A Valuation of Norske Skogindustrier

Master Thesis MSc Accounting, Strategy and Control Copenhagen Business School 2013

- A Strategic and Financial Analysis

Student: Henrik Hartwig Hand-in-date: 11.11.2013 Characters incl. spaces: 156.562 (79 pages)

Signature:

Supervisor: Kay Sun Park Department of Finance

Acknowledgements

In memory of Jacob August Hartwig

This thesis is dedicated to my grandfather who sadly passed away in July 2013. His kind support and encouragements helped me through a period in life which could be characterized as challenging. He encouraged me to work hard in order to reach great things in life. He will never be forgotten.

I would like to thank my supervisor, Kay Sun Park, for her support and challenging thoughts as the thesis progressed. Her proven knowledge within the field of corporate finance and valuable feedback has stimulated the workflow of this paper. I wish her the best in the upcoming future.

Finally, a special thanks to family and friends which have supported me through this period. I hope that the future will bring us closer together, and I apologize for my none-existence during the latest months of hard work.

Executive Summary

The objective of this thesis was to assess the fair value of the NSG stock per 17.07.2013. The fair value assessment was facilitated through the establishment of a strategic and financial analysis, enabling the provision of a reliable forecast budget. NSG is recognized as a world leader in the paper industry, yet the shareholders of the company have experienced an immense decline in equity since mid 2007. The cyclical characteristics of the industry combined with the recent financial crisis affected publishers earnings potential due to lower circulation as well as ad-spending levels, thereby influencing NSG’ total supply of newsprint and magazine paper. The company has been forced to discard the global playing field, rather emphasize Europe and Australasia as main markets of interest. These are characterized as advanced economies where positive growth in demand is not expected to occur. Mainly this is supported by the rise of digital mediums and where the competition in Europe is considered to put NSG at test. However, even though it is reasonable to expect that demand for newsprint and magazine paper will decline in the nearest future, it is believed that printed and digital media will live side by side in the future, thereby signaling a minimum need for NSG’ product range.

The European reference price for newsprint has proven to be strongly market driven, seen in light of few possibilities to diversify as well as the current state of oversupply. However, some of NSG’ closest competitors have announced capacity closures and potential seeking in growth markets, which is believed to stimulate price improvements for NSG in Europe. Announced efficiency programs, low future capital expenditure frame, as well as witnessed capital efficiency improvements, are some of the key elements defining the expected model of the company. This is opposed to the “as 2012” model where NSG will end up in bankruptcy if necessary initiatives and actions are not taken forward.

The valuation of NSG was primarily conducted based on a present value approach, supplemented by a sensitivity analysis which proved that the estimated market value of equity is quite sensitive to different levels of WACC. The present value approach was also supplemented by a relative valuation approach based on the application of multiples, however the main findings derived from the DCF- model was not supported. This may stem from the lack of comparability among the selected peers, which is considered to be an important criterion when applying such a valuation technique. Among others it was proven that NSG has a less diversified product portfolio compared to their peers.

The theoretical equity value was found to be NOK 9.43, based on the findings presented in the expected model. The NSG stock was traded at Oslo Børs on the 17.07.2013 at NOK 2.85. This signals a significantly optimistic assessment of NSG’ future cash flow potential and risk compared to the expectations of the market at the time, indicating an underrated stock in the market.

Table of Contents

CHAPTER 1 – INTRODUCTION 6 1.2 METHODOLOGY 7 1.2.1 DATA COLLECTION 7 1.2.2 RESEARCH DESIGN 7 1.3 LIMITATIONS 9

CHAPTER 2 – THE NSG STORY 10

2.1 HISTORICAL OVERVIEW 10 2.2 VISION, GOAL AND STRATEGY 12 2.3 OWNERSHIP STRUCTURE 12 2.4 PRODUCT RANGE 13 2.5 MAIN MARKETS 14 2.6 GLOBAL DEMAND – NEWSPRINT 15 2.7 GLOBAL DEMAND – MAGAZINE PAPER 17 2.8 PEER GROUP 17 2.8.1 UPM (FINLAND) 18 2.8.2 STORA ENSO (FINLAND) 19 2.8.3 RESOLUTE FOREST PRODUCTS (CANADA) 19 2.8.4 NIPPON PAPER (JAPAN) 19 2.8.5 OJI HOLDINGS CORPORATION (JAPAN) 20 2.8.6 HOLMEN (SWEDEN) 20

CHAPTER 3 – STRATEGIC ANALYSIS 21

3.1 MACRO FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 22 3.1.1 POLITICAL FACTORS 22 3.1.2 ECONOMICAL FACTORS – NEWSPRINT DEMAND AND REAL GDP 23 3.1.3 ECONOMICAL FACTORS – GDP OUTLOOK 26 3.1.4 ECONOMICAL FACTORS – PRICING MECHANISMS 29 3.1.5 ECONOMICAL FACTORS – COST OF MATERIALS 31 3.2 INDUSTRY FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 31 3.2.1 THREAT OF NEW ENTRIES 32 3.2.2 EXISTING RIVALRY AMONG COMPETITORS 33 3.2.3 BUYERS BARGAINING POWER 34 3.2.4 SUPPLIERS BARGAINING POWER 35 3.2.5 THREAT OF SUBSTITUTES 36 3.3 COMPANY SPECIFIC FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 38 3.3.1 ADAPTED VALUE CHAIN ANALYSIS 38

CHAPTER 4 - FINANCIAL ANALYSIS 39

4.1 SECURING THE QUALITY OF FINANCIAL STATEMENTS 39 4.2 SHARE PRICE ANALYSIS 40 4.3 RESTRUCTURING NORSKE SKOG`S FINANCIAL STATEMENTS 40 4.3.1 BALANCE SHEET - INVESTED CAPITAL 41 4.3.2 INCOME STATEMENT – NOPAT 43 4.4 HISTORICAL PROFITABILITY 43 4.4.1 PROFIT MARGIN 44 4.4.2 TURNOVER RATE OF INVESTED CAPITAL 49 4.5 INVESTED CAPITAL ENTRIES AND RESPECTIVE DEVELOPMENT 49

4.5.1 INTANGIBLE AND TANGIBLE ASSETS 50 4.5.2 NET WORKING CAPITAL 51 4.5.3 NET INTEREST BEARING DEBT 52 4.5.3.1 NET BORROWING COST 53

CHAPTER 5 – WEIGHTED AVERAGE COST OF CAPITAL 55 5.1 CAPITAL STRUCTURE 55 5.2 REQUIRED RATE OF RETURN ON NIBD 57 5.2.1 RISK-FREE INTEREST RATE 58 5.2.2 COMPANY SPECIFIC RISK 58 5.4 REQUIRED RATE OF RETURN ON EQUITY 59 5.4.1 SYSTEMATIC RISK (BETA) 60 5.4.2 MARKET RISK PREMIUM 61

CHAPTER 6 – FORECAST AND VALUATION 63

6.1 DISCOUNTED CASH FLOW MODEL (DCF) 64 6.1.1 DISCOUNTED CASH FLOW MODEL STRUCTURE 65 6.1.1.1 “AS 2012” - MODEL 66 6.1.1.2 EXPECTED - MODEL 67 6.1.2 SENSITIVITY ANALYSIS 75 6.2 THE RELATIVE VALUATION APPROACH 76

CHAPTER 7 - CONCLUSION 78 7.1 CONCLUSIVE REMARKS 78

REFERENCES 80

APPENDIX 87

CHAPTER 1 – INTRODUCTION

“Demand for newsprint and magazine paper has been characterized by weak economic conditions…” (NSG, 2012, p. 6)

Publishers of newspapers and magazines operate in a tough market threatened by a decline in circulation and less ad spending. This clearly affects Norske Skogindustrier, hereby known as NSG, which supply a variety of publishers’ physical paper. Many publishers have been forced to shut down or supplement existing operations with digital offerings. The growing popularity and accessibility of digital devices such as tablets and smartphones cannot be ignored.

Recent years of operations have troubled NSG, leading to poor results and an immense decline in market value of equity. Several initiatives have been made along the way, among others, cost-cutting initiatives and mill-closures in order to improve utilization rates as well as selected conversion of newsprint to magazine paper production. Targeted investments have been announced which seek to modernize and streamline current production processes. In addition these investments seek to strengthen the competitive power of NSG, especially in the European market. However, it is announced that investments will maintain at a low level in the future (NSG, 2012). The historical development of NSG’ equity value combined with shifting media habits among the growing population motivates a strategic and financial analysis of the company. It is questioned whether NSG will be able to survive in what is believed to be a challenged industry in a challenged market. This leads to the main problem statement: What is the fair value of the NSG stock pr. 17.07.2013?

Approaching the main problem statement it seems reasonable to examine the competitive environment of NSG, as well as to provide some ideas for the future. This leads to the following sub-questions:

 What characterizes the competitive environment of the industry?  What must happen in order for NSG to secure future survival?

1.2 Methodology This section aims to provide the reader reasonable assumption to how the main problem statement is intended to be answered by the author of this thesis. It aims to present a clear and logical step-by-step approach with the objective of facilitating a sound conclusion.

1.2.1 Data collection NSG’ financial statements serve as an important reference when estimating the future earnings potential of the company. However, additional information must be collected and analyzed in order to grasp the competitive environment in which a company operates (Petersen and Plenborg, 2012). This thesis is written from the perspective of an external investor, which limits to publicly known information based on the application of secondary data. The inputs to the main valuation model are based on data extracted from the strategic and financial analysis. This suggests that the paper is based on a qualitative as well as a quantitative approach. Among others, NSG’ websites have been frequently visited and supplemented by data extracted from the peer group, as well as data extracted from different sources such as the International Monetary Fund, Deloitte and Datastream. The academic literature plays an important role when presenting a variety of arguments in this thesis, greatly motivated by the work of Petersen and Plenborg (2012) and Koller, Goedhart and Wessels (2010).

1.2.2 Research design In order to estimate the fair value of NSG’ equity, it is important to apprehend the historical development of the company. The historical performance of the company has been affected by the competitive situation, market characteristics which differ as well as a general development in demand for NSG’ products. Chapter 2 pursues this historical development. Among others highlighting a defined peer group, ownership structure of the company as well as NSG’ vision, goal and strategy for the future.

