Norske Skog: farewell Korea!

Norske Skog is selling its two South Korean newsprint mills to Morgan Stanley Private Equity Asia and Shinhan Private Equity. The deal could well be completed just in time for 7 August 2008, when Norske Skog discloses its results for the first half of 2008. One of the mills was acquired in 1998, the other was partly acquired the following year and fully consolidated since 2005. The Korean disposal will generate $830 million proceeds for Norske Skog and will reduce the group's debt by about 25%. The mills have a 1-million-tonne newsprint paper production capacity, that is about 2/3 of Norske Skog's Asian newsprint capacity or just under 1/4 of the entire group's newsprint capacity. No material disposal gain or loss will result. In the third quarter of 2006, Norsk Skog had recorded a provision of NOK 1 billion for a 1,000-headcount reduction and a 180,000-tonne capacity reduction in Korea.

In January 2008, the largest shareholder of Norske Skog was Unionen, with almost 6% of the capital. Owned by activist shareholders, Unionen then made a rather protectionist call that Norske Skog should sell assets outside Norway to keep its home-based mills afloat, for instance by splitting the group into two geographical poles. This was a strong objection of the pro-Asian strategy that had been pursued since Norske Skog took minority stakes in what are now majority- or fully-owned Norske Skog Asian operations.

For now, the group is holding on to its smaller Chinese assets, and management probably still sticks to its belief that long-term prospects there are "bright", despite the current over-capacity situation.

Paper sector outlook

Early this morning, Finland-based Stora Enso, Europe's largest paper producer, warns that its second quarter operating income will be half the €223 million generated in the same period last year. Main culprits: higher pulp and oil prices, and factory stoppages for maintenance and due to technical problems. Shortly thereafter, its compatriot UPM-Kymmene also warned that it now expects 2008 operating profit to be lower than in 2007 for similar reasons, despite having expected a flat year-on-year trend as recently as early 2008. Stora and UPM will both release their second quarter results on 24 July.

Yesterday, Standard & Poor's released an industry report card on the US forest products sector. Pam Rice and her colleages issued a rather gloomy, if predictable, comment: "two-thirds of the rating actions we took in the past three months were negative, and now almost 40% of the companies we rate have negative outlooks or are on CreditWatch with negative implications, with just over 50% having stable outlooks. As a result, any material adverse deviations from our base case assumptions will likely lead to more downgrades." At the end of May, Standard & Poor's made similar comments about the European paper sector: despite the sector-wide downgrades of October 2007 and April 2008, over half of Europe's forest products companies still have negative rating outlooks, "indicating a high likelihood of further negative rating actions."

All this echoes Moody's global paper and forest products report of 1 April 2008: "many companies in the printing and writing paper, paper packaging and wood-based building products sectors are expected to experience negative rating pressure" and "over the past year, approximately 75% of rating actions in the paper and forest products industry have been negative, constituting either outright downgrades or negative outlook changes."

Let me look at the lowest-rated names. If a company is already rated, say, B- or B3, further downgrades will presumably require a further deterioration in liquidity. S&P's liquidity snapshot of 16 May 2008 is particularly helpful in that respect. M-real will report its second quarter results on 23 July 2008. It is rated B-/stable by S&P and B3/negative by Moody's. At 31 March 2008, €197 million of its long-term interest bearing liabilities were due by the end of the year, but its €500 million syndicated credit facility (2009) was still completely available, so no imminent liquidity crisis can reasonably be expected in 2008. Lecta is rated B+/stable by S&P, but its senior unsecured debt is rated B-. It was downgraded by Moody's a week ago, to B1 corporate family rating and B3 senior unsecured debt rating, with a stable outlook. Both agencies could well change the rating outlooks on Lecta to negative as the year progresses. Moving up the rating scale, Norske Skogindustrier ASA (BB-/Watch Negative and B1/negative) is the best candidate for (more) downgrades, especially by S&P. It reports on 7 August 2008, so watch rating news around that date.