Chinese paper companies have accelerated overseas investment, targeting foreign waste paper and forest resources

On October 22, 2020, Nordic Paper was listed on the Nasdaq OMX Stock Exchange in Stockholm, Sweden, with an issue price of 43 SEK. It is a subsidiary of Chinese paper giant Mountain Eagle International (600567), headquartered in Backhammar, Sweden, and mainly engaged in the production of high-end specialty paper.

Mountain Eagle International acquired 100% of Nordic Paper in October 2017 for SEK 2.4 billion (about 1.952 billion yuan). As of June 30, 2020, Nordic Paper contributed a cumulative net profit of SEK 1,004 billion. In this listing, Mountain Eagle International recovered about SEK 2.417 billion through the sale of 51 percent of Nordic Paper. As of November 23, 2020, Mountain Eagle International, through the lead underwriter, exercised the over-allotment option to sell an additional 565,000 shares of Nordic Paper, equivalent to approximately 0.84% of the total share capital of Nordic Paper, for a recovery of approximately SEK 24.295 million.

With the proceeds from the sale of the stake plus dividends, Mountain Eagle International has recovered SEK 2.667 billion from Nordic Paper in just three years, more than the principal investment. More important than the cash income is that Nordic paper has injected high-end specialty paper businesses such as greaseproof paper, special kraft paper, and high-strength paper bags into Mountain Eagle International, helping it to expand the European and North American markets.

Mountain Eagle International's investment in Nordic paper is regarded as a model of overseas mergers and acquisitions of Chinese paper enterprises and a microcosm of the overseas investment boom.

Why does China's paper industry invest abroad? What are the characteristics of current investments? What are the future trends? This paper attempts to explore one or two through combing from multiple angles.

01 Raw materials, energy, environmental protection: paper companies go to sea three major pursuits

Raw materials, energy and environmental protection are the most important factors restricting the development of China's paper industry.

First of all, China's "ban on waste" limits the source of raw materials. The core raw material pulp is highly dependent on foreign countries, which has always been the biggest bottleneck restricting the development of China's paper industry. Due to the lack of wood resources in our country, the lack of domestic raw pulp production capacity, the high cost of imported raw pulp, waste pulp has been the main raw material of our paper industry, and it is heavily dependent on imported waste pulp. Due to the needs of environmental governance, China has tightened the import control of solid waste, including waste paper, since 2015, and completely banned the import of solid waste from 2021, and the raw material source of domestic papermaking enterprises has encountered a bottleneck.

Secondly, the energy-saving New Deal will increase the energy cost of the paper industry. Paper making and paper products industry is the second largest energy consumer after textile industry in China. Self-owned power plant is an important way for large paper enterprises to meet electricity demand and reduce energy costs. Under the guidance of the goal of "carbon peak, carbon neutrality", the state no longer approves the construction of new coal-fired self-owned power plants in principle, and existing power plants must also be reformed within a time limit, which indirectly increases the energy cost of paper enterprises and limits the capacity expansion of paper enterprises to increase production.

Thirdly, the paper industry is also directly affected by pollution control policies. Paper industry is one of the main industrial pollution sources in our country, which has been included in the implementation scope of the emission permit system, and the pollution without a license will face severe legal responsibility. Due to the short supply of industrial land in the southeast coastal provinces where papermaking enterprises are concentrated, local governments have high requirements for environmental protection and energy saving and strong law enforcement, which greatly limits the possibility of papermaking enterprises expanding in the region.

In this context, through "going out" to obtain high-quality and cheap resources, reduce operating costs, and expand production scale, it has become an inevitable choice for many Chinese paper enterprises.