Chapter 3 presents the strategic analysis, which seeks to highlight the external and internal factors which may affect NSG’ cash flow potential and risk. When examining macro factors main emphasis have been placed at political and economical influences. When examining the characteristics of the industry, a five-forces analysis is presented, which covers among others the competitive rivalry within the industry, and the emerging threat of substituting products such as digital media.

Chapter 4 highlights the financial aspects of the thesis. In this section, historical financial performance has been evaluated based on reformulated financial statements. The purpose is to examine the development in NSG’ ability to manage debt-holders as well as equity-holders invested capital.

Chapter 5 seeks to estimate the weighted average cost of capital, which purpose is to be used as a discount-factor when calculating the present value of all future free cash flows to the firm. Chapter 6 presents the estimated cash flow potential of NSG, motivated by findings derived from the strategic and financial analysis. The estimation of future performance ends up in a company valuation, based on a DCF-approach supported by an EVA-approach, which ensures that the valuation process is free from mechanical errors or errors in economic logic, and that the reformulated financial statements articulate. The present value approaches to valuation are supplemented by the application of multiples in which can be characterized as a relative valuation approach. Finally, chapter 7 presents a final conclusion to the main problem statement, as well as some thoughts for NSG’ future.

1.3 Limitations This thesis is written from the perspective of an external investor, relying exclusively on publicly known information. Time of valuation has been set according to the publication date of the second quarter report, which was on the 17th of July 2013. This thesis addresses the theoretical value of NSG at this point of time, consequently excluding information known to the market beyond this point. The author of this paper acknowledges that the fair value assessment may not be considered “up-to-date”, since ideally a valuation should present a snapshot of the company today.

The financial analysis of this paper mainly emphasized the historical financial performance of the company between 2007 and 2012. In terms of forecasting the future, historical performance serves as an important reference point. It is therefore acknowledged that the historical period analyzed may not be considered sufficiently long, in order to capture a reliable input to future performance estimates. The fair value assessment of NSG is primarily based on the application of a present value model, know as the DCF. Due to its wide acceptance and popularity among practitioners, the structure of this thesis does not prioritize an in depth theoretical justification of the model or its origin. Popularly, a variety of positive and negative scenarios are presented when conducting a valuation. However, this thesis relies solely on two potential scenarios, namely the “as 2012” and “expected” scenario. The expected scenario is supplemented by a sensitivity analysis, which is believed to serve this thesis well due to the significant effect in which different levels of WACC have on the estimated equity value. The presented WACC in this thesis should be up for further discussion, and it should be questioned whether the presented WACC truly represents a “fair estimate” to NSG’ overall risk.

Based on the findings presented in the sensitivity analysis, it can be concluded that one scenario presents NSG as a bankruptcy candidate. It should therefore be questioned whether a valuation based on a liquidation methodology should have been up for discussion. However, it is decided not to include such a methodology, and for the purpose of this thesis, it is held that the approach provided throughout this paper yields a sensible conclusion to the fair value of the NSG stock pr. 17.07.2013.

CHAPTER 2 – THE NSG STORY

2.1 Historical overview NSG was founded in Norway in 1962. At the time of establishment, the investors were primarily forest owner associations which controlled nearly 70% of the company. In 1989, NSG merged with Follum and Tofte, and later joined forces with the independent newsprint producer, Union. Through these activities, the Norwegian publication paper industry had “merged into one company” (NSG, 2012b, p. 2). By the end of the 1980’, NSG controlled numerous production facilities in Norway, and the product portfolio ranged from fine paper to furnishing. As the company expanded, activities in which fell outside newsprint and magazine paper production were sold off. Forest properties and plants at numerous locations in Norway were eliminated (NSG, 2012).

NSG entered the European as well as South American and Asian market in the second half of the 1990’. This was possible due to the acquisition of several European mills and one third of PanAsia paper. The latter, granted NSG access to numerous mills in Korea, Thailand and China. From being a national newsprint and magazine paper supplier NSG established an international profile. Total production capacity rose from 1.3 – 7.9 million tonnes, and the market value of equity rose from 3 – 20 billion NOK. NSG was the first company which could be characterized as global when Fletcher Challenge Paper was acquired in 2000. This company was the sole producer of paper in New Zealand and Australia, as well as the largest producer of newsprint in South America. NSG was also granted access to Canadian mills. From the position of being the third largest newsprint producer in Europe, NSG developed into being the second largest newsprint producer, and third largest magazine paper producer globally (NSG, 2012b).

In 2005, NSG announced that the shareholders hadn’t been rewarded satisfactory financial results since 2002. Excess capacity in the market place caused low utilization, and disappointing reference prices in terms of NSG’ products (NSG, 2012b).

Efforts have been made in order to improve the downward heading financial performance witnessed in table 1. Among others, NSG has closed down numerous mills at several locations around the world with the objective of rebalancing supply and demand. The financial year of 2001 could be characterized as the peak year for NSG generating a gross operating margin of 28%. Since then, a continual drop can be witnessed, and according to NSG, the negative development has led to a sharp drop in market value of equity (NSG, 2012b). The return indexes of NSG and the Oslo Børs Benchmark Index (OSEBX) have been extracted from datastream (2013). The returns in the period between 1990 and 2013 are highlighted in figure 2.

OSEBX comprises the most traded shares listed on Oslo Børs (Oslo Børs, 2013). The return index adjusts for potential corrections in price caused by a variety of actions such as dividend payments or stock splits, and reinvests these so to say. This enables a comparison of different assets over time as illustrated in figure 2. NSG displays cyclical characteristics which suggest that returns are influenced by general market movements, though with some time lag. However, the economic crisis starting in 2007 (Koller et al., 2010) clearly disturbed the observed returns. It seems evident that NSG has not been able to recover to prior heights,

while the OSEBX has gradually recovered. The upcoming strategic and financial analysis will highlight some of the challenges in which NSG has been faced with during the latest years.

2.2 Vision, goal and strategy “NSG is recognized as a world leader in the paper industry. The goal is to deliver good returns for shareholders. To reach this objective, the company has opted to be a low-cost producer, pursue profitable growth and focus on its core business, newsprint and magazine paper” (NSG, 2013)

An examination of NSG’ latest conference presentations reveal a certain change in NSG’ area of interest for the future:

“Global presence – strong European footprint” (NSG, 2012c) “Two business systems – Europe and Australasia” (NSG, 2013b)

2.3 Ownership structure Nobelsystem Scandinavia AS is the most significant shareholder in NSG, controlling 4.61% of total equity1. All shares have equal right and are freely transferable (NSG, 2013c). This implies that NSG is owned by a variety of shareholders, which individually control a minor percentage of total equity. A single Norwegian investor, which controls Nobelsystem Scandinavia AS, announced the following in 2012: “The reason why I am buying should be evident. The bride is dressed and ready to be handed over. What doesn’t happen in six months often don’t happen in ten years either. Actions are needed and that is what I am here to promote” (Nationen, 2012). It was strongly insinuated that NSG was owned by a set of tired shareholders, which should initiate tighter control. It was further suggested that NSG should be up for sale. Hans-Erik Jacobsen in First Securities replied to the latter statement in the following manner: “We find it unlikely that anyone would like to buy NSG due to the current position of the company” (Nationen, 2012).

1 Number of shares = 189.945.626, Price per share 17 July 2013 = 2,85 NOK, Value of equity = 541,3 MNOK

2.4 Product range The company supply newsprint and magazine paper to publishers. Newsprint is highly standardized and suitable for cold set printing presses. Magazine paper is separated into super calendered paper (SC) and lightweight coated paper (LWC). SC grades are uncoated and matt, suitable for magazines, catalogues and other advertisement material. LWC is produced in matt or glossy finish, and suitable for magazines, catalogues, promotion materials and other commercial literature (NSG, 2013c). Figure 3 below presents a variety of operational ratios, aiming to describe NSG’ historical performance.

More than half of total newsprint production took place in Europe followed by Australasia, while certain production took place in South America and Asia (NSG, 2012). Magazine paper production took only place in Europe in 2012. However, some conversion from newsprint to magazine paper has been announced to take place in Australia from 2013 (NSG, 2012). Even though a revenue drop can be witnessed for both products in the selected period (figure 3), the drop aggressiveness of the two differ considerably. Later in this thesis, the respective volume and pricing effect will be discussed in greater detail.

2.5 Main markets Segment reporting is first and foremost directed towards NSG’ newsprint and magazine paper activities. Newsprint is additionally divided into two geographical segments, Europe and outside Europe, motivated by place of production (NSG, 2012). Due to NSG’ segment reporting, it is considered difficult to extract detailed data about specific markets, which include a variety of key ratios. However, total operating revenue per market has been possible to extract from the financial years between 2007 and 2012, as illustrated in figure 4 (NSG, 2007-2012).

NSG extracted close to 57% of total revenue from the European market in 2012, which clearly dominated the overall revenue picture, followed by Australasia. The most significant single drop in revenue extracted from individual markets, can be witnessed in the Asian region. The CEO in 2008, Christian Rynning, strongly suggested that China made Asia the largest newsprint region in the world. However, due to prosperous growth in this market, numerous suppliers were drawn towards Asia, consequently generating poor returns for NSG. NSG’ retreat from the Asian market caused massive restructuring and closure of numerous production facilities (NSG, 2008).

Compared to Asia, the European situation has not been as dramatic, rather gradually on a decline. The CEO of NSG in 2012, Sven Ombudstvedt, characterized the European newsprint and magazine paper market as troubled by weak economic conditions (NSG, 2012). It was also suggested by NSG in 2010 that new technology contributed to a change in media habits, which challenged the European market for paper (NSG, 2010).

Africa is the region in which NSG has experienced the utmost individual growth. However, Africa contributes the least to total revenue. As NSG’ total revenues declined during the historical period, so did production capacity. However, larger cuts in newsprint capacity compared to newsprint can be witnessed, believed to be the product of a greater drop in demand for newsprint compared to magazine paper (figure 3).

2.6 Global demand – newsprint RISI, which claims to be “the leading information provider for the global forest products industry” (RISI, 2012), provides an illustration which highlights the global demand for newsprint in the period between 1996 and 2011, also extending the historical development with a forecast of future demand (RISI, 2012b; Figure 5).

