This Week in Paper by Joe Masters (TMF Master) Charleston, SC (May 9, 1997) -- Papers were set ablaze this week by merger news and an analyst upgrade of a major player in the industry (INTERNATIONAL PAPER CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IP)") else Response.Write("(NYSE:IP)") end if %>. While both the Dow and the S&P500 did well this week (rising 1.39% and 1.45%, respectively), our Paper/Forest index rocketed ahead by 3.69%. Leading the charge, as you might have suspected, was one of the stocks involved in the merger news: FORT HOWARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FORT)") else Response.Write("(Nasdaq: FORT)") end if %>, which gained a whopping 19.52% this week (a total of 33.72% over the past two weeks). Its proposed partner, JAMES RIVER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JR)") else Response.Write("(NYSE: JR)") end if %>, finished up 7.69%. Other big winners this week included JEFFERSON SMURFIT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JJSC)") else Response.Write("(Nasdaq: JJSC)") end if %>, up 14.29%, STONE CONTAINER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STO)") else Response.Write("(NYSE: STO)") end if %>, rising 8.86%, and BOWATER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BOW)") else Response.Write("(NYSE: BOW)") end if %>, up 4.83%. Some of Smurfit's gain may have been attributable to Morgan Stanley having a vested interest in the company, one which they have publicly stated they would like to end. Morgan Stanley also has a backing stake in Fort Howard, and favored the Fort Howard/James River merger as a way to end the relationship and take their huge profits. Speculation is they might strive to promote a similar scenario with Smurfit. Anyhow, only two of our stocks finished down this week: CONSOLIDATED PAPER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDP)") else Response.Write("(NYSE: CDP)") end if %>, off 0.91%, and CHAMPION INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHA)") else Response.Write("(NYSE: CHA)") end if %>, declining 0.26%. All the News that Fits the Print: On Monday, Suomen Optioporssi, a Finnish options exchange, put the value of northern bleached softwood pulp at $524.55 per ton, up from $519.18 last week. In April, the PIX mean was $518.12, down from $522.28 in March and from $546.59 in February and $556.86 in January. The big news on Monday came before the open when it was announced that James River and Fort Howard would merge in a transaction valued at $42.45 and a total value of $5.8 billion to Fort Howard shareholders, including the assumed Fort Howard debt. James River said Fort Howard holders would get 1.375 shares of the new entity per share. The new company, to be called Fort James, would have annual sales of more than $7 billion. Excluding non-recurring items and an anticipated reorganization charge, the merger is expected to be accretive to pro forma 1997 earnings, without anticipated synergies, and accretive to 1998 earnings by approximately 10%, including synergies. The board of directors of Fort James will be comprised of 15 directors, 11 from James River and four from Fort Howard. As a result of the merger, Fort James will have a total market capitalization of $11 billion, including debt of $4.4 billion. Fort James will have approximately 218 million outstanding fully diluted common shares. Fort Howard currently pays no dividend. James River pays a current quarterly cash dividend of $.15 per share, which will be the initial dividend rate of Fort James. Fort Howard has about 16% of the tissue market based on capacity, while James River has 13.4%. The combined company will surpass KIMBERLY-CLARK CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %>, the current leader with 21.6%, as the No. 1 tissue maker. Also Monday, THERMO FIBERTEK INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TFT)") else Response.Write("(AMEX: TFT)") end if %> reported revenues of $44.7 million for the first quarter of 1997, compared with $49.0 million in 1996. Net income was $3.5 million, or $0.06 per share, in 1997, compared with $5.2 million, or $0.09 per share, in 1996. Thermo Fibertek Inc., a subsidiary of THERMO ELECTRON CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TMO)") else Response.Write("(NYSE: TMO)") end if %> develops equipment and products for the papermaking and paper recycling industries. And Monday, Bear Stearns & Co. analyst Linda Lieberman said she raised INTERNATIONAL PAPER CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %> to "buy" from "neutral". Lieberman set a 12-month share-price target of $66. Finally Monday, circulation declined at six of the nation's 10 biggest newspapers during the most recent reporting period. The circulation weakness came as the industry felt the effects of newspaper price increases and cutbacks of costly deliveries to outlying areas. Of the 10 biggest papers, only USA Today, the Los Angeles Times, Newsday and the San Francisco Chronicle posted circulation gains, according to the new figures compiled by the Audit Bureau of Circulations for the six months ended March 31. The Newspaper Association of America calculated that the figures for all dailies showed a combined 1.2 % circulation decline. Circulation gains were seen in 33% of the papers, which had a total circulation of more than 51 million. On Tuesday, CS First Boston downgraded Fort Howard to "buy" from "strong buy", removing the stock from its focus list of recommended stocks. On Wednesday, NORSKE SKOG ASA (Y.NSK) said pretax profits fell 80% in the first quarter of 1997 to 118 million kroner. Norske Skog is one of the top newsprint manufacturers in the world. Also Wednesday, Furman Selz Inc. initiated coverage of TENNECO INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TEN)") else Response.Write("(NYSE: TEN)") end if %> and put the stock on its recommended list. The firm's 1997 and 1998 per-share earnings estimates are $2.36 and $3.25, respectively. On Thursday, REPAP ENTERPRISES INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RPAPF)") else Response.Write("(Nasdaq: RPAPF)") end if %> reported a net loss (before discontinued operations) of $37.0 