02 America, Europe and Southeast Asia: Popular investment destinations

Foreign investment of Chinese paper enterprises began at the beginning of this century. In August 2007, Leven Paper (http://02314.HK) announced investment in construction of 1.5 million tons per annum paper mill and 1 million tons per annum wood pulp mill in Vietnam. In August 2010, Sun Paper (002078) established a wholly-owned subsidiary in Laos, responsible for the implementation of the "forest pulp and paper integration" project. With the implementation of the quota system for waste paper imports in 2015, the pace of overseas investment by Chinese paper enterprises has accelerated significantly, especially between 2017 and 2018. Nine Dragons Paper and other giants have actively established their presence in Vietnam, Malaysia, the United States, Myanmar, Laos and other places.

While Chinese companies are aggressively investing abroad, foreign competitors are also expanding aggressively, seizing resources and markets. In January 2019, Japan's Marubeni Corporation announced that it would build a new 350,000 tons/year box board corrugated paper project in Bati - Vtau Province, Vietnam, and put into production in the second half of the fiscal year 2020. GS Paperboard & Packaging (GSPP), controlled by Japan's Prince Paper, has built a new 1,445 tons per day box board corrugated machine in Malaysia, which will be put into production in 2021, thereby increasing local production capacity from 300,000 tons per year to more than 750,000 tons.

In April 2019, the Philippines' United Pulp and Paper (UPPC) was reported to be investing 8.5 billion Philippine pesos (about $165 million) in a new corrugated paper machine with an annual capacity of 220,000 tons, which will be put into production in November 2020. In Indonesia, a subsidiary of PT Fajar Surya Wisesa Tbk, a major local paper company, will switch to corrugated paper production, with an estimated annual capacity of 230,000 tons.

With the post-COVID-19 economic recovery, global demand for paper and paper products has rebounded rapidly, and overseas investment by Chinese paper companies is expected to only increase under the pressure of competition at home and abroad.

At this stage, the overseas investment destinations of Chinese paper enterprises are mainly in the United States, Northern Europe and Southeast Asia. Although the primary purpose of foreign investment is to obtain paper raw materials, the investment projects in the United States, Europe and Southeast Asia still show a relatively sharp regional difference.

Why invest in Europe and America?

First of all, North America and Northern Europe have the most urgently needed waste paper and wood pulp resources in our paper industry. The United States is the main source of imported waste paper in China, more than 70% of its waste paper is sold to China, the annual import volume has accounted for more than 45% of China's total waste paper imports, and more than 50% in 2020. The United States and Northern Europe are rich in forest resources and are also important sources of coniferous wood pulp in China. In 2019, bleached coniferous wood pulp from the United States accounted for the second place in China's total imports of wood pulp, and wood pulp from Finland accounted for the third place. Nine Dragons Paper's Old Town project in the United States uses local waste box board paper as the main raw material to produce 200 tons of waste pulp per day. In 2016, Sun Paper had planned to invest in the construction of a bio-refining project with an annual capacity of 700,000 tons in Arkansas, the United States, one of the important factors for the location of the site is that the local has rich southern pine forest resources, the quality of the tree species and the price of wood chips is very advantageous, which can effectively reduce the production cost of the project.

Secondly, paper companies in the United States and Northern Europe have more advanced production technology and operation models, which can improve the production efficiency of the project, or help Chinese enterprises to enter the international high-end market. In the announcement of the acquisition of Nordic Paper, Mountain Eagle International said that the target company mainly focuses on the high-end market in Europe and North America, and the production configuration of pulp and paper integration and the self-supply of fiber raw materials can give full protection in terms of quality and output, and has obvious cost advantages in operation. The company also mentioned in the announcement of the acquisition of Verso Wickliffe that the deal will "facilitate the company to land a production base in North America and directly open the North American wrapping paper market."

Third, although the labor costs in the United States and Northern Europe are higher, the costs of raw materials, electricity, water, capital and other aspects are lower than those in the Asia-Pacific region, helping to reduce production costs. According to the estimation of Huachuang Securities in 2019, the production cost of paper raw materials in North America/Asia-Pacific/Europe is 230/285/284 US dollars/ton, respectively, considering that raw material cost is the most important component of paper cost and the operation efficiency of US and European enterprises is higher, local production can still obtain a large cost advantage. Mature capital markets in Europe and the United States and long-term low interest rates are also conducive to reducing investment costs.