A general drop in demand for newsprint can be witnessed on a global scale, and the global demand for newsprint decreased 3% in 2012 (NSG, 2012). RISI (2012b) further claims that the odds for a return to positive growth should be considered to be slim. The most significant and single market decline for newsprint can be witnessed in the North American market. US newsprint consumption dropped close to two-thirds last decade, referring to the period between 2000 and 2010. However, even though there has been a continuous decline in demand in this region, the negative trend significantly slowed down in 2010. In comparison, North American publishers consumed 13 million tonnes of newsprint in 2000, while the total US consumption was 6 million tonnes in 2010 (NSG, 2010b; Figure 6).

The European market for newsprint has not suffered from a continuous decline as observed in the North American market. However, in both markets a dramatic drop can be witnessed in 2009. Western Europe dominates the European market. However, evidently the Eastern European market could be characterized as rather stable historically (NSG, 2010b; Figure 6). Newsprint demand in Australasia proved to be quite stable in the period between 2000 and 2006, close to 1 million tonnes. However, demand dropped significantly in Australasia between 2006 and 2012, representing the region in 2012 with the highest relative decline compared to 2011 figures (NSG, 2012d). NSG’ Australasian newsprint capacity by the end of 2012 equaled close to 800 thousand tonnes and future capacity closures and conversions have been announced (NSG, 2012).

RISI (2012b) expects that Asia will display positive growth in the time come. However, RISI (2012b) announced that growth is already negative or slowing down in some countries in the Asian region. Total Asian growth of 660 thousand tonnes is expected, dominated by China and India, but were Japan and South Korea display an expected negative growth in the future. The International Monetary Fund (IMF) characterizes India and China as part of “developing Asia”, while countries such as South Korea and Japan are part of “advanced Asia” (IMF, 2013). The declining demand in more advanced countries in Asia resemblance the development witnessed in Europe, Australasia and North America.

2.7 Global demand – magazine paper The European market for magazine paper is the largest, followed by North America, Asia, Latin America and Australasia (NSG, 2012e). NSG characterized the magazine paper market as challenging at the DNB Markets SME Conference (NSG, 2013b). Europe which is NSG’ main market is clearly dominated by western European consumption, similar to newsprint. The European and North American consumption of magazine paper display fairly similar levels and trends, which might suggest that these markets share similar characteristics (NSG, 2010b; Figure 7).

2012 figures display a global decrease in demand for magazine paper of 6%, a negative growth in which is dominated by more advances economies, such as Western Europe, North America and Australasia (NSG, 2013b). Positive growth is expected to take place in Asia, but NSG is not heavily engaged in this market.

2.8 Peer group It is a requirement that firms that are benchmarked are comparable (Petersen and Plenborg, 2012). A cross sectional analysis of NSG should therefor include companies in which core operations are related to newsprint and magazine production, and not companies in which solely focus on different areas outside NSG’ operations. Comparable companies should have similar risk profiles in order to assure an appropriate analysis and comparison of return on invested capital and other profitability measures. Companies within the same industry may also have different risk profiles based on the different markets which they operate (Petersen

and Plenborg, 2012). Once an appropriate peer group is selected, Koller et al. (2010) suggest that an examination of fundamentals behind differences within the peer group should be taken forward. An examination like this could provide insights to best practice, best products, or other factors, like economies of scale or better access to customers. It may be argued that a peer group analysis will provide a qualified guess to potential producers of print which are best suited to face the current business climate as well as future challenges in which the paper industry is expected to face. It may also be argued that an ideal peer group is similar in size and operate in the same market, thereby competing for the same customers. However, it is considered difficult to pin companies which are exactly alike. NSG focuses solely on newsprint and magazine paper, while several of their closest competitors also sell other products such as construction material and office paper. NSG ranks some of their closest competitors based on production capacity (NSG, 2013b, Figure 8).

The strategic and financial analysis deals mainly with the European peers in terms of benchmarking due to the importance of the European market for NSG and its current strong individual position in Australia/New Zealand. As revealed in the upcoming sections, Resolute which originates from Canada mainly focuses on the Northern American market, while Oji and Nippon from Japan mainly focus on national as well as Asian markets. However, they are included in the upcoming sections in order to emphasize potential challenges which NSG might face in relation to the penetration or expansion in these markets.

2.8.1 UPM (Finland) UPM is number one in Europe and globally in terms of magazine paper production, and the leading producer of newsprint in Europe. The company operates 21 mills in Europe, China

and the US, and extracts revenue from all regions in the world. Opposite to NSG, UPM offers a wide range of products, ranging from construction material to toilet paper. The company owns forest areas and has invested in power plants in order to reduce the cost of energy as well as to secure energy supply in the time to come. The company claims to focus on cost leadership and European profitability, while seeking growth in China and other emerging economies (UPM, 2012).

2.8.2 Stora Enso (Finland) Stora Enso produces a wide range of products from printing and writing to building and living. Geographical distribution of sales is mainly allocated to Europe, but the company also extracts a smaller proportion of total revenue from regions such as Latin America and Asia. The company owns a magazine paper production facility as well as land in Brazil, and claims to invest in mills with the lowest cost of logistics, as well as low fixed and variable costs. These elements are considered by Stora Enso to be key success indicators for future survival (Stora Enso, 2012).

2.8.3 Resolute Forest Products (Canada) Resolute Forest Products claims to be a global leader in the forest product industry, offering a wide range of products, ranging from newsprint and coated paper to wood products. The company’s production facilities are to be found in North America, Canada and South Korea, and the company’ products are distributed to 90 countries around the globe. A large proportion of total sales derive from newsprint, while a minor proportion derives from magazine paper. International sales constituted close to 40% of total newsprint sales in 2012, and 24% of total revenue came from the western European market. In terms of magazine paper, the company is North America’s third largest producer of coated mechanical paper. Uncoated paper was mainly sold to North American customers in 2012 (Resolute Forest Products, 2012).

2.8.4 Nippon Paper (Japan) Nippon paper offers a wide range of products, including printing and writing, paperboard, household paper products, specialty paper products, liquid-packaging cartons, chemical products and building materials (Nippon Paper Group, 2013). The Japanese market for newsprint is mainly driven by domestic shipments and also considered self served in terms of newsprint. Close to all of Nippon´s sales in 2012 could be allocated to the Japanese market,

where the company has a market share of close to 34%. The Japanese market for coated paper equaled 5.3 million tonnes, which 85% were served by domestic suppliers. The Japanese demand for uncoated and specialty paper was 2.26 million tonnes, which 91% were served by domestic suppliers (Nippon Paper Group, 2013b).

2.8.5 Oji Holdings Corporation (Japan) Oji Holdings Corporation has almost 140 years of history, and claims to have constantly been a leader in the paper and pulp industry of Japan. Today, the company has business and forestry operations in several countries of the Asian region. The company also operates to some extent in countries within the Australasian region, as well as Europe. The operations in Australasia relates only to tree plantation as well as the promotion of pulp and lumber products. In Europe, operations are stationed in Germany where the production of communication material takes place (Oji Holdings Corporation, 2013).

2.8.6 Holmen (Sweden) Holmen`s overall strategy is to grow and develop in their five business areas: Printing paper, Paperboard, Sawn Timber, Forest and Energy. Europe is Holmen`s main market. In terms of printing paper, production is gradually shifting away from newsprint to improved grades of paper. Production of printing paper takes place at two mills in Sweden and one in Spain. Printing paper consists of magazine paper, book paper and newsprint. Overall demand in Europe for magazine paper fell in 2012, but Holmen has a growing market share. Holmen explains that the company witnessed difficulties in the European newsprint market. Holmen further claims that their position in Europe and among newsprint suppliers remains strong. Holmen will not continue to deliver super calendered paper in 2013. Holmen claims to be a significant supplier of newsprint to the daily press, primarily related to the Nordic region (Holmen, 2012).

CHAPTER 3 – STRATEGIC ANALYSIS The strategic analysis provides insight to external and internal factors, in which may affect NSG’ cash flow potential and risk. A careful strategic assessment is important because it serves as key input to the estimation of financial value drivers, which help generate forecasts that are better and where there is a high degree of visibility (Petersen and Plenborg, 2012). According to The Center for Paper Business and Industry Studies (CPBIS), the paper industry has been faced with major challenges during the latest 15 years. Global decrease in demand for newsprint and magazine paper, overcapacity among producers, low prices, poor profit outlooks, and deteriorating shareholder value, are some of the main challenges which the industry is and has been faced with (CPBIS, 2013).

Petersen and Plenborg (2012) suggest a top-down approach which seeks to uncover the most important aspects of NSG’ cash flow potential and risk.

The introduction of this thesis highlighted the present value approach to valuation as main model of application when estimating the fair value of NSG’ equity. More precisely, this paper relies heavily on the discounted cash flow approach (DCF) motivated by its popularity among practitioners and rather “simple” notion that the market value of a company depends on the level of future free cash flows to the firm (FCFF) and the weighted average cost of capital (WACC) (Petersen and Plenborg, 2012). The theoretical and practical features of this model as well as its individual components will be discussed more closely in chapter 5 and 6. However, it is important to stress that the strategic as well as financial analysis must address

external and internal factors which influence future FCFF and WACC. Due to the scope of this study, only the factors which are considered most relevant for the upcoming future estimations of NSG’ value drivers will be discussed in greater detail.

3.1 Macro factors influencing cash flow generation and risk In order to analyze macro factors in which influence NSG’ cash flow potential and risk, a PEST model has been chosen as point of reference (Petersen and Plenborg, 2012, p. 188). This model covers Political, Economical, Sociocultural as well as Technological factors in which influences NSG and the industry today, and which will play an important role in the future. Due the scope of this study, emphasize will be placed at the political and economical factors. These are believed to be of greatest significance to NSG’ future cash flow potential and risk, even though an analysis of sociocultural as well as technological factors probably would have strengthen the overall assessment further.

3.1.1 Political factors Norwegian forest owners are pessimistic in terms of what the future will bring for NSG: “NSG runs into the sunset and needs help from the government” (Nationen, 2013). The chairman of the Norwegian Forestry Association strongly suggested that the Norwegian government had to decide if forestry was an important resource for the country, and if so, facilitate necessary restructuring. The president and CEO, Sven Ombudstvedt, signaled that NSG would keep working towards improved conditions, especially referring to a reduction in transportation and property taxes (Nationen, 2013). Ombudstvedt claimed that Norwegian regulations drained the industry for nearly 200 MNOK per year, and that the Swedish and Finnish regulatory conditions were far more favorable for their Nordic competitors (E24, 2013).

