The paper industry was quite eyeball-catching in China’s stock market in May. After the announcement by the giant paper-making group of Shandong Chenming that it would issue additionally not more than one billion A-shares in a private placement to one of Asia-Pacific largest investment and acquisition firms, namely, CVC Asia Pacific on May 24th and raise some 5 billion Yuan for the construction of 700,000 t/y pulp project in Zhanjiang, Guangdong Province, another large-sized paper group—Tiger Forest & Paper Group also claimed to introduce $187 million (RMB 1.5 billion Yuan) from an Asian enterprise investment and acquisition fund, namely, Affinity Equity Partners in its forest-paper integration project. At present, these two transactions are subject to the approval from the government authorities.
There are several outstanding characteristics in these two transactions: firstly, both of the investors are strategic funds. Established by American Citigroup and CVC Capital Partners, CVC Asia Pacific buying shares in Chenming is an investment & consulting company focusing on equity investment in Asia-Pacific areas, while Affinity Equity Partners planning to invest in Tiger Group is also one of the largest Asia-Pacific enterprise investment and acquisition funds. Secondly, all the two Chinese firms introducing foreign funds are domestic industry leaders. With the annual capacity of over 3 million tons of papers, Chenming’s sales revenue reached nearly RMB10 billion in 2005, and its annual capacity may rise to 4.5 million tons and become to be one of the globally largest paper enterprises after fulfilling the pulp project in Zhanjiang. Similarly, Tiger Group is also one of the top four paper companies in China, which achieved sales revenue of RMB4.2 billion in 2005. Thirdly, these foreign investment will all be put into the implementation of "forest-pulp-paper integration" programs and their Chinese partners are relatively rich in forestry resources. At the end of 2005, Tiger Group’s self-operating plantations stood at 100,000 ha, and its total forestry area could be up to 320,000 ha if including those plantations in the forms of co-operative and purchase-mode with local farmers and forest firms. It is the same way that Shandong Chenming’s proceeds will also be used in building 200,000 ha of plantations and the construction of 700,000 t/y pulp project in Zhanjiang. All above clearly interpreted that the foreign capital has been putting their eyes on China’s "forest-pulp-paper integration" program.
The frequent incidents of capital merging in China’s paper industry indicated that the general environment of the industry has been changing and getting more and more attractive to foreign investors. To be specific, the following factors may be the main reasons for foreign investors to be actively involved in China’s paper industry.
Firstly, foreign investors are optimistic about the future of the industry. Since the 90s', China’s paper industry has kept developing quickly all along. In recent years, paper and paper board output and consumption maintained double-digit growth rate (see Table 1 and Table 2). However, the remarkable backward between China and its foreign counters should not be ignored in terms of per capita consumption. In 2004, China’s figure was only 42 kg, while the world average was 56 kg. In USA and Japan, the figure could be as high as 300 kg. It is believed that China’s paper and paper board consumption will grow inevitably along with economic development, improvement of residents' living standard and the impelling of the 2008 Beijing Olympic Games and 2010 Shanghai Expo. All these have been well acknowledged by foreign investors and to encourage them to participated in it actively, longing to share the benefit of the high growth of China’s paper industry.
Table 1: Paper and Paper Board Output, Consumption and Growth Rate in China
Table 2: Paper and Paper Board Consumption Per Capita in China
Secondly, the general environment of paper industry in China is ameliorating gradually, which is shown in two aspects: one is that the forest-paper integration process has made great progress. Since the proclamation of policies on forest-paper integration program, foreign-invested enterprises represented by APP and Stora-Enso, as well as domestic enterprises represented by Tiger Group and Shandong Chenming, have put much efforts to develop their forest resources and made significant achievements. Many of them are expected to benefit from the results from the year of 2007 or 2008 while the pulp they need is to be produced by their own plantations. According to the information from the National Forestry Bureau, China’s wood supply for paper-making has been reinforced rapidly in recent years, by 2010 paper-making forest bases can provide 56 million cubic meters of timber and 13.5 million tons of bamboo, and some 13 million tons of wood pulp and 4 million tons of bamboo pulp could be manufactured by these fibers. The hurdles in front of China’s paper industry like heavenly relying upon imported fiber may be released to great extent or removed ultimately and thoroughly by then. On the other hand, more and more small and medium size paper mills whose non-wood pulping facilities can not meet more strict environment protection standards, shall have to shut down. Therefore, some large mills, whose non-wood pulping lines are still running and able to well protect the environment, will have less competition in sourcing the straw materials. This in turn will improve the profitability of these big mills due to the availability of less expensive straw fibers. In particular, the country’s eleventh "five-year programs" called the nation to develop circulating economy, and build an energy-saving, environment-friendly and sustainable growth society. Meantime, the environment protection will also be enhanced. These policies will compel more small-sized paper mills characterized with "high-resource cost, high-energy consumption, and heavy-pollution" to disappear in the near future, which will further increase the concentration of the industry, and provide a wider stage for those leading players.
Thirdly, the value of Chinese leading paper companies in general are under estimated comparing with their foreign counterparts. In recent days, the market performance of many industry players including those paper companies in Europe, North America and Hong Kong market was excellent. However the stock prices for China’s paper companies with A shares were relatively sluggish. For instance, the PE level of Nine Dragon Paper Industries, one of China’s largest paper firms and newly listed in Hong Kong market, stood at about 17, while its counterparts in American market stood at about 30 at the same time. It is the very same point that the PE level of Shandong Chenming was merely 9. Nevertheless, it is well believed that the value of Chinese paper enterprises will be brought in line with international practice as the internationalization of China’s stock market. Thus it is a precious opportunity for foreign investors to enter the Chinese market now. Furthermore, CVC Asia-Pacific which acts as share investment in Shandong Chenming and Affinity Equity Partners in Tiger Group are all not willing to hold these shares for a long time. It is very likely that they will sell it at a proper time to make big profit. So we do not exclude the possibility that other Chinese enterprises that are underestimated in the capital market now will be acquired by other overseas capitals in the future.