Finally, circumventing trade sanctions is also an important objective. In recent years, the United States and the European Union have imposed anti-dumping and countervailing measures on coated paper and other paper products originating in China, and China has also responded in due course. With the intensification of the US-China trade conflict, the United States and China have imposed tariffs on each other's pulp and paper products industry products since 2019, involving wood pulp, waste pulp, finished paper and so on. Locally produced and sold in the US and Europe can effectively avoid punitive tariffs.

Why Invest in Southeast Asia?

First of all, Chinese paper enterprises to invest in Southeast Asia, the primary purpose is still to solve the problem of raw material supply, and the United States and Europe's waste paper resources are the main target. At present, Southeast Asian countries do not restrict or prohibit the import of waste paper, and implement zero or low tariffs on imported waste paper (Laos's waste paper tariff is 5%). Set up factories in Southeast Asian countries, import waste paper from Europe and the United States after processing into pulp or pulp board, re-export to China, is the business model of most Chinese paper enterprises in Southeast Asia. For example, Jingxing Paper's Malaysia 1.4 million tons of pulp and paper project, Forest Packaging (605500) Thailand's 100,000 tons of waste pulp project, Jintian Paper's Thailand pulp and paper project are all in this situation. According to China Customs data, China's recycled pulp imports increased nearly 24 times in 2018, more than 208% in 2019, and more than 93% in 2020; The source of recycled pulp has also expanded from a few regions such as Vietnam and Taiwan to Laos, Malaysia, the United States, Thailand, Myanmar and many other countries and regions, which is echoing the above business model.

Secondly, Southeast Asian countries, except Singapore, labor costs, energy consumption requirements, environmental standards are relatively low, which is conducive to the expansion of production scale of paper enterprises. At present, the Chinese-funded paper projects in Southeast Asia, such as the Vietnam project of Lewen Paper, the Laos project of Sun Paper, and the Selangor project of Nine Dragons Paper in Malaysia, have almost all built their own power plants, which is difficult to achieve under China's current policy environment.

Third, the pulp is not suitable for long transportation, otherwise it is easy to deteriorate. Southeast Asian countries are close to China, and exporting pulp from these countries to China is not only conducive to ensuring quality, but also to saving transportation costs.

Finally, the governments of Southeast Asian countries are competing to introduce various investment preferential treatment to attract foreign industrial investment. For example, Malaysia encourages foreign investment in pulp products and grants income tax relief for 5 to 10 years for eligible projects. Laos encourages the development of forestry and the production of export commodities, exempts imported raw materials used in the production of export products from customs duties and value-added tax, and projects set up in areas where investment is encouraged can also enjoy the reduction and exemption of profit tax, value-added tax, lease fees, concession fees, etc. In Thailand, the production of aseptic pulp and paper products can be exempted from corporate income tax for up to 8 years.

03 M&A VS Greenfield Investment: Differences in the path of overseas investment

Chinese paper companies have invested in the US and Europe mainly through mergers and acquisitions of existing companies. In general, the cycle of mergers and acquisitions is shorter than that of new factories, helping investors acquire new capacity faster. The US paper industry has entered a mature period of decline, the US market research institution IBIS World data show that the scale of the US paper industry is shrinking at an average annual rate of more than 2%, the number of paper factories, enterprises continue to decrease, a large number of production facilities idle, which provides objective conditions for Chinese enterprises to carry out mergers and acquisitions.