“Høyre”, which is one of the largest political parties in Norway, will most likely be elected into government in September 2013. Høyre has announced that the party will work towards a stronger skogpakke (“forest package”), adding 750 MNOK of additional funding to the industry. Among others, it is suggested to increase the cargo weight currently allowed when transporting timber across the Norwegian landscape. The Norwegian forest industry has been considered an important industry with strong historical roots, which employs thousands of people, and which is considered to be the lifeblood of rural communities across the country

(E24, 2013). The former Norwegian government recently decided to reduce corporation tax on profits to 27%, down from 28%. This tax-type is considered to be the most important type of tax in the Norwegian tax legislation system. The main features of the Norwegian tax system have remained unchanged since 1992, and it is acknowledged that the world has changed since then, in light of globalization and lower tax rates among Norway’s closest neighbors (Bjørnestad, 2013).

3.1.2 Economical factors – Newsprint demand and real GDP Business cycles and employment rates are economical factors in which influence demand and consumer spending (Petersen and Plenborg, 2012), also considered relevant for NSG’ future operations. A business cycle can be defined as “fluctuations in output around its trend” (Miles, Scott and Breedon, 2012, p.755), and a cyclical company can be characterized as “one whose earnings demonstrate a repeating pattern of significant increases and decreases” (Koller et al., 2010, p.731). NSG characterized newsprint demand as strongly cyclical (2013b), extending the characterization with an illustration of how newsprint demand fluctuated with GDP growth in the period between 1992 and 2012, as seen in figure 10.

Real GDP can be defined as: “a measure of aggregate output” or “the sum of quantities produced in an economy times their prices in a base year” (Blanchard, Amighini and

Giavazzi, 2013, p.572). The recent financial crisis which began at the beginning of 2007 and where equity markets first started to show signs of improvement at the end of 2009 (Koller et al., 2010) clearly troubled demand for newsprint. As previously highlighted in the introduction to this thesis, NSG’ market value of equity dropped significantly at the beginning of 2007, and has not been able to recover to former heights. A recovery in demand for newsprint can be witnessed as real GDP growth improved mid-2009 (figure 10), but has later fallen as GDP growth once again fell in the period between 2011 and 2012. The Organization for Economic Co-operation and Development (OECD) published a report in 2010, named “The evolution of news and the internet” (OECD, 2010). This report discusses developing trends in the publishing market, and found that the economics of news production and distribution has been radically altered, seen in context of the recent financial crisis. A dramatic decline in newspaper circulation as well as printed ad spending seems to be a challenge for publishers in most OECD-countries, and 2009 was the worst year for these publishers (OECD, 2010).

Kotler (2003, p.149) states the following: “when a recession strikes, most companies rush to cut their expenses, the most obvious one being advertising”. Top management, which often consist of finance people; don’t see advertising as a profit generator; rather a defensive insurance, and advertisement budgets are often based on a percentage of expected revenue (Kotler, 2003). In other words, when poor outlooks for the future are expected, it is suggested that companies spend less on advertising, thereby limiting publisher’s future ad-revenues, thereby affecting demand for newsprint.

Total advertisement spending in relation to printed media; fell dramatically in all markets in 2009 (table 2). Further development are somewhat mixed between the regions. The Asian Pacific and Latin American regions have accelerated upwards after 2009. The North American market on the other hand has declined further. Australasia regained 2007 levels in 2012, while the European market to some extent signals a continuous and negative path. According to the World Association of Newspapers and News Publishers, later referred to by Mediapost (2013), total ad spending has declined close to 25% in the latest five years, where three-quarters of total decline stemmed from the North American market, while the European decline has eased. A decline in circulation levels can be witnessed in mature markets, but newspaper readership has remained high, supported by the rise of free newspapers. Mediapost (2013) claims that the newspaper audience has grown 4.2% since 2007, concluding:

“Newspapers are pervasive; they are part of the fabric of our societies. Our industry is stronger than many imagine” (Mediapost, 2013).

The future survival of publishers operating in the print segment seems dependent on future circulation and ad spending. If demand drops due to poor economical conditions or poor expected economic climate, it is reason to believe that NSG will suffer as a provider of newsprint and magazine paper. The financial year of 2012 ended relatively weak for NSG. The macro pictured turned worse, and according to NSG’ 4th quarter webcast presentation in 2012, the company was hit harder than an average player in the industry, due to high exposure in Australia where the retail sector still was weak (NSG, 2012f).

NSG commenting on demand in 2012 stated that the European and Australian market took a hard hit in 2012. The company experienced a two-digit percentage decline in revenues, as the advertisement market continued to suffer as well as a noticeable pressure from digital substitutes. However, NSG estimated that only 2-3 percentage points of the witnessed two- digit decline could be linked to the print/digital conversion, the residual could be explained by macro economical factors. Ombudstvedt ended the presentation by stating the following: “it is reason to believe that the negative demand development will flatten out in mature markets such as Europe and Australasia in the time to come” (NSG, 2012f).

So far, the strategic analysis of NSG has suggested that the demand for newsprint is highly dependent on the general development in GDP, thereby being cyclical. Therefore, an analysis of future expected real GDP growth will be up for discussion, which will contribute to a better estimation of future expected revenue as a value driver.

3.1.3 Economical factors – GDP outlook The International Monetary Fund’ latest world economic outlook report (IMF, 2013), provides information in which covers several economical aspects, among others real GDP growth and regional unemployment rates. IMF (2013) refers to what until now has been a “two-speed-recovery”, characterized by strong emerging and developing economies, and weaker advanced economies. The two-speed-recovery has transformed into what IMF (2013) describes as a “three-speed-recovery”, with still strong emerging and developing economies at one side, but where there is a separation of the US and the euro area on the other.

According to the European Economic Area (EFTA), the euro area consists of 17 countries in Europe, while the European Union as a whole consists of 27 countries (EFTA, 2013). The euro area has suffered from financial stress, but in which has been lowered since October 2012 due to national as well as political actions crafted by the European Union. However, economic activity in the euro area remains weak due to the weakness of the periphery and related threat to the core. The acute risk of a credit crisis in the euro area seems less after the implementation of some crucial policy actions at the European level, among others the completion of the “European Stability Mechanism”, the agreement on the “Single Supervisory Mechanism” and the deal on “Greek Debt Relief”. Real GDP growth in the euro area was negative in 2012, and it is expected that 2013 also will display negative growth, followed by a positive outlook in 2014. Unemployment rates are expected to increase between 2013 and 2014 (IMF, 2013).

A positive real GDP growth outlook from 2014 is believed to stimulate more favorable conditions for publishers in the time to come, thus NSG as a supplier of newsprint and magazine paper. NSG originates from Norway and what IMF (2013) defines as “Advanced Europe”. Norway had the lowest unemployment rate in Europe with the exception of Switzerland in 2012. Projected unemployment rates are expected to remain low and stable, and real GDP growth is expected to remain positive in 2013 and 2014 (IMF, 2013).

NSG’ main European competitors originate from Sweden and Finland, countries in which are expected to experience positive growth in GDP, but where unemployment rates are expected to remain higher than what can be observed in Norway (IMF, 2013). Both Sweden and Finland are members of the European Union, but only Finland has adapted to the Euro. The EU participation is believed to put extra pressure on companies operating in these areas, due to the current euro climate. However, even though Norway is not part of the EU or the euro, Norway is believed to be strongly affected by policies in this region, due to Norway`s participation in the European Economic Area. This area comprises the 27 EU member states as well as Lichtenstein, Norway and Iceland, and where goods, services, capital and persons, can move freely across the membership states (EFTA, 2013). The EU is considered to be Norway’s most important trade partner, where close to 80% of total exports is allocated to the EU, and where more than 60% of total imports stems from the EU (Regjeringen, 2013). It is therefore believed that Norway`s solid economical position is strongly affected by the European economic climate.

Economic performance in Asia slowed down in 2012, but the economic outlook for Asia appears to be quite positive, characterized by robust and recovered external and domestic demand. This positive outlook is supported by positive labor market conditions, multiyear low unemployment rates and stronger financial conditions, which all in all is believed to support consumption and private demand (IMF, 2013). IMF (2013) further predicts a positive Asian real GDP growth in 2013 and 2014, dominated by China and India, characterized as “Developing Asia”. The weakest growth expectations can be linked to what IMF (2013) defines as “Advanced Asia”, which comprises countries such as South Korea, Australia, Japan and New Zealand. However, the expected real GDP growth is believed to be positive, also in these countries. Projected unemployment rates are considered fairly stable in Australia

while unemployment in New Zealand is believed to trend downwards in the future (IMF, 2013). Regions such as Australia, New Zealand and Europe are considered to be main strategic areas for NSG in the time to come. However, it is evident that emerging and developing economies across the globe are expected to display higher growth rates compared to more advanced economies.

“Around 70% of world growth next few years will come from emerging markets, with China and India accounting for 40% of that growth” (Forbes, 2013)

Some trends can be witnessed in the industry, which points towards seeking potential in these growth markets:

Stora Enso’ strategy:

“Transformation from a European pulp and paper company to a value creating, growth markets renewable materials company” (Stora Enso, 2013)

UPM’ announced strategic direction:

“Advancing in growth markets… Securing cash flow in mature markets” (UPM, 2013)

It is evident that NSG wishes to strengthen its current position in Europe and Australasia. This is a strategy somewhat dissimilar to Stora Enso and UPM. The Asian expansion in the second half of 1990’ was not a success for NSG, even though Asia was considered to be a lucrative growth market. Both Stora Enso and UPM have announced that they will seek potential in growth markets in the time to come. It might be argued that this will require significant resources, and one possibility might be that resources must be extracted from current European operations, thus ease competitive conditions for NSG in Europe.

3.1.4 Economical factors – Pricing mechanisms Figure 11 presents European reference prices for newsprint and magazine paper in the period between 2006 and 2013 (NSG, 2013e).