Fourthly, because of China’s high foreign exchange reserves, the international pressure to push RMB’s further appreciation is heavy all the time. With recent international and domestic influences in terms of political, economic and financial environment, the reformation of RMB exchange rate regime is expected to speed up. It seems that further appreciation of RMB is inevitable (See Table 3). Under this circumstance, China’s fixed assets should be very attractive to foreign capitals.
Since China’s decision to have one rate for its currency in 1994 (China used to have two exchange rates for its RMB), the country’s foreign currency reserves have climbed up dramatically due to the double-way surplus (trade & foreign investment). On July 21st, 2005, China readjusted its foreign exchange rate regime, and a flexible exchange rate system was carried out which was based on market supply and demand, regulating and managing with reference to a basket currency. RMB was appreciated by 2% against the US dollars on the same day, and will not peg to the green back any more, instead a more flexible RMB exchange rate system was created. This, to some extent, has influenced the country’s import and export balance.
China’s saw its export increased 26.6% in the 1st quarter 2006 comparing with 4th quarter 2005, but declined 8.3% over the same period of 2005. While the import increased 24.8% and 12.6% respectively. Some USD23.3 billion surplus was created, a further increase vs the 1st quarter of 2005. To the end of March 2006, China’s national foreign exchange reserves stood high at $875.1 billion which surpassed Japan, becoming the no.1 globally. At the same time, the rapid increase of foreign exchange reserves still continues. China’s foreign exchange reserves are very likely to break $1000 billion by end 2006 considering the current trend of trade surplus and the inflow of foreign investment and hot money into this country.
The pressure on China’s unbalanced international payments is accumulating and brings much greater passive impact upon the economy. Under the circumstance that foreign exchange reserves increase fast by very large amounts, the supply growth of RMB base currency issued through the channel of foreign exchange department is up to 36% in the first quarter. Although the central government has adopted measures actively to hedge the problem of excessive base currency by issuing central bank’s bills, the growth rate of broad money supply M2 in the first quarter was still up to 18.8%. The overflowed liquidity resulted in overheated investment in some industries and assets price bubbles in the real estate industry. All this made us to believe that China will seep up its reform on RMB rating regime in the future.
Table 3: RMB Exchange Rate against USD, Japan Yen and Euro
Sixthly, since China’s industry is a typical one that its sales market concentrates in the domestic but raw materials mainly come from abroad, quantitative wood pulp and recovered paper are imported from foreign countries every year. The total amount of import in 2004 stood at 7.59 million tons and 17 million tons for pulp and recovered paper respectively (see Table 4) and the relevant foreign exchange spending ranked number 3 in the country right after the import of steel and petro-chemical industries. As the pulp prices in the international market always stand at the high side and fluctuate frequently, a large number of Chinese paper enterprises' profitability is nibbled up, meanwhile the strategic safety of the industry is also threatened (See Table 5 and Table 6). Consequently no matter in a long term or in a short term, it is the important guarantee of competitiveness for industry players to achieve relatively low cost and steadily provided raw materials. So do the Chinese paper mills. If they’d like to participate in the international market in the future,, they must carry out the forest-paper integration program just as that their foreign counterparts done for years. Many forest-paper integration projects have been carried out in recent years and fast growing plantations are being constructed just because the industry players' wake up of the importance of fiber material. But the forest-paper integration projects normally need abundant of capital investment, like Shandong Chenming’s Zhanjiang project, whose total investment is up to RMB 9.432 billion, and the entrance of overseas investors exactly makes up for the capital shortage of China’s paper industry.
Table 4: Imported Wood Pulp and Recovered Paper in China
Table 5: FOEX NBSK and BHKP price index in USD and Euro
Table 6: Dollar Price of American Recovered Paper and European Recovered Paper to China (CIF)
Seventhly, the share purchasing by foreign strategic investment will further perfect Chinese paper firms' corporate structure and may lay foundations for them to speed up the internationalization strategy in the future to achieve a sustainable development with foreign investors bringing in their advanced managing experience. Take Chenming as an example, one of the preconditions for CVC’s acquisition is that CVC will work out share/option award program for Chenming’s senior management team, and this has been mutually confirmed. It can be expected that Chenming’s corporate structure will be greatly improved once these programs are fulfilled. In addition, CVC’s experience in international project management and risk-controlling will facilitate Chenming to develop faster in future.
Besides, considering the capital market, it will promote Cheming and Tiger’s recognition and popularity in capital market effectively, broaden their fund-raising channels and help them to explore more business opportunities when they introduce these outstanding industry investment funds in. In particular, it is more helpful to Tiger Group as they are scheming to go public in their agenda.
In short, the measures to attract strategic investors adopted by Chinese key paper enterprises are the right choice if they wish to achieve a sustainable and faster growth in the future. However, it should also be noted that attracting strategic investment must be a win-win or multi-win strategy. Owing to the influence of corporate culture, history and China’s policies and regulations concerning foreign investment, preliminary preparation works must be well down before paper companies make their final decisions.
This article is prepared by Mr. Zhou Wenbo, an analyst of CFI Consulting Ltd, China’s consulting firm in pulp and paper industry. Mr. Zhou can be contacted at csgzwb@chinaforestpaper.com or +86-21-61049456 by phone.
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