Distressed Debt Analysis: NewPage

NewPage has been discussed in distressed circles for quite some time now. In fact, if I am not mistaken, it has the most investment write-ups on the Distressed Debt Investors Club:

• In April 2010, a member recommended going long the 2nd lien floaters
• In September 2010, a member recommended going long the 1st liens
• And a few weeks ago, a member recommended going short the 10% 2nd liens

With that said, and given such a rich capital structure, distressed debt investors have spent a significant amount of time on the credit over the past few months. And that focus increased over the past few days as rumors swirled about a possible restructuring around the corner culminating with news on the wire last night and today that Newpage is working with advisors (Lazard, FTI, and Dewey & LeBoeuf) to evaluate alternatives.

Further, it was reported that Apollo and Avenue Capital hold more than $400M of NewPage's aforementioned 2nd liens. For reference here is a chart of the 10% 2nd liens going back to May 2008:

From looking at my runs, by far the most liquid bonds are the 11.375% 1st liens and these 10% 2nd liens.

NewPage is the largest coated paper producers in North America. Cerberus purchased the company in 2005 and currently own ~80% of the company. The balance is owned by management and Stora Enso Oyj which divested its North American operations to NewPage in late 2007.

According to its most recent 10K, coated paper products represent 80% of 2010 net sales at NewPage. Coated paper is the used in media and marketing applications such as glossy advertising brochures, magazine covers, company annual reports, catalogs and textbooks. Look around at your desk and you will see numerous examples of coated paper. The remaining 20% of sales comes from supercalendered paper (inserts and flyers), newsprint and specialty paper.

As one can expect, the coated paper products market has faced both cyclical and secular declines in the past few years. With that said, industry capacity has been taken out over the past few years as demand has fallen and rising raw material and operating costs (energy) have made a number of plants across North America unprofitable. Because of back integration (they produce ~95% of their pulp requirement), NewPage is the low cost producer in North America.

It is estimated that utilizations of plants across North America are running in the mid 90s. Supply is fairly tight right now. Contributing to this, in October 2010, the International Trade Commission voted unanimously that imports of NewPage's principal product (coated paper) from China and Indonesia (15-20% of the market) and harmful to U.S. producers and workers. This allows the Department of Commerce to impose duties on imports. Industry trade group, RISI, expects coated paper to increase $67/ton in 2011 and $56/ton in 2012. Supporting this, NewPage announced a $60/ton increase on coated free sheet products starting June 1.

As on can expect in a paper / packaging company, operating leverage is magnificently high in this business. The company's EBITDA nearly doubled in 2010, and given where pricing is today plus a slight increase in volumes, Newpage should be able to double EBITDA in 2011 (from 2010 levels) in spite of higher raw material costs. This trend would continue into 2012 assuming RISI's price expectations come to fruition.

For comps I am going to use Sappi and Verso paper, both well known names in the high yield universe. Sappi trades at 5.3x 2011 EBITDA and Verso trades at 5.6x 2011 EBITDA. Assuming conservative multiples of 5.0x, 5.5x, and 6.0x versus the expected $500M of EBITDA Newpage should generate in 2011 gets us to a valuation of Newpage between $2.5-$3.0B. Without completely oversimplifying things, this is what I come up with:

So on a back of the envelope calculation, the 2nd liens are worth between 56-105. At today's price of 57-58 that looks pretty compelling for these reasons:

1. In our low case I used a 5.0x multiple versus 5.3x and 5.6x for Sappi and Verso respectively
2. I used a fairly conservative EBITDA number. Goldman Sachs' credit analyst Joe Stivaletti pegs 2011 EBITDA at $574M and Banc of America's Roger Spitz is using $525M for normalized EBITDA
3. Assuming a restructuring and the 1st lien getting adequate protection in the form of post petition interest, run rate interest in a restructuring for NewPage will be between $200-$250M. With capital expenditures in line with previous years, NewPage (on $500M of EBITDA) could generate between $150M - $225M of free cash flow per year. Given $1.030B of 2nd lien debt, this translates into 15-22 bond points. This number increases assuming EBITDA continues to rise in 2012
4. In line with the above, given how hot the bank debt market is today, it wouldn't surprise me to see NewPage refinance its entire first lien structure at a 7-9% handle saving the company $40-$70M pre-tax dollars a year
5. The company has non cash flowing operating assets it can sell to generate additional proceeds. Further, cash proceeds ($100M) from already announced sales will flow to the balance sheet over the next few quarters

So all in all, with very little downside and tremendous upside NewPage's 2nd lien looks like a very interesting investment opportunity. The 1st liens look well covered as well and are attractive for risk averse investors at a healthy 12%+ yield. I personally think a 1/3 1st lien, 2/3 2nd lien position also looks interesting to hedge one self against a rapid drop in coated paper products. The biggest risk I see here is Cerberus offering to exchange 2nd lien debt into 1st lien debt (street estimating ~$500M of first lien capacity under various indentures). Instead of capturing the upside of a strong 2011/2012 pricing cycle, investors would be stuck in a fixed instrument with a longer maturity profile.

We will continue updating and fine tuning our analysis as more facts emerge in this fascinating distressed debt case.