Weak demand accompanied by surplus capacity in the European market contributed to the steep drop in prices for publication paper in 2009, beginning of 2010. However, an improved relationship between supply and demand in the market late 2010 and beginning of 2011 enabled a price recovery (NSG, 2010). Almost 2 million tonnes of newsprint and magazine paper capacity in Europe will be closed down during 2013 (Holmen, 2013). UPM, Stora Enso, Holmen, as well as NSG, contribute to these closures, however NSG has announced a smaller closure rate compared to their European competitors. Closure of capacity is believed to provide a stronger balance between supply and demand in the European market; in which is believed to stimulate higher paper prices in Europe as well as it facilitates lower overheads in the time to come. In addition to providing data on planned capacity shutdowns in the European market, Holmen (2013) provides a model (figure 12), in which stipulates capacity utilization in 2013, with and without announced closures.

As previously highlighted, European and global demand for newsprint plunged in 2009, which could help explain the poor newsprint delivery-to capacity ratio in Western Europe

(figure 12). Comparing the respective development of publication paper prices and utilization rates reveals similar paths, which suggest that a relationship between these exist.

Companies, which operate in commodity markets, are “typically price takers, meaning they must sell at the market price to generate business, because the products are so hard to differentiate” (Koller et al., 2010, p.61). It seems unrealistic for NSG or any of its peers to justify a differentiated price, since it is assumed that newsprint and magazine paper are rather standardized/homogeneous products. NSG (2013e) claims that the European and Australasian outlook remains challenging, but that industry-wide closures support a more prosperous outlook. Sven Ombudstvedt characterized the price level observed in the 1st quarter of 2013 to be “at the low point, the bottoming out of the paper market” which pricing wise was believed to be “the bottom of the cycle” (NSG, 2013f). In the long run, NSG (2013f) expects a European newsprint reference price of 550 EUR2 per tonne, which is supported by capacity closures, and future price negotiations will favor paper producers, as there will be lower total supply in the European market in the future.

2 1 EUR = 7.6535 NOK  550 EUR = 4209 NOK (Norges Bank, 2013).

3.1.5 Economical factors – Cost of materials

Cost of materials mainly consists of round wood and recovered paper, in addition to chemicals and electricity. NSG owns a small forest area in Australia, but a very small proportion of NSG’ wood consumption stems from this area (NSG, 2012). “Energy is the largest single cost for NSG, which accounted for 22% of the total cost payables in 2012” (NSG, 2012, p.39). NSG is exposed to electricity spot prices in Europe while long-term contracts are entered in Norway and Australia. Purchased electricity accounts for nearly two thirds of NSG’ annual consumption whiles the residual stems from self generated electricity. In 2012, wood prices declined in Norway while NSG mainly bought wood based on long- term purchase agreements in Australasia and Brazil (NSG, 2012).

The best guidance NSG can provide for the future cost picture is stability, defined by long- term energy and fiber contracts (NSG, 2013f). Fixed costs are believed to decrease, as NSG close down capacity, while two thirds of total cost reductions stems from managerial initiatives. NSG seek initiatives, which will streamline and make production more efficient, among others using less energy and pulp/fiber in production (NSG, 2013f).

3.2 Industry factors influencing cash flow generation and risk The intensity of competition within an industry are determined by five forces, namely threat of new entries, pressure from substitutes, bargaining power of suppliers and customers, and existing rivalry among competitors. It is the competitive advantage of a company in which enables a company to earn greater returns on invested capital than others (Koller et al., 2010).

Therefore, an investigation of the structure of the industry will be assessed in the upcoming sections in order to get a better understanding of the business climate in which NSG operates.

3.2.1 Threat of new entries According to the Finnish Forest Industries Federation (FFIF) “the rapid growth of Asian paper production in recent years has increased self-sufficiency and led to reduced export opportunities for both European and American manufactures” (FFIF, 2013). Not only are European and American manufactures threatened by increased self-sufficiency in Asia, but paper is also starting to enter Western markets from Asia. It is further argued that the global competition has increased as there has been a rise of new producing countries, where Asia typically is characterized to experience lower production costs than their European and American counterparts (FFIF, 2013).

New entrants generally add capacity to the market as well as having the ambition to capture market shares from existing suppliers, which may harm returns negatively. Typical barriers are economies of scale, product differentiation, capital requirements, switching costs, access to distribution channels and government policies (Petersen and Plenborg, 2012). Neither the European nor the Australasian newsprint and magazine paper market can be defined as under supplied. As Deloitte (2012) points out:

“Europe is facing a potential economic recession where producers must address a declining demand and overcapacity for paper products”.

Declining demand and overcapacity does not seem to be lucrative characteristics in which potentially attracts new entries. In addition to NSG, there are several strong European producers, which currently serve the European market. The paper industry is considered to be capital intensive, illustrated by the value of NSG’ property, plant and equipment, amounting to 9.5 BNOK (NSG, 2012; appendix 2). As Koller et al. (2010, p.65) puts it: companies in which would like to compete with large and existing players “must first pay the enormous fixed expense of installing a nationwide network, and then operate at a loss for quite some time while drawing customers away from the incumbents”.

Another feature in which is considered lucrative for new entries is the ability to sell products at a price premium. However, as Koller et al. (2010, p.61) argue: “to sell its products at a price premium, a company must find a way to differentiate its products from those of competitors”. Innovative products, quality, brand and customer lock-in, are four sources of price premiums. Companies in commodity markets must often sell at market price in order to generate business due to the difficulties of differentiating the actual product. A 38-year profitability investigation proved that commodity-based companies fluctuates up and down with the respective business cycle, but rarely matched industries which supplied pharmaceuticals and consumer goods (Koller et al., 2010, p.60). Koller et al. (2010) argued that the reason was that commodity-based companies have “undifferentiated products and few opportunities for innovation”. Paper mills were specifically mentioned as an example since “almost all paper mills use the same machines” which makes it difficult for commodity-based companies to charge a price premium or build a sustainable cost advantage.

In terms of paper innovation, NSG administers projects which purpose is to improve competitiveness at the mills by reducing energy consumption and enhancing quality. NSG manages research and development projects in cooperation with external research institutions. NSG has also initiated several environmental actions and investments primarily aimed at energy conservation, and all of NSG’ business units are certified in accordance with ISO 14001 (NSG, 2012). NSG as a brand seems to be well known and respected in the “paper community”. NSG’ business units and sales networks confer a unique position in the market, characterized by local presence and knowledge. In addition, more than fifty years of history as a paper producer is believed to have strengthen NSG’ position as a trusted supplier of newsprint and magazine paper. In 2011, NSG introduced quarterly contracts for newsprint customers in Europe (NSG, 2011). In 2012, NSG reported long term contracts running through mid 2015 in Australia and New Zealand (NSG, 2012). These initiatives are believed to secure customer lock-in. Based on the discussion above, it is believed that the treat of new entries is little or minimal. However, the threat of new entries from Asia should be taken seriously.

3.2.2 Existing rivalry among competitors Tough competition tends to affect returns negatively, and competition tends to get intense if the industry is characterized by slow growth, numerous competitors, customers that perceive

the products as commodities, overcapacity, high fixed cost and high exit barriers (Petersen and Plenborg, 2012). As highlighted so far in this paper, it seems that these characteristics fit the paper industry fairly well.

There are several European newsprint and magazine paper producers, and NSG is “only” the third largest as highlighted in the peer analysis. Closures have been announced in order to rebalance supply/demand. Closures are lagging behind changes in demand, which seems to be explained by the time it takes for suppliers to respond to changes. Closures are considered to be time as well as cost intensive, and it may be argued that suppliers wait to imitative closures in hope that demand will reaccelerate.

NSG claims that the industry is ready for consolidation (Euroinvestor, 2013): “…we promote what we can… it turns out to be difficult to accomplish these things in a low cycle when everyone is pessimistic”. A number of executives in highly competitive industries hope that consolidation will lead to lowered price competition and thereby greater returns. However, in order for this to work an industry needs to consolidate down to just three or four competitors and keep entrants out. Unless this happens “competitive pricing behavior does not change”, since smaller companies and new entrants will always have an incentive to try competing for market shares through lowered prices (Koller et al., 2010, p.441).

The upcoming value chain analysis, as well as the overall financial analysis presented in chapter 4, will present a comparison of financial and competitive strength among the European peers. The upcoming analysis intends to provide a more solid conclusion to the threat of existing rivalry. To conclude, it is believed that the current rivalry among competitors in Europe is of great threat to NSG. However, announced capacity closures, UPM’ and Stora Enso’ announced strategy reformulations, as well as a slowdown in the aggressive demand drop, seem to benefit NSG positively.

3.2.3 Buyers bargaining power Buyers tend to possess high bargaining power if a large portion of sales in an industry is purchased by a given buyer, the products purchased from the industry are commodities, the switching costs are low, and when the customer experience low returns (Petersen and

Plenborg, 2012). Customers, which can switch suppliers at low cost, have the ability to force suppliers to compete largely on price (Koller et al., 2010). NSG’ most significant customer equaled roughly 11% of total sales in 2012 (NSG, 2012). Even though this customer seems to be significant, it is argued that NSG’ exposure to individual customers could be considered as low, which seems to reduce individual customers buying power. The purchased products can be characterized as commodities and undifferentiated, while there are several European competitors with available capacity. Due to the standardized characteristics of the products, which NSG sell, customers switching cost are considered to be low. Also as previously highlighted in the analysis, customers/publishers are struggling with poor returns due to low circulation levels and low ad spending, which might cause customers to seek new suppliers, which can provide more beneficial arrangements. However, as previously highlighted, the pricing mechanisms are mainly market driven, and NSG is considered to be highly competitive, at least in the short term.

It seems that buyers bargaining power has been high due to overcapacity among European suppliers. However, an improved market balance reduces some of the perceived bargaining power of the customer. Also, long-term as well as quarterly contracts are considered to reduce the bargaining power, or at least stabilize the bargaining climate for a certain period.