After acquiring US and European companies, Chinese companies usually repair, transform or increase capital and capacity of the target company to adapt it to the business direction of the acquirer. The Old Town Paper Mill in the United States, formerly a plant with an annual output of 150,000 tons of bleached hardwood kraft pulp, has been idle since the fourth quarter of 2015. After being acquired by Nine Dragons Paper, the plant resumed production in August 2019 after nearly a year of refurbishment to produce unbleached softwood kraft pulp; In April 2021, the plant was transformed again with the commissioning of a new waste pulp production line capable of producing 200 tons of waste pulp per day.

The Verso Wickliffe plant acquired by Mountain Eagle International originally produced pulp and cultural paper, but due to the continuous decline in demand for local cultural paper in North America, the plant was discontinued in November 2015 and has been idle. After the acquisition, Mountain Eagle International invested $42 million to repair some equipment, so that it has an annual output of 360,000 tons of high-end cow paper/wood pulp capacity, and changed its name to "Phoenix Paper". On August 9, 2019, Mountain Eagle International announced an additional investment of $200 million to expand the new recycled paper business with an annual production capacity of 700,000 tons, and its pulp products will enter the Chinese market.

Investing in Southeast Asia is a completely different path. In view of the low degree of modernization of the local paper industry and fewer large-scale manufacturers, most Chinese paper companies landing in Southeast Asia choose new projects, that is, the way of green field investment. Large-scale greenfield investment projects are also more likely to win preferential treatment from local governments, such as tax breaks and land supplies.

In September 2018, Sun Paper, through its wholly-owned Lao subsidiary, acquired the concession rights of 22,006 hectares of land, on which Sun Paper will build pulp board and wrapping paper production lines, thermal power plants, waste paper recycling paper shed, water supply plants, roads and other supporting projects, with a total investment of $636 million.

In addition to bringing a huge amount of capital, Chinese paper enterprises have also introduced modern production technology and management system to the site of the project to improve the operational efficiency of the landing project. For example, Nine Dragons Paper announced in March 2021 that it intends to invest in two new plants in Pahang and Selangor, which will introduce fully automated production lines in line with Industry 4.0 high-tech, and apply high-tech technologies such as the Internet of Things, big data analysis and cloud computing.

04 Three potential obstacles constrain overseas investment

The path for Chinese paper companies to invest abroad has not been straightforward. In addition to inherent constraints such as capital, talent, and management capabilities, three potential obstacles will have a huge impact on the success or failure of overseas projects.

The biggest destabilizing factor is the direction of US-China economic and trade relations. Although the US-China economic and trade conflict has stimulated the boom of Chinese paper enterprises to invest in the United States, the continued uncertainty about the policy direction of the two countries and the impact on trade and investment has intensified the concerns of enterprises, and even led to the abortion of projects in serious cases. On April 26, 2016, Sun Paper signed a memorandum of project investment cooperation with the state of Arkansas, intending to invest $1.36 billion to build the world's largest, most advanced and most efficient single-line fluff pulp production line locally. This was the largest manufacturing greenfield investment project by Chinese private enterprises in the United States at that time. However, less than five years later, in early March 2020, Sun Paper officially notified the United States that it would terminate the project due to the economic uncertainty brought about by the COVID-19 pandemic and the ongoing trade dispute.

This is not unique. According to the Report on the Development of China's Outbound Investment Cooperation 2020 released by the Ministry of Commerce of China on February 2, 2021, China's outbound direct investment flow in 2019 was US $136.91 billion, ranking second in the world for eight consecutive years and ranking top three in the world. However, in the same period, Chinese enterprises' direct investment in North America fell by 49.9% year-on-year, of which the investment flow to the United States fell by 49.1% year-on-year, and the investment flow to Canada fell by 69.7% year-on-year.

The public sentiment of the investment destination will also cause unexpected risks to the project. In mid-May 2014, there were serious violent incidents of beating, smashing, looting and burning targeting foreign investors and enterprises in Vietnam. Some Chinese enterprises and personnel, including those from Taiwan and Hong Kong of China, as well as those from Singapore and South Korea, were affected to varying degrees.