almost st assu assured redly ly conv convert ert thei theirr bond bonds s to common shares to sell them on the open maret if %tone)s maret e&uity price returns to

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;an Creditors: renegotiation renegotiation of ban loan agreeme agreements nts !ould result in hefty fee income !ith no change to the bans) arrangement as %tone)s senior lending group !ith rst claim on company assets in the event of banruptcy

uestion A: Which of the financing alternatives would you recommend Stone Container pursue in 055@? If you recommend more than one, which do you view as most important and why? Which would you do first, and which later?

fter analyKing each alternative %tone Container Corporation could implement in order to relieve its debt pressures$ the best option !ould be to tae a t!o sided approach. Evaluation of the dierent options ?ption number one !as to renegotiate the terms of its loans. The e*ects of this !ould be (8-8 million in fees. This option is the only solution that doesnHt involve the %toneHs familyHs interest in the company to lessen but doesnHt have an upside of  taing in money. ?ption number t!o !as to sell o* some assets or e&uity interest in the company that could raise "48-488 million. This option !ould decrease the %tone familyHs interest in the company company but !ou !ould ld sti still ll br bring ing in the funds needed needed to hel help p dec decre reas ase e the companyHs debt. ?ption number three !as to sell a senior intermediate-term note !ith a 4-year term and a coupon of 1" to 1" L9. This is a bond that taes priority over the other debt securities sold by the company. +f %tone !ere to go banrupt$ this debt must be repaid before other creditors receive payment. ?ption number four !as to 288 million in convertible subordinated notes !ith a life of ( years and a  M9 coupon. These options !ould allo! the company to receive funds up front !ith coupon payments paid in the future. ?ption ?pt ion number number ve !as to iss issue ue up to 48 488 8 mil millio lion n in com common mon stoc !ith net proceeds e&ualing '49 of the o*ering price. This option could potentially allo! the

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Renegotiation of loan: loan : +f %tone !ere to renegotiate the terms of its loans as in option one$ they could tae a smaller hit than if they !ere to pay out the interest payments outlined in option three <=0hibit 2>. /enegotiating these terms !ill also allo! the company more time to restructure its debt portfolio and give them a chance to depend less on an alternative that decreases the familyHs share in the company.  This option out!eighs the alternative to sell e&uity in the company or its subsidiaries because there is no loss of family stae in the company .

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?ption B: +f the company !ere to also go !ith option number four they could see a good return on their e&uity. @ith this option the company !ould see a higher /?= and only pay interes interestt of 1(4 million over the seven year life. This alternative out!eighs the option to issue senior notes because the /?= is higher and the to tal interest paid is less. The longer life of this option !ould allo! %tone to spread out its default ris farther than any of the other options. This option !ould also eep the %tone familyHs interest in the company the greater than compared to option number

ve. nd they provide issuers a chance to raise capital at a lo!er interest rate and delay the dilution of their common stoc

%o option 1 and option B are the best options. +f %tone Corporation !ants to stay out of banruptcy it needs to restructure its debt rst.  The company had a long time standing of not needing debt or paid it o* &uicly but that changed and it &uicly got in over its head because large ac&uisitions.  The company should restructure its loan terms rst and then issue 288 million in convertible notes$ in order to relieve the immense debt and also help restore the company to its former glory of nancial stability.