3.2.4 Suppliers bargaining power Suppliers tend to be powerful if they are more concentrated than the industry, the industry is not an important outlet for the suppliers, the products or services being offered are important to the industry, and where the industry faces high switching costs (Petersen and Plenborg, 2012). Energy proved to be the most significant cost of materials item in the accounts (NSG, 2012). Close to 80% of total production of newsprint and magazine paper took place in countries where NSG had established long-term energy contracts in 2012 (NSG, 2012). This is believed to limit suppliers bargaining power outside negotiation periods. However, even though long-term contracts reduce the threat of negative price fluctuations, it also limits NSG possibility of enjoying upside risk. NSG mainly purchased wood under long-term purchase agreements in Australasia and Brazil (NSG, 2012). These agreements secure deliveries and prices on significant input factors. Suppliers of wood and energy are considered to be many

and the switching cost of NSG is believed to be low. It is concluded that the bargaining power of suppliers should be characterized as low.

3.2.5 Threat of substitutes Digital media is considered to be the main substitute to printed media, which drives demand for newsprint and magazine paper. As NSG puts it: “digital media has created challenges for the paper industry, yet it is clear that paper and digital media will exist side by side in the future” (NSG, 2012, p.6). Europe did not immediately follow the sharp decline in newsprint demand as North America did from its peak in 2000. RISI (2013) claims that: «the incursion of electronic media was slower to take hold in Europe, sapping less of newspapers` advertising revenue and circulation base”. However, it is further argued that the same forces as shook the North American market, have been observable in Europe, causing downward heading spirals since 2006 (RISI, 2013).

Previously it was suggested that ad spending and circulation levels were core to publisher’s future existence, and that the expected future development naturally will play its role when estimating future newsprint and magazine paper consumption. It is claimed that more than half of the global population reads a newspaper, 2.5 billion in print and over 600 million digitally. Time used reading a newspaper has remained quite stable over the last five years, while daily internet usage has increased about 20 minutes (Mediapost, 2013). It is tempting to suggest that revenues lost in print have been replaced by digital advertising. However, this proves not to be the case. It is found that digital media lacks the intensity when it comes to digital reading, since the consumer “spend less time and visit fewer pages on digital platforms than they do in print” (Mediapost, 2013).

Statistics Norway (2013) provides a useful input to the understanding of the print-digital development among the Norwegian population (table 3). It is clear that print has suffered to digital during the years observed, at least in the Norwegian market. Previously it was highlighted that NSG experienced a decline in revenues for newsprint as well as magazine paper. However, the latter has not been as dramatic.

Mediebedriftene (2013) presents and index in which illustrates the development in total circulation of Norwegian magazines in the period between 1992 and 2012 (figure 14).

Mediebedriftene (2013) concludes that the paper-based platform for magazines is on a decline while an increase can be witnessed digitally, particularly driven by the expansion of mobile phones and tablets as digital mediums. It is further claimed that all magazine categories have experienced setbacks compared to 2011. However, certain categories have performed better than others. These include categories such as wildlife, interior and health (Mediebedriftene, 2013). It might be suggested that the “success” of these categories cover certain interest areas of the consumer, which the consumer prefers to read in print. It may also be argued that these categories cover areas where the need for instant updates is less important for the consumer.

The lack of diversification in NSG’ product portfolio may place the shareholders at greater risk compared to more diversified companies, such as Holmen, Stora Enso and UPM. However, diversified companies are often slower than undiversified companies to respond to new opportunities (Koller et al., 2010, p.425). In a capital-intensive industry such as the paper

industry, where fixed costs are high and where efficiency and advantages of scalability seems to be high, it is considered important for a company to respond quickly to changing market patterns. The threat of substitutes is considered to be very high, and perhaps the most significant forcing threat of them all, accompanied by the current rivalry within the European market.

3.3 Company specific factors influencing cash flow generation and risk Company specific factors describe in greater detail what share of the market that NSG can expect to gain by comparing NSG’ competences relative to its peers (Petersen and Plenborg, 2012). The upcoming section will highlight any potential operational competitive advantages or disadvantages.

3.3.1 Adapted value chain analysis “The adapted value chain analysis informs the analyst about the cost efficiency of peers in the industry” (Petersen and Plenborg, 2012, p.192).

NSG’ cost efficiency seems to be greater than some of its peers based on the COGS/revenue ratios displayed in table 4. However, both NSG and UPM have experienced greater depreciation and impairment rates in 2012, which might explain why their operating expense to revenue ratio are somewhat poorer compared to Holmen and Stora Enso. Otherwise it seems that all companies are fairly equal in terms of expenses related to employees. Even though NSG invested the least in research and development in 2012 compared to reported revenues, the general level in the industry seems to be low. This might indicate that the industry in general doesn’t see great gains from investing in research and development in terms of paper.

CHAPTER 4 - FINANCIAL ANALYSIS

Chapter 3 of this paper highlighted the “non-financial” aspects of the valuation process. Now it is time to address the financial aspects of NSG by looking at the company`s historical financial performance in the period between 2007 and 2012. Measuring a firm`s profitability is key to financial analysis (Petersen and Plenborg, 2012). It is important to understand what drives profitability since it is vital for a company`s future survival as well as the assurance that shareholders receive a satisfactory return. In order to assess the historical performance of NSG, raw data presented through NSG’ annual reports have been reformulated into analytical statements and balance sheets (Appendix 1 and 2). Reformulation is done in order to separate NSG’ operating and financing activities, since “the company`s operations is the primary driving force behind value creation” (Petersen and Plenborg, 2012, p.68).

As highlighted in the previous chapters of this paper, NSG has gone through massive restructuring efforts in the last couple of years, and it may very well be that the period examined tells a story quite different from what can be expected of NSG in the future. Therefore, it is important to treat the historical financial observations with great care, but use these data as reference for future estimations of NSG’ cash flow potential and risk.

4.1 Securing the quality of Financial Statements NSG’ auditor is PricewaterhouseCoopers AS, which on 1st of March 2013 signed NSG’ 2012 annual report stating, “it is our opinion that management has fulfilled its duty to produce a proper and clearly set out registration and documentation of the company`s accounting information in accordance with the law and bookkeeping standards and practices generally accepted in Norway” (NSG, 2012). It is therefore assumed that the accounting data provided by NSG are free from bias and manipulation, which potentially could harm the assessment of the fair value of the company.

4.2 Share price analysis Based on total return index data extracted from datastream, the following figure can be presented which illustrates the return development for NSG as well as NSG’ closest European competitors in the period between 1999 and 2013 (figure 15).

The total return index displays the performance of a stock assuming that all dividends and distributions are reinvested. NSG has yielded a total return of -95% in the period, which defines NSG as the weakest performer in the selected group. The Holmen Stock has yielded a return of 231%, which defines Holmen as the strongest performer in the selected group. Even though Holmen and NSG display different growth rates compared to Stora Enso and UPM, which are quite similar, it may be argued that the European companies to some extent follow a similar path. However, it seems evident that NSG was hit harder than the European counterparts in the years of global financial crisis. It is also evident that NSG has not been able to recover from these “rocky years”. Comparing these companies’ total returns in the period with figure 10 (GDP change to newsprint demand change), it might be suggested that there exists a relationship in which confirms the cyclical nature of the industry.

4.3 Restructuring Norske Skog`s Financial Statements The overall objective of this section is to separate operational elements from financial elements in the accounts, so that the operational elements in which are the primary driving forces behind value creation can be uncovered. Return on invested capital (ROIC) is the overall profitability measure of any operating unit (Petersen and Plenborg, 2012). Koller et al.

(2010, p.57) argue that: “the higher a company can raise its ROIC and the longer it can sustain a rate of ROIC greater than its cost of capital, the more value it will create”. This chapter will highlight ROIC3 while chapter 5 will analyze NSG’ weighted average cost of capital (WACC).The development in net operating profit after tax and invested capital are highlighted in appendix 1;2. In the following sections, a closer description to the operational and financial elements of NSG will be provided.

4.3.1 Balance sheet - Invested capital Investments in associated companies NSG has an owner share of 33.5% in Malaysian Newsprint Industries and a minor unspecified owner share in other associated companies (NSG, 2012). These investments are considered to be aligned with NSG’ main area of operations, therefore included in invested capital.

Separation of operating and excess cash Excess cash should never be included in invested capital since it is unnecessary for core operations and incorrectly depresses a company’s ROIC (Koller et al., 2010). NSG does not provide information on cash needed in daily operations. However as recommended by Koller et al. (2010) a minimum of cash to revenue within the industry has been assessed in order to estimate NSG’ true operational cash need in the period between 2007 and 2012. The minimum clustering of cash to revenue (represented by Holmen and UPM) displays an average operational cash need of 3% (Appendix 3).

Deferred tax assets and liabilities In 2012, NSG had a net deferred tax liability of 177 million NOK (NSG, 2012, p.177). Deferred tax is the result of differences in how NSG and the government account for taxes. A cost benefit analysis suggests that all deferred tax items are to be treated as operating items and included in invested capital. Any potential misclassifications is not believed to cause any significant effect to financial ratios, even though it is acknowledged that a more precise analysis would yield a more precise outcome.

3 ROIC = NOPAT / Invested capital (Petersen and Plenborg, 2012)

Other non-current assets and other non-current liabilities Other non-current assets include among others loans to employees, long-term shareholdings, derivatives, commodity contracts and pension plan assets. Other non-current assets equaled 986 MNOK in 2012 (NSG, 2012, p.73) and NSG characterized 831 MNOK of these as “financial assets at fair value through profit or loss” (NSG, 2012, p.63). Other non-current assets are treated as financial items.

Other non-current liabilities include among others derivatives, environmental provisions and deferred recognition of government grants (NSG, 2012, p.89). Other-non-current liabilities have been separated into operational and financial elements. Derivatives and commodity contracts are not considered to be part of core operations, rather financial activities related to hedging, also defined as financial assets by NSG (2012, p.63). However, entries such as dismantling provisions and environmental provisions are considered to be operational as dismantling typically relates to downsizing of production capacity and environmental provisions are typical governmental and society requirements related to the production of newsprint and magazine paper.

Tax payables The balance sheet entry, tax payables, is considered to be of operational nature. Petersen and Plenborg (2012, p.79) argue that “tax payable arise because a firm pays too little tax on account”. There may be several reasons for this, among others differences in tax rates or changes in tax-legislation (NSG, 2012, p.86).

Pension obligations At year-end 2012, NSG had net unfunded pension plans of 436 MNOK or close to 88% of total pension obligations. Unfunded pension liabilities are sources of financing and debt equivalents (Koller et al., 2010, p.144). NSG (2012) reports that retirement benefits are discounted to present value based on an interest rate for covered bonds. Petersen and Plenborg (2010, p.79) find it reasonable to treat retirement benefits as a financing activity since retirement benefit plans are discounted to present value.

