Stone Container Corporation Rebuttal

Executive Summary Stone Container Corporation is the United States largest producer of cardboard containers and related paper products, but it is in financial trouble due to being overleveraged from financing a recent acquisition. This paper provides a rebuttal to the presentation given in class by highlighting points of agreement and disagreement with the presenting group as well as providing our recommendation that Stone Containers problems can be solved through liquidating assets and selling equity shares in subsidiaries. Presentation Observations The presentation group did a thorough analysis of the Stone Container Corporation case and provided a solution which they supported well with relevant facts from the case and assumptions. Our team felt they had two strong ideas that were not directly presented as options in the case and represented good out-of-the-box thinking and analysis. The first was to

restructure Stone Corporation in order to streamline production and create efficiencies as a way to clean up from the series of mergers that had happened quickly within the company. The restructuring plan would also being aimed at getting Stone back to their original growth and financing strategy of buying during downturns in the industry and not overleveraging purchases. The second idea was to consider opportunities to lease capital assets with an option to purchase rather than making initial capital investments. Points of Agreement We agreed with several of the groups assumptions regarding Stone, the key problems and their root causes, and parts of the proposed solutions. A key assumption that was made is that the industry and market is currently at a low point and will recover soon before experiencing more significant losses. This assumption means

sales will begin to recover and Stone Corporation will primarily need to focus efforts on keeping the company solvent until the market recovers. Short-term efforts combined with a long-term strategy change will help keep Stone in business. The other key assumption we agreed with is Stones poor credit rating. Due to their increased borrowing and increasing debt-to-equity ratio, we believe Stone has a low credit rating that would affect the willingness of financial institutions to lend money and lead to high interest rates when financing is obtained. This assumption is supported by their continued use of high yield or junk bonds for financing. The key problem for Stone is their coming losses and inability to pay several obligations including interest, debt repayment, and required capital expenditures. The root cause of this problem was the shift in growth strategy from purchasing at the low point in the market with cash or paying off debt quickly to an increasing trend of high leverage for acquisitions. This peaked with the purchase of Consolidated-Bathurst for a 47% premium over the market value. As a partial solution to this problem, we agree with the groups recommendation to sell off the least profitable assets. Stone grew quickly and it is a reasonable assumption that some of the assets gained through acquisitions are underperforming and should be liquidated. Points of Disagreement A key assumption made by the presenting group that we disagreed with is that Stone will be able to renegotiate their debt with the lending agency. Given Stones variance from past policy leading to an increased use of debt, cash flow problems, and consecutive losses, we feel a bank would not be willing to lower interest rates (which are based inherently on risk) or extend the terms (which raises risk of repayment). This leads to a direct disagreement with the

recommendation for negotiating new terms to lower interest and the extended repayment period.

We also disagreed with the groups recommendation to issue more stock. Issuance of stock would further dilute the familys already diluted ownership of the company and could anger current shareholders. The market is also likely to react negatively to a new stock issuance which, combined with the companys financials and performance, will be seen as a sign of weakness in Stone Container Corp. Their stock price, which has already lost almost 50% of its value since the latest acquisition, would likely decrease further. Recommendation In order to make our recommendation we made the assumption that Stone Container has several assets on the books that are underperforming. On the contrary, we also assumed that strong performing subsidiaries have a ready market for an equity interest at premium value. Our analysis of Stones problem indicated they were not going to have sufficient cash to meet current year obligations. We performed and reviewed the prior year cash flows and made projections for the current year. The overall change in cash flow represented the cash needed to be raised for Stone to remain solvent through the current year. A key assumption in this analysis is that sales and related payables would not decrease, either remaining stagnant or slightly increasing. (See Exhibit 1.) Some of our key changes in the final cash flow were increasing net loss numbers, reducing borrowings to 0, reducing payments made on debt to the minimum level which cannot be escaped, reducing new project financing to 0, reducing other items, and acquiring no new business which comes down to 0. We projected this amount with the intention of covering only what cannot be escaped so that we can save up cash and prevent future investments for the year. Our recommendation for Stone is to sell underperforming assets and sell equity shares in strong performing subsidiaries. Stone grew quickly over the past few years through a series of

acquisitions. We believe several of those assets are likely underperforming or inefficient due to duplication of certain processes. These assets should be sold, which will both provide an inflow of cash and reduce our interest expense and debt obligations on those that are still financed. It is likely that some of these assets will be sold at blue-light special prices as they are underperforming. The second piece of our solution will be to sell an equity interest in our strong performing subsidiaries. This has been done in the past and is less likely to have an unfavorable reaction from the market as issuing a new equity offering for the company as a whole. Based on the numbers provided by the case, we believe $500 million can be raised this way. The $500 million along with the $58.9 million of cash on hand will provide Stone with enough funds to meet the $521 million cash deficit projected by our analysis. This solution will allow Stone to survive the current year. However, long-term success is dependent on a return to their original growth strategy and/or slow acquisitions at low points in the market without overleveraging the company.

Exhibit 1.
Changes in cash flow Cash flows from operating activities Projected Net loss -$450 1992 -$171 Difference -$280

Cash flows from financing activities Borrowings Payments made on debt $0 -$365 $1,025 -$909 -$1,025 $544

Cash flows from investing activities Capital expenditures: Funded by project financings Other Payments made for businesses acquired $0 -$100 $0 -$79 -$202 -$27 $79 $102 $27

Summary

-$965

-$367

-$521