Description

I recommend going long Wausaupaper. Wausau’s price significantly misrepresents their unique position in the AFH “Green” tissue market along with the growth opportunity that comes with it, and with a vocal activist and catalysts in place to realize this value, I believe the risk investors take for the significant return opportunity is minimal.

Business Description

Wausau is a leading producer of fine printing and writing papers, towel and tissue products, and specialty papers.  The company is divided into two units: (i) Paper and (ii) Towel & Tissue.  Both groups are managed separately with specialized marketing, production and technology strategies. Wausau also owns about 80,000 acres of timberland.

Background

Wausau has an interesting history and today it is a much different operation than it was five years ago.  Five years ago there was very limited specialization at Wausau facilities as a facility might produce products that fell into multiple segments.  This prevented Wausau from seamlessly exiting sub-optimal product categories as certain items were tied into their production processes.  For the past five years Wausau has restructured their operations and now the company has engaged a financial advisor to assist them with exiting a sub-optimal category so they can focus on their high margin tissue business.  Tissue is not exactly what it sounds like as the segment includes the dispensers you would find in your office bathroom.  This is a good business because as the installed base grows, so does recurring revenue as Wausau’s dispensers are only compatible with replacement cartridges / paper rolls from Wausau.  Furthermore, Wausau claims to be the only LEED approved provider in the away-from-home (AFH) market (again, think of the dispensers in your office bathroom) so they have a unique position as the “Green” solution for building managers with a green mandate. In 2010 the company began reporting operations in two units: (i) Paper and (ii) Towel & Tissue (tissue).  Prior to 2010 the Paper segment was comprised of two separate operations: (a) Specialty Products and (b) Printing & Writing.  The tissue business is their gem but I think my confidence in the thesis is largely based on what I have learned about their history and how far they have come, so I’ll start with Printing & Writing.

Printing & Writing

In P&W, Wausau produces uncoated free sheet paper which is paper used for copy machines, business forms, stationary, etc. (their specialty is a product called Astrobright Color paper and they have a leading position in color paper).  If you are familiar with the uncoated free sheet business then you know it’s not the best business to be in as annual demand for uncoated free sheet is about nine million tons vs. thirteen million in just 2005.  The decline is largely the result of electronic substitutes and it’s a trend that hasn’t gone unnoticed by paper companies like WPP who have consolidated operations and shut down plants.  In 2005 WPP began what became roughly a four year restructuring to transition away from P&W but it seems to have initially started by accident when the company acted on an opportunity to purchase a high quality “A” asset for a song.  The asset was a plant in Brainerd, Minnesota and the song was a mere $9 million bucks. 

They got a deal on the Brainerd facility because at the time it was being run by a company who couldn’t efficiently employ the asset due to operational issues.  The company operating Brainerd was owned by a PE shop and it appears the shop dumped the asset into Wausau’s hands just to recoup what they could.  WPP initially used Brainerd for P&W operations and produced opaques and heavier papers for things like Annual reports but as demand waned for these products they decided to modify the facility and use it to produce specialty products, which carried slightly higher margins (7-8% normalized EBITDA margins vs. 6-7% or so in P&W).  The weakening P&W end markets motivated Wausau to close and divest other print & color assets as well and these included the closure of a sulfite mill in 2005, the closure of a paper mill at Groveton, New Hampshire in 2007, and the sale of a plant in Appleton, Wisconsinin 2009.  These initiatives rationalized the size of their P&W operation but the one-time items also made analyzing the P&L a task, especially because Wausau was restructuring the Specialty Products segment at the same time.

Specialty Products

The specialty products business produces technical items like papers that repel grease, burn at higher temperatures, etc.  In 2007 Wausau began rationalizing operations by selling a roll-wrap business (a non-core product line) and shutting down a mill in Maine in 2008.  Prior to the restructuring activities at P&W and Specialty Products, Wausau had mixed production operations at various plants (i.e. some plants produced products for both segments). Wausau began shifting production around to improve efficiency and obtain specialization at each plant, something they have almost completed.