4.3.2 Income statement – NOPAT Non-operating items are infrequent or unusual items in the accounts which are related to the company`s activities indirectly and not expected to reappear. By including non-operating items in the historical financial analysis there is a chance that expectations for the future will be biased. Operating items often grow in line with revenues and are related to the core business (Koller et al., 2010, p.544). In the upcoming financial analysis, a separation of different items has been made in order to get a more solid picture on typical and stable items as well as infrequent and more volatile items in the accounts. A clear separation is believed to provide a stronger foundation for a proper forecast.

Koller et al. (2010, p.543) characterizes restructuring charges as “typical nonoperating expenses”. However, Petersen and Plenborg (2012, p.84) state: “every firm needs to adjust its organization and restructure, in order to stay competitive” which favor an operational classification. The strategic analysis revealed some of the challenges which NSG has coped with throughout history, and it is no doubt that restructuring and downsizing of capacity has been a vital factor in order for NSG to stay competitive. The income statement entry, other gains and losses, is believed to include both operating and non-operating/financial items. Non-operating/financial items such as changes in value of commodity contracts, embedded contracts and biological assets are excluded from NOPAT (appendix 1).

4.4 Historical profitability

Average balance sheet figures have been applied in order to calculate the ratios highlighted in table 5. It is believed that average year balance sheet entries provide a more precise estimate to financial performance throughout the year, compared to the application of year-end figures.

NSG’ ROIC and return on equity (ROE) signal an overall negative trend in the period. An analysis of the components in which ROIC consists of will be analyzed and presented, in order to get an idea of the fundamentals behind this negative development. The introduction of this paper highlighted that shareholders hadn’t been rewarded satisfactory results since 2002. The findings presented in table 5 support this. In general, it seems difficult to assess whether a given return could be characterized as satisfactory. Profitability measures such as ROIC and ROE need a proper benchmark in order to be able to assess whether the returns are satisfactory or not. ROE is commonly benchmarked against the required rate of return of equity holders, while ROIC commonly is benchmarked against the WACC (Petersen and Plenborg, 2012). WACC and the required rate of return on equity will be up for discussion in chapter 5 of this paper. The following sections decomposes ROIC, and compares NSG to their European peers.

4.4.1 Profit margin NSG’ profit margin development is calculated based on data extracted from the reformulated financial statements (appendix 1; 2). In terms of NSG’ European peers, figures are extracted from ORBIS (2013). The ratios provided by ORBIS are based on raw data, and are therefore considered not fully comparable, and should therefore be treated with care. However, by including these data, a more thorough analysis of the competitive environment is believed to be the outcome.

A trend analysis (appendix 4) reveals that NSG’ total operating revenue decreased close to 35% in the period between 2008 and 2012, dominated by a decline in revenues extracted from

the newsprint segment. The magazine paper segment has remained rather stable. However, both segments experienced a significant drop in 2009, which may stem from the troubled world economy in this period as previously highlighted in the strategic analysis. Data presented by NSG (2012, p.3) displays a production to delivery ratio which is close to 1, signaling a production rate driven by actual demand rather than specific forecasts.

Based on the findings presented in appendix 4, it seems reasonable to conclude that the total drop in revenue mainly relates to a volume effect rather than a price per tonne effect. The decline in total operating revenue might indicate that NSG operates at a declining stage of the product cycle as illustrated by Petersen and Plenborg (2012, p.107). The organic growth potential is believed to be limited due to general market trends, heading away from print towards digital products. A more, but still unlikely scenario is for NSG to capture current market shares from existing competitors. Petersen and Plenborg (2012, p.106) suggest that that this is often done by:

o Lowering prices o Offer more features on the product

At this point of time NSG is not believed to be in a position where they can initiate a “price war” in order to attract new customers. It is considered highly likely that NSG’ competitors will adapt to the lowered prices as a defense mechanism in order to retain customers. As Petersen and Plenborg (2012, p.106) claim: “increased competition will gradually lead to pressure on profit margins and thus the return on invested capital”.

Increased competition is believed to trigger the “survival of the fittest” notion, at least in the long run. The fittest is believed to be the ones that are able to generate the highest profit margins at the highest turnover rates of invested capital. Examining profit margins for the peer group in the period between 2008 and 2012 (figure 16) reveals that NSG on average generated poorer profit margins compared to its peers. This may support the view that NSG probably are not likely to be able to run below market conditions for a longer period of time due to its already weaker margins.

Newsprint and magazine paper is not believed to have the greatest potential in terms of being supplemented by additional features. Newsprint and magazine paper is considered to be highly standardized products with the purpose of fitting standardized newspaper and magazine publishers press facilities. It is rather believed that publishers seek products in which are characterized to have the absolute necessary features at a competitive price. This may be supported by the declining economical trends in the printed media business where lower circulation and less ad spending has proven to be the reality, and which have put pressure of publishers profit margins (Fossbakken, 2013). The presented illustration in figure 17 describes the relationship between different accounting margins based on the reformulated financial statements.

Operating profit before special items This profit measure includes only the most typical operating elements in relation to production of newsprint and magazine paper (appendix 1). The poorest performance can be witnessed in 2010, equaling a margin of 7%. Much to blame for this poor performance stems from the cost of materials level, which in 2010 surpassed any other years relative to operating revenue. The effect is significant since cost of materials is the single largest expense item in NSG’ accounts. However, cost of materials relative to operating revenue has trended downwards in the period between 2010 and 2012, signaling a positive development in this margin for NSG. Operating expenses related to distribution and employees have remained fairly stable between 2010 and 2012 as highlighted in the common-size analysis displayed in figure 18.

An index analysis as displayed in appendix 5 reveals that NSG’ operating revenue decreased close to 39% in the period between 2007 and 2012, while operating expenses (not considering special items, depreciation and tax) decreased close to 35% (appendix 1). This signals that NSG has not been able to cut operating expenses at the same rate as the general drop in operating revenue in the period. However, as cost of materials relative to revenue decreased in the period between 2010 and 2012, NSG has shown that a negative development can be turned around to the better. The latest press release by NSG (2013g) commenting on the second quarter of 2013 with the headline “stable quarter, brighter prospects” highlights improved margins as a result of “ongoing efficiency programs”. Also it is stated that ongoing investments at certain machineries will improve efficiency in the time to come.

EBITDA and EBIT The EBITDA subtracts special items from operating profit as highlighted in appendix 1. It is evident that special items heavily affect the EBITDA-margin.

Impairments have been a main contributor to the widely fluctuating EBITDA in the period. According to information extracted from NSG’ annual reports (2009, p.23; 2012, p.38) impairments relate among others to lower sales price expectations, closure of machinery and recognized losses in relation to the disposal of mills. Looking at an average impairment level, the number is close to 1.95 BNOK (appendix 1). This is fairly in line with the level observed in 2011 and 2012. As previously described, the latest decade has been tough for NSG and closures on a global scale have been significant.

“… We will actively continue our efforts to cut costs and improve productivity, and if necessary, close or convert paper machines…” (NSG, 2013g)

Based on the past, it may be argued that any upcoming closures or conversions would imply additional impairment losses and restructuring effects to the accounts. However, as illustrated in the strategic analysis, especially referring to newsprint, it seems clear that the drop in demand has to some extent slowed down compared to the massive drop observed in 2009. NSG has in the years cut capacity and taken massive impairment losses in order to adapt to changing markets, which might favor lower special item expenses in the future compared to the past. NSG “settling down” in Europe and Australia might favor lower special item expenses, as the facing out of other markets seem soon to be completed.

The EBIT margin, which subtracts depreciation from EBITDA (appendix 1), follow similar path as the EBITDA margin. Depreciations relate mainly to non-current operating assets as machinery and equipment (NSG, 2012, p.60), and averaged close to 10% of non-current assets in the period between 2008 and 2012.

4.4.2 Turnover rate of invested capital Figure 20 presents the development in NSG’ turnover rates of invested capital. In terms of NSG’ peer group, data has been extracted from ORBIS (2013) in which covers individual companies net asset turnover in the same period. There is a difference between the term net assets and invested capital, and therefore the data series are not fully comparable. However, they are still included in order to color the analysis.

As illustrated in figure 20, NSG’ turnover rate of invested capital has trended upwards, meaning that NSG has been able to accelerate revenue per NOK invested capital. At first glance this might seem to be a positive development. However, a negative acceleration in ROIC can be witnessed due to the fact that there has been a negative development in NOPAT in the period between 2010 and 2012 (appendix 1). In order for NSG to improve the return on invested capital, the company must find ways to improve NOPAT in the time to come. First of all, NOPAT must be turned around to positive figures.

4.5 Invested capital entries and respective development An index analysis, which is presented in appendix 6, reveals that invested capital has been on a continuous decline in the period between 2007 and 2012. In the upcoming sections this thesis will discuss elements in which are included in NSG’ invested capital, and which are considered important for the ongoing forecast and valuation process of NSG. Main emphasis will be put at the following items:

o Intangible and tangible assets (Investments) o Net working capital o Net interest bearing debt

4.5.1 Intangible and tangible assets

The most significant changes to NSG’ intangible and tangible assets relates to changes in property, plant and equipment, and for this reasons examined in order to assess the future level of investments to be expected. The carrying value of property, plant and equipment is mainly affected by the disposal of mills, impairments and depreciations in 2011 and 2012 (NSG, 2012, p.60). Capital expenditure levels based on additions of property, plant and equipment have remained fairly stable around 500 MNOK per year in the period between 2010 and 2012. In order to strengthen cash flow, the board of NSG has decided to grant management a relatively low capital expenditure frame in the future (NSG, 2012, p.122). A capital expenditure level of 600 MNOK is expected to occur in 2013 due to the conversion from newsprint to magazine paper production at a mill in Australia, as well as an energy efficiency program at one of the Norwegian mills. Depreciations are expected to fall below 800 million NOK in 2013 (NSG, 2012d). The lowered depreciation levels witnessed is the result of an extension of useful life of mills, impairments and disposals. NSG announced in 2012 that closures of 5 machines would take place in 2013 (NSG, 2012).