million, $0.30 per share, in the first quarter of 1997, down from a net income of $0.2 million, or $0.02 per share, in the first quarter of 1996 and down slightly from a loss of $33.7 million, or $0.27 per share in the fourth quarter of 1996. Revenues from continuing operations were $334.4 million, up nine percent from $306.5 million realized in the first quarter of 1996. "Model Portfolio" Update: Based upon some rudimentary analysis of the the proposed Fort Howard/James River merger and the post-announcement valuation, we decided to take some money off the table and "sold" our Fort Howard stock on Monday at a price of $42 per share, for a nice 52% gain. Though merely an approximation, I calculate pro forma earnings at $0.61 for 1995 and $1.30 for 1996, with estimates of $1.62 for 1997 and $2.06 for 1998 (based upon an estimated 218 million outstanding shares for the post-merger corporation). This gives us a trailing P/E of 23.8 and a one-year forward P/E of 19.1, based upon a $31 per share price for James River stock. Given that past growth rate in earnings is about 25% based on our estimate, which is only moderately sustainable in our view, we feel the stock has reached fair valuation. I still feel the company has some positives going forward. Earnings growth will be supported as Fort Howard shows James River how to reduce manufacturing costs and sales growth will be helped along as James River projects their marketing savvy. However, earnings growth could be stifled somewhat by future capacity increases in the tissue segment and increased competitive pressures from Kimberly-Clark, Procter & Gamble and Georgia-Pacific. In addition, the potential for wastepaper prices to increase seems more likely than for prices to stay at this level or drop further, and this will impact Fort Howard's margins in particular. We will most likely return to the stock once valuations are more favorable and/or more information is learned which causes us to reevaluate our decision. In any event, THANK YOU, FORT HOWARD. We now start looking at other prospects for our new-found cash. Since the start of our port-faux-lio on Dec. 31, we have made a total of three trades: sold MX (44% gain in 4 weeks), bought CARAUSTAR INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSAR)") else Response.Write("(Nasdaq: CSAR)") end if %> and now sold Fort Howard (52% gain in 18 weeks). My objective is not to "rub it in," but rather to point out that fundamental analysis and puchase/sale timing based upon fundamentals does work, and that one does not need to trade on a daily basis in attempts to attain superior results. Purchase: IP = $40.50, CDP = $49.13, CSAR = $29.00 Last Trade: IP = $44.75, CDP = $54.38, CSAR = $27.25 This Week: Year-to-Date: Model = + 5.59 % Model = + 26.99 % SP500 = + 1.45 % SP500 = + 11.35 % FSPFX = + 3.60 % FSPFX = + 1.03 % Commentary: On Tuesday morning, I attended a phone conference given by the Canadian Pulp & Paper Association (CPPA) reviewing recent economic performance of the Canadian Paper/Forest industry (a special thanks to Mr. Francois Blain, Director of Media Relations for the CPPA, for the invitation). Presenting were Mr. K. L. MacDonald, current Chairman of the CPPA and President and CEO of Noranda Forest, Inc., and Mr. M. MacCallum, Partner and Chairman of Price Waterhouse. It was noted that approximately 77% of the $49 billion worth of industry sales in 1996 were directed to the export market. Paper/Forest accounted for 14.8% of total Canadian export sales, which is more than the export sales of the next three sectors combined. The biggest declines from 1995 were in the areas of pulp ($11.7 to $6.5 billion) and paper other than newsprint ($7.6 to $6.0 billion). Lumber sales were strong in 1996, rising to $14.2 billion from $11.6 billion in 1995. Newsprint sales showed a modest decline ($10.0 to $9.5 billion). In regards to earnings, the pulp segment recorded a net loss of $1.0 billion, compared to earnings of $2.1 billion in 1995. It was noted that Canada is a high-cost producer of pulp relative to other countries, primarily due to labor and maintanence expense differentials. Below $1.5 billion in earnings, a hinderance to reinvestment and moderization results (cost of capital), making the needed efforts to reduce these expenses very difficult. In the newsprint segment, earnings declined from $1.5 to $1.0 billion, but this was not as bad as it could have been given the decline in newsprint prices as many producers switched to higher value-added products during the period. Also contributing was a lag created by contractural obligations at higher prices. Other paper and board manufacturers posted net losses of about $9 million, compared to earnings of $850 million in 1995. Earnings in the paneling sement (OSB and MDF) were terrible as product prices were essentially cut in half due to overcapacity in this area. The only positive segment in 1996 was lumber, where earnings climbed from $800 million in 1995 to $1.1 billion in 1996 due to record levels of exports and to prices being up 10% during the period. However, lumber earnings could have been greater had it not been for dramatically increased stumpage costs imposed by the Canadian government. In summary, the Paper/Forest sector realized earnings of $800 million in 1995, compared with $5.8 billion in 1995. Looking to the future, it is projected that 1997 will probably be comparable to 1996 in respects to sales and earnings, and companies will probably not achieve the profitability required to satisfy long-term investors. While demand is increasing, inventories are still too high to support more than a modest increase in paper prices. Lumber prices are about as high as they are going to get, with profitability hurt by rising stumpage expenses. And as exports are such a sizable portion of the Canadian Paper/Forest industry, the effect of varying exchange rates is especially important. A strengthening Canadian dollar could significantly impact the sector in a negative manner as it would make their exports less economically attractive to prospective importers. Keep them presses rolling !!! TMF Master

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