WausauToday

Wausau still produces uncoated free sheet and specialty products but the transition to specialized production by plant is nearly complete and this finally provides them with the opportunity to seamlessly exit their sub-optimal print & color business.  Wausau is in the process of transferring all print and color to a facility in Brokaw, Wisconsin and transitioning all technical product production to their high quality Brainerd facility.  The company expects Brainerd will be strictly a technical grade facility and Brokaw strictly a P&W facility within a year or so.  While the argument can be made that nobody would want to buy an uncoated free sheet business, Wausau has a strong position in the color paper market and as a leader in the space I believe the asset is quite saleable.  In today's Q3 earnings press release Wausau announced they have engaged a financial advisor to assist in the process of a sale of this asset and it’s my opinion they will find a buyer in a satisfactory period of time.  The sale of Brokaw would mean the removal of the ball and chain restraining margins and I think this would lead to a re-rating in the stock as the value of the Tissue business would become obvious.

In addition to the sale of the print & color business Wausau is undergoing a major expansion in their tissue operation, which should create long-term value for shareholders (brief details on that later).

Valuation

My SOTP analysis reveals upside of 58-111% to my target range of $12.48 to $16.67, what I believe is an extremely conservative estimate of intrinsic value.  Starboard Value, the activist involved in the stock, spells out there SOTP valuation clearly in a July 28^th letter to the board and arrives at a fair market value of $10.26 to $14.05.  The stock currently trades for around $8.00.

I’m not going to spend a lot of time going through the SOTP analysis as Starboard spells it out in their letter but I present summaries of both valuation methods below to explain how my analysis is different.  I believe my method is more thoughtful but I’m sure readers will make up their own mind about that.

Starboard SOTP Analysis

-          Tissue: $70-75 in EBITDA at 7-8x multiple = value of $490 to $600

-          Paper: $20-25 in EBITDA at 4.5-6x multiple = value of $90 to $150

-          Timberland: 80-85,000 acres at $700-800 per acre = $56 to $68

-          Hydroelectric Assets: $10-15

-          Total of $646-833 less net debt of $139 = $507 to $694 ($10.26 to $14.05 per share)

My Analysis

-          Tissue: $75-80 in EBITDA and 7-8x multiple = $525 to $640

-          Legacy P&W segment: $10-15 in EBITDA at 3.5-4.5x multiple = $35 to $68

-          Legacy Specialty Products segment: $28-$32 in EBITDA at 5-6x multiple = $138 to $189

-          Strategic Timberland: 72,800 acres at $800-900 per acre = $58 to $66

-          Timberland forSale: 7,500 acres at $1,100-1,300 per acre = $8 to $10

-          Hydroelectric assets: zero

-          Total of $764-$972 less net debt of $139 = $625 to $833 ($12.65 to $16.86 per share)

As you can see my analysis differs in a few ways.  First, I assume run-rate EBITDA in Tissue is $75 to $80 million vs. Starboards assumption that it is $70 to $75 million.  Second, I break the Paper segment and the Timberland assets into pieces.  Third, I assign zero value to the hydroelectric assets.  I believe this is a more accurate method of valuing the company.  My reasoning follows.

Tissue EBITDA

I use $75 to $80 million in EBITDA because normalized op. margins of around 13-15% and historical D&A rates lead you to $75-$80 million in EBITDA vs. Starboards estimate of $70-75 million.  I think the historical filings make this fairly clear.

Separating the Paper Segment – Print & Color

The thesis is largely based on the idea that value will be unlocked as a result of the divestiture of the legacy print & color business, so I think it makes more sense to value the Paper segment in two pieces.  After adjusting for restructuring charges and other unusual charges related to the ultimate isolation of print & color at the Brokaw facility, I arrive at normalized EBITDA margins of roughly 6-7% for print & color.  As for revenue, one consequence of moving production to the Brokaw facility was a decline in production capacity from 200,000 tons per year to 160,000 tons per year (Brokaw is a smaller facility).  Assuming flat ASP of $1,380 per ton and assuming 160,000 tons per year leads you to a revenue figure of roughly $220 million.  Applying a 6% EBITDA margin gives you $13 million in run-rate EBITDA at normalized margins.  This is how I get my range of $10-15 million.  I apply a multiple range of 3.5x to 4.5x because the uncoated free sheet business is worth as much but likely wouldn’t fetch more.  I think this is a reasonable range and comps support this.