4.5.2 Net working capital

The development of NSG’ NWC is illustrated in table 8, and consists of operating elements such as inventory, accounts payable and accounts receivable. Inventory and accounts receivable consume cash while liabilities such as accounts payable generate cash, and cash flow will improve if NSG is able to reduce the number of days it takes to convert working capital into cash, measured as the liquidity cycle4 (Petersen and Plenborg, 2012, p.153).

In the period between 2008 and 2011, a negative liquidity cycle trend can be witnessed, however displaying significant improvements in 2012. Comparing NSG’ cash flow statements in the period, seems to prove that the spread between cash generated from operations and cash used in operations have improved significantly. According to NSG (2012) a strong cash flow in 2012 is supported by the company`s increased capital efficiency.

4 Liquidity cycle = 365 / Turnover rate of working capital

4.5.3 Net interest bearing debt Between 2007 and 2012, NSG made an interest-bearing debt reduction of 10 BNOK, which more than halved the total interest-bearing debt level observed in 2007 (appendix 2). The president and CEO of NSG announced the following (NSG, 2012, p.6):

“…the level of debt is now beginning to approach our goal”.

According to the reformulated balance sheet (appendix 2), a net interest bearing debt level of 6.15 BNOK has been calculated year-end 2012, close to 6 BNOK as reported by NSG and which is close to the announced target level year-end 2012 (NSG, 2012, p.6). NSG has strengthened its financial position due to significant reductions in interest-bearing debt during the latest years (Skogindustri, 2013).

NSG’ financial position may have been strengthening during the latest years observed. However, it may also be argued that debt repayments must ease due to the year-end 2012 cash and cash equivalent level (table 10). Even though there has been a mission to reduce interest- bearing debt, new debt has also been raised in all years examined. This signals that NSG is in need of alternative cash funding from sources other than from operating and investing activities in order to support ongoing operations. It may be of interest to examine the development in financial leverage and compare NSG’ financial leverage to peers within the industry. According to Petersen and Plenborg (2012, p.158), financial leverage expresses the long-term liquidity risk of a company, which also is supported by NSG expressing “high financial leverage amplifies the business risk” (NSG, 2012, p.40).

The increase in NSG’ gearing in 2012 compared to 2011 signals a higher long-term liquidity risk. With the exception of Holmen, all peers have experienced a “negative” gearing development, which seem to suggest that the industry in general (represented by the European peers) may be considered more risky than previously, isolating gearing as a risk-factor for an investor. However, it should be noted that these figures are based on accounting data, and may not represent the true value of a given capital structure. Koller et al. (2010, pp.476-477) claim that leverage provides benefits such as reduced taxes and avoidance of overinvestments, but leverage is also associated with costs arising from business erosion and conflicts of interests among investors. Highly leveraged companies may also be more likely to forgo good investment opportunities which will pay off in the future due to the need for available cash in order to repay debt.

4.5.3.1 Net borrowing cost According to Petersen and Plenborg (2010, p.117) a firms net borrowing cost rarely matches a firms borrowing rate since it among others may include currency gains and losses, and should therefor be interpreted with care. According to the analytical income statement (appendix 1) it is confirmed that NSG’ net borrowing cost has fluctuated widely in the period between 2007 and 2012, heavily affected by general financial items as well as other gains and losses. According to NSG (2012, p.76), the average interest rate at 31 December 2012 was 7.5%, which was an increase of 1.1% percentage points compared to 2011.

Credit ratings are a useful summary of a firm’s capital structure health where lower credit ratings reflect higher probabilities of default and ratings largely determine the company`s access to debt markets (Koller et al., 2010, pp. 484-485). At the end of 2012, Standard & Poor`s downgraded NSG’ credit rating from B- to CCC+. The poorer credit rating provided

by Standard and Poor`s indicates a higher degree of uncertainty and risk related to NSG and its respective activities (DN, 2012).

Empirical evidence suggests that credit ratings often are based on size of sales or market capitalization and interest coverage in terms of EBITA (Koller et al., 2010, p.485). NSG’ total sales and market capitalization have proven to fall in the period examined which might explain poorer credit ratings. Petersen and Plenborg (2012, p.161) argue that EBIT is not a cash flow measure, and that some analysts prefer to replace EBIT with cash flow from operations. Examining the interest coverage ratio5 reveals that NSG in the period between 2010 and 2012 gradually increased cash flows from operations while net financial expenses fell, which supports an improved interest coverage ratio (appendix 7). Petersen and Plenborg (2010, p.161) argue that higher ratios signals lower long-term liquidity risk. The improvement in interest coverage ratio together with the argumentation provided by Petersen and Plenborg (2012) seem to conflict with Standard & Poor’s downgrading of NSG. It may very well be that the decrease in sales and market capitalization have played a greater role in the credit rating assessment of NSG, or due to different accounting estimations provided by the author of this paper and analysts at Standard & Poor’s.

5 Interest coverage ratio (cash) = Cash flow from operations / Net financial expenses after tax

CHAPTER 5 – Weighted Average Cost of Capital The main valuation model applied in this thesis is a present value model known as the “Discounted cash flow (to firm) model” (Petersen and Plenborg, 2012, p.210). The DCF- model discounts the estimated future free cash flows by the weighted average cost of capital (WACC), which reflects the opportunity cost that investors face when investing in a firm instead of others with similar risk (Koller et al., 2010, p.231). Another way of describing WACC is that it is the return that investors expect to gain from investing in a specific company (Koller et al., 2010, p.40).

Where: D = NIBD (Net interest-bearing debt) E = Equity rd = Required rate of return on NIBD t = Tax rate re = Required rate of return on equity

The upcoming sections will provide inputs to the estimation of NSG’ long term capital structure, required rate of return on NIBD and required rate of return on equity. Finally, the estimations are gathered and a final WACC will be presented, which will be assumed constant throughout the complete forecast period.

5.1 Capital structure Koller et al. (2010, p.233) argue that a target level of debt to value and equity to value should be applied, since the current capital structure might not remain as the life of the business goes on. Among others, it is recommended to combine an estimate of the current market value based capital structure with an analysis of managements approach to financing the business (Koller et al., 2010, p.262). Petersen and Plenborg (2012, p.246) add that: “market values reflect the true opportunity cost of investors or lenders”.

Evidently there are differences between the perceived market value of NSG’ equity and the reported book value of equity. The book value of NSG’ equity at the end of the second quarter of 2013 equaled 2801 MNOK (NSG, 2013h), while market value of equity at the release date6 of the second quarter report equaled 541,3 MNOK7. A BVE/MVE ratio of 5.178 signals that book value of equity is overstated in the accounts. Alternatively, it may be argued that an investor could buy equity at a discount, consequently suggesting that the market undervalues the true value of equity, had book values been a fair assumption of its true value.

When estimating the market value of NIBD, figures presented by NSG (2013h) based on IFRS accounting principles are assumed to be close to fair value. However, NSG (2012, p.64) argued that no guarantee could be provided that the reported amount year-end 2012 represented the true value of NIBD if the company were to liquidate the debt immediately.

A NIBD/EQUITY ratio of 12.28 as illustrated in table 12 will be used as input to the future WACC estimation. This ratio is assumed constant throughout the forecast period. In other words, it is assumed that NSG is near the target capital structure. If this assumption were correct, then a constant WACC would lead to a reasonable valuation (Koller et al., 2010, p.262). However, it is fully recognized that this assumption might not hold and that it would lead to a biased estimate of a true WACC. If it is expected that capital structure will rebalance over a significant period of time, then it could be argued that an application of a different cost of capital each year, which reflect the given capital structure would be more suitable.

6 17 July 2013 7 2.85 NOK per share * 189 945 626 outstanding shares = 541 345 034 (NSG, 2013i) 8 BVE/MVE = 2801 MNOK / 541.3 MNOK = 5.17

However, this is considered challenging at best since cost of debt and equity might change as weights are modeled (Koller et al., 2010, p.262).

There are several scenarios in which should be taken into account. Companies, which are characterized to have high debt-to-value ratios often, repay debt when cash flow improves (Koller et al., 2010, p.119). This might favor a D/E ratio closer to the observable levels witnessed in the period between 2007 and 2011 as highlighted in table 12, assuming that NSG’ cash flow actually improves in the future. It should also be noted that from a valuation perspective applying the DCF-model, capital structure only affects the enterprise value through the WACC, since debt among others are not included as part of free cash flows to the firm (Koller et al., 2010, p.205). However, a wrongful estimation to how NSG is going to finance operations, either through debt or equity, may overstate/understate WACC, since the required rate of return on debt may differ from the required rate of return on equity.

The author of this paper finds it challenging at best to estimate the target capital structure, and related changes to the required rate of return on NIBD and equity as capital-weights fluctuate. Therefore, a sensitivity analysis will be presented as a supplement to the expected DCF- outcome presented in chapter 6. This is believed to provide a more complete picture of equity value had another assumption about the true WACC been applied in this analysis.

5.2 Required rate of return on NIBD According to Petersen and Plenborg (2012, p.265) cost of debt after tax can be calculated as:

rf = Risk-free interest rate rs = Company specific risk (Credit spread) t = Corporation tax rate

The following sections will describe the risk free rate as well as NSG’ specific risk or credit spread.

5.2.1 Risk-free interest rate The risk-free rate expresses how much an investor can earn without bearing any risk, where a government bond often is used as a proxy. Ideally a short-term government bond, which matches the duration of the underlying cash flow, should be applied. However Petersen and Plenborg (2012, p.249) argue that this would require a recalculation of the cost of capital in each forecast year, and that this is tedious. Koller et al. (2010, p.236) argue that the risk-free rate in developed economies can be estimated using a highly liquid long-term government bond, such as a 10-year zero-coupon government bond. In the valuation process of NSG, a Norwegian 10-year government bond is used to find the risk-free interest rate. In order to increase the accuracy, it has been chosen to apply the average of a 10-year Norwegian government bond in the period between 2003 and 2012, the average of the same bond in the period between 2007 and 2012 as well as the average of the first six months of this bond in 2013.

A risk-free interest rate of 3.21% will be used as input to the WACC, derived from table 13.

5.2.2 Company specific risk Company specific risk may also be referred to as the credit spread or risk premium on debt. NSG’ credit spread is believed to be the difference between the interest rate on a NSG bond and the risk free rate. The average NSG coupon rate in