Stone Container

Background

J.H. Stone & Sons, a cardboard container and paper products manufacturer was founded by Joseph Stone in 1926 and after World War II reincorporated as Stone Container Corporation. Early on in its conception Stone was able to grow significantly by way of acquisition. The company had a policy of paying for its acquisitions either entirely in cash or borrowing funds with early repayment. Continuing to grow, the company became publicly-owned when it issued its first 250,000 shares of stock in 1947. After its first IPO, Stone was able to widen its reach demographically. The company began acquiring even more to better diversify itself in the paper industry. By 1987 Stone had quintupled its production capacity but had borrowed heavily to do so. Stone Forest Industries, a subsidiary of Stone Container, was created to relieve some of this debt and Stone Container was able to diminish the rest. In 1989, Stone was back at it when it acquired Consolidated-Bathurst Inc in conjunction with its $3.3 billion of debt. Even with its high standing in the industry, in 1993 Stone Containers future was a shaking one; one that came down to how it would avoid defaulting on its $4.1 billion of debt.

Problems Facing the Company

Due to heavy acquisition, Stone Container Corporation has put themselves in a tight financial situation with upcoming debt and interest payments. Stone's plans to finance its large acquisitions such as the one of Consolidated-Bathurst, went awry when its plan to refinance its loans with high-yield bonds was eliminated. This was partially due to regulators forcing many saving and loans banks to dump their junk bonds. Stone found a way to relieve some of its financial pressure by refinancing and restructuring its debt using securities such as interest rate swaps and convertible exchangeable preferred stock. An interest rate swap would allow Stone to exchange a stream of interest payments for another party's stream of cash flows. This would alter their exposure to interest-rate fluctuations, by swapping fixed-rate obligations for floating rate obligations. Convertible exchangeable preferred stock is stock that can be exchanged at the issuer's option for convertible debt that has the same yield and conversion terms. Both of these options could be problematic for Stone because it leaves them open to interest rate risk.

Not only does Stone Container have to battle repayment struggles but it is also facing a volatile industry. In the early 1990's, the paper industry saw a rise in recycling with a rate of 33.5% of the paper consumed could be recovered for recycled use. An increase in recycled paper would influence price changes in the paper industry. This could be contributed to the price decrease in the early 1990's. Stone was facing changes in how paper was being produced but also large swings in the industries profitability. Between 1986 and 1992 the paper and forest products industry grew from $61.6 billion in sales to $85.2 billion. Even though this was a 40% increase, the net profit dropped from $6 billion in 1988 to $.97 billion in 1992. Such a large decrease in a short amount of time didn't prove favorable for Stone. These two factors could make it difficult for Stone to accurately forecast its financials thus its ability to pay back its debt.

Assumptions

Multiple assumptions have been made throughout the analysis of the Stone Container Corporation case. Some of the financial assumptions include:

Ð'* A weighted average of the past three years will be used for net sales for the year ending December 31, 1993 (Exhibit 1).

Ð'* Selling, general, and administrative expenses are last year's expense plus the average of the change in expense over the past three years (Exhibit 1).

Ð'* Depreciation and amortization expense is calculated the same as selling, general, and administrative expenses (Exhibit 1).

Ð'* Sales tax rate of 35% (Exhibit 2).

Relevant Data

In order to fully analyze Stone Container Corporation's financial situation some relevant data was needed in order to get a better picture of what it was facing. During the year of March 1993 to March 1994, the company would:

Ð'* continue to pay $400 to $425 million in interest on its debt

Ð'* make debt repayments of $365 million

Ð'* extend, refinance, or replace another $400 million in revolving credit that was scheduled to terminate

Ð'* be required to make $100 million of new capital expenditures

Ð'* face pre-tax losses of $450 to $500 million

Problem Statement

Having seen great success with acquisition in the past, Stone Container Corporation hasn't seen the results it would have hoped for recently. Stone disregarded its policy to only buy when it could pay in cash or pay their debts back quickly. This in turn left them with the uncertainty on how to pay back the large amounts of debt that were taken on. Because the company's original plan to refinance their loans with high-yielding bonds went south; they now face the problem of which of the five alternatives available to them is the best plan of action to take to arrive at a sound financial plan. This plan will need to relieve the immense debt that is plaguing them, help it get through the paper pricing trough, and also restore the company to its former glory of financial stability.

Debt Relief Avenues Available to Stone Container Corporation

1. The terms on the bank loans could be renegotiated to extend their maturities and ease some of the binding covenants. Fees for this transaction would range from $70 to $80 million.

2. Assets or equity interest in a Stone Container Corporation subsidiary could be sold for a cash flow of $250 to $500 million.

3. The bank debt could be repaid by selling intermediate-term senior notes to the public. $300 million of 5-year notes bearing a coupon in from 12% to 12 Ð'Ð...% could be sold.

4. The company could sell up to $300 million of convertible subordinated notes. The notes would have 7 year life, bear a coupon of 8 Ð'Ñ*%, and be convertible into Stone's common stock at a 20% premium over the market price of Stone's common stock at the time of the offering.

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