Separating the Paper Segment – Specialty Paper

If the print & color segment is sold, then investors will be left with a specialty paper business so a SOTP requires this be valued separately.  After adjusting for restructuring charges and other unusual items related to the eventual isolation of the Brokaw facility, I arrive at normalized EBITDA margins of roughly 7-8% for specialty products.  In 2010 the company reported the total Paper segment had revenue of $712 million and that specialty products accounted for roughly 50% of that value, or $356 million in revenue.  With this in mind, through the first half of 2011 the Specialty Products division likely posted revenue of $197 million, or $394 million annualized.  Assuming that is a decent run-rate revenue figure and normalized adjusted EBITDA margins are 7-8%, the Specialty Products division should contribute roughly $27.5 to $31.5 million in EBITDA.  This is how I arrive at my range of $28 to $32 million in EBITDA.  I apply an EBITDA multiple of 5-6x, which I think is fair considering comps, the margin profile, and the relative resilience and sustainability of the business.

Separating the Timberlands – Strategic Timberland

I separate the timberlands into pieces because the timberlands are really two different sets of assets.  IR will tell you they think they can get $800-900 per acre for their strategic timberlands, which they report to be roughly 72,800 acres.  During the third quarter, the Board of Directors authorized management to try and unload the timberlands to fund the expansion at the Tissue segment and Wausau reported today they have engaged LandVest Timberlands, a leading timber advisory firm, to market and broker the sale of the Northern Wisconsin commercial timberlands.  At $800-900 per acre, the asset is worth between $58 and $66 million.

Separating the Timberlands – Timberland forSale

The 7,500 acres of Timberland for sale is a different story.  Wausua has been selectively selling prime timberlands since 2005 and has collected an average of $1,222 per acre.  At $1,100 to $1,300 per acre for the remaining timberland, this asset is worth $7 to $9 million.

Hydroelectric Assets

Not a lot of information is available on these assets so I consider them a free option.

Conclusion

Add it all up and you have a SOTP analysis that implies a value of $12.65 to $16.86 per share vs. today’s price of around $8.00.  There are also catalysts in place to start unlocking value.  I find additional comfort knowing management has made the decision to significantly grow the tissue business.  I haven’t spent more than a few sentences describing this asset and not a whole lot needs to be said but a summary is below.

Snapshot of Tissue Segment

-          Normalized EBITDA margins are over 20% and EBITDA margins have only dipped blow that level once since 2002.

-          Prior to the expansion, Capex in Tissue ran around 3% of sales so pre-tax CF margins (EBITDA minus capex) have averaged 18% since 2002.

-          Top player in AFH market with unique position through “Green” product company due to LEED certification.

-          Dispensers are profitable sales on their own but only Wausau products can fit inside the cabinets so they are a tremendous source of recurring revenue.  Also, the average dispenser is in place for 5-8 years.

-          Competitors have tried to enter the green AFH market but their systems are built around virgin fiber inputs (grinding up trees) and the cost to switch to recycled fiber inputs is expensive.  Furthermore, you can’t get LEED certification unless you are 100% recycled fiber.

-          Expansion provides opportunity to increase Tissue/Paper mix from 33%/67% to 50/50.  Targets include 7% revenue CAGR from 2010 to 2017, 10% EBIT CAGR from 2010 to 2017 and expansion supports doubling of revenue and profit.

-          Expansion provides ability to leverage technology to make green products feel as soft as virgin based products and Wausau believes this could help them expand their business, specifically into healthcare.

Catalyst

Catalysts

-          Exit print & color

-          Sell Timberlands