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The Year of the TAKEOVER

By Paul MacDonald

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The past year was a time of surprise as lumber markets experienced a short-lived boom and consolidation in the Canadian forest industry continued at a rapid pace. During the summer, lumber prices hit a peak of $435 (US) per thousand board feet and prices for panel products, such as oriented strand board, reached highs of $355 per thousand square feet. That was welcome news for mills and the forest companies, but towards the end of the year, prices had fallen and settled in at lower levels. For logging contractors and industry suppliers, the takeovers and mergers in the forest industry usually mean far more than just a different corporate name on their pay cheques.

For as much as the acquiring companies may say there will be little change in the way things work on a day to day basis, each company has its own unique way of operating. That usually means reviewing existing operations to see how they can operate leaner. One of the biggest surprises of the year came in the summer when Weyerhaeuser announced that it would be taking over for est industry icon MacMillan Bloedel, a deal that was finalized in October. Until then, it was thought that MacBlo would be one of the companies doing the acquiring, rather than being acquired. From Weyerhaeuser's perspective, the move is aindustry_overview_2.jpg (3517 bytes) good fit for its Canadian operations, complementing the mills and timber rights the company holds in the BC Interior and in Alberta and Saskatchewan. Also in British Columbia, Canfor took over Prince George based Northwood Inc and its sawmills and pulp mill in a $635 million deal. Louisiana Pacific was also busy in BC, doing a deal to take over Evans Forest Products, a lumber and engineered wood products producer in southeastern BC. The takeovers in the forest industry reflected a general consolidation trend in North American business. A report by Canadian merchant bank Crosbie & Co. tallied 954 transactions with a whopping dollar value of $105.2 billion during the first nine months of 1999 alone. In the paper and forest products sector of the Toronto Stock Exchange, there were 30 deals-takeovers or mergers-with a value of $9.4 billion in the first nine months of 1999.

This pace is much higher than when there were 19 deals with a value of $5.5 billion in the same period. James Lorimer, a partner at Crosbie & Co., says activity quickened in the resource sector in the third quarter. Analysts generally point to three major reasons for the continuing consolidation trend-relatively low interest rates, companies actively looking for ways to cut costs and improve efficiencies and the well established globalization of business. What is the outlook for 2000? "We see continued strong merger and acquisition activity in the resource sector," says Lorimer. One of the big stories of the year was the prolonged battle for Quebec based Groupe Forex, the largest producer of oriented strand board in Canada. OSB prices were on a tear in 1999, thanks to healthy new home construction in the United States and a booming American economy. Both Louisiana Pacific and Boise Cascade were after Forex, with LP eventually winning the day with a bid of $760 million (US).

Even though his firm was predicting half a dozen forest industry deals would be done in 1999, Pricewaterhouse Coopers forestry partner Craig Campbell said he could not recall a year with so much takeover and consolidation activity. A close runner-up would be the late 1980s when MacMillan Bloedel was put in play, with then BC Premier Bill Bennett announcing with great bravado that "BC was not for sale". "What a change we've seen since then," says Campbell. "We had an NDP Premier, Glen Clark, who said Weyerhaeuser taking over MacMillan Bloedel was a great deal. "Politics aside," Campbell added, "the business community and all the stakeholders now realize that we are in a global market and BC is a global player." The sheer number of consolidations and takeovers during the year may have left some industry people with their heads spinning, but Campbell noted that "it's in sync with what's happening in the forest industry in the US, Scandinavia and Japan". The big international deal of the year was International Paper taking over Union Camp in a $7.9 billion (US) deal.

Campbell agreed that the interest in Groupe Forex was driven mainly by the expanded market share oriented strand board has taken in the panelboard market. "If you could have got inside Louisiana Pacific's boardroom, they would have been talking about how the Forex deal represented an opportunity to get in the market at a relatively good price and ramp up their OSB production capabilities." At one point, with their share prices being quite beaten up, Canadian forest companies looked very attractive to American companies, especiallyindustry_overview_3.jpg (10704 bytes) with the low value of the Canadian dollar. That scenario changed over the course of the year, however, with the share prices of some companies tripling compared to their lows. That said, Campbell says there are still some attractive and undervalued companies out there, but he declined to mention particular companies. But he believes there are more deals to come-in the order of two to three the size of the Canfor Northwood deal-in the Canadian forest industry in 2000. Internationally, Pricewaterhouse Coopers believes the industry is only two to three years away from having a $50 billion player. International Paper Union Camp now stands at about $25 billion. Campbell says he has a cautious outlook for 2000, and will be watching closely where pulp and lumber prices go. But he added that he has concern that the industry may be repeating past mistakes with the rush to add OSB capacity. It is very similar to the moves the forest companies make to add pulp capacity, when prices are high, only to find that the market is then flooded with product. At the other end of the country, Francois Perrault, senior analyst, paper and forest products in Merrill Lynch's Montreal office, said he began the year looking at what industry giant MacMillan Bloedel might be doing in terms of acquisitions.

Like most industry observers, the Mac Blo/Weyerhaueser deal basically came out of the blue for Perrault. The Groupe Forex deal was not a surprise, however, he said. "It was the right time to put an OSB company into play," with the market for OSB being hot. Perrault noted that while the stock mar ket valuations of Canadian forest companies might look inexpensive compared to American companies, they are not far off the valuations of similar companies in Scandinavia and South America.

The American forest companies have benefited from a very healthy growth in their stock market over the past few years. Perrault also predicted that more consolidation is to come in 2000. He said the expiry of the Softwood Lumber Agreement in March 2001-as well as what starts to emerge around renewing or replacing the agreement-will be a "dominant theme" in what happens in the industry. He added that its possible that cross border consolidation-meaning interest in Canadian forest companies outside of the Unitedindustry_overview_4.gif (22912 bytes) States-could occur. Vancouver forest industry consultant Russell Taylor agreed on the surprise of the MacBlo/Weyerhaeuser deal. "That was a classic. It came out of left field." He noted that Weyerhaeuser started negotiating with MB on their packaging plants. "That was the carrot that got the deal going." Taylor said there had been expectations that consolidation would occur in the BC industry, but the poor provincial economy and a weak Japanese lumber market had held this back. In recent years, the BC forest industry has been an extremely poor place to invest, he added, but recent deals indicate that may be changing. This is in spite of a government forestry policy that has been punishing to the industry.

Taylor foresees steady activity in the next year, saying there is potential for another "blockbuster deal" in BC in particular. Investors seem to be looking for "pure plays", companies that are focused on one segment of the market, such as lumber or OSB. "There are opportunities for some of the forest conglomerates to be broken up." Taylor said the moves going on in the Canadian forest industry are part of a broader trend toward change worldwide in the industry, including the emergence of e-commerce and consolidation on the distribution side. In terms of the leading lumber producers, "the pecking order is changing". Mark Kennedy, forest industry analyst for TD Securities, said the consolidation trend will continue as the industry works to achieve a return on equity of 15 per cent. Company CEOs favour mergers and acquisitions, he says, rather than greenfield startups because the startups have not been delivering high enough returns. Most of the recent consolidation has been going on in what Kennedy terms a "regional basis", within North America or Europe, and that might become more international. Kennedy said there is speculation that StoraEnso, which has done a lot of deals in Europe, may start to look to North America. Roy McIntosh, national director of the forest industry practice group at KPMG, also said the industry could easily see an outside player, from Scandinavia for example, enter the picture. "There are some companies in Sweden that are fairly big and are looking to expand beyond their traditional areas." This would more likely be on the pulp side than solid wood, however, he said. "I certainly don't think the consolidation in the industry is over," says McIntosh.

There may be some opportunities-though they might not be on as big a scale-for further consolidation in BC as the pioneer sawmilling families review whether they want to stay in the industry, he noted. The degree of consolidation activity during the year did not surprise McIntosh. "The only surprise that caught most people off guard was the Weyerhaeuser/MacMillan Bloedel deal," he said. "It was more than what we expected." The bidding war and resulting purchase of Groupe Forex by Louisiana Pacific reflected the "revolutionary and extraordinary" manner in which oriented strand board has taken a dominant share in the panelboard market, he says. He noted that OSB has gone from a small share-10 to 20 per cent of the market-to a large share of over 50 per cent of the panelboard market in a relatively short period of time.

There were great fears-four or five years back about the amount of OSB production coming on stream. But thanks to a buoyant housing market in the US, which has readily absorbed OSB as an alternative to plywood, it has taken off. "But if the North American housing market goes sour, OSB will have some difficulties," says McIntosh. With the amount of additional OSB planned or going ahead, there are fears of another glut in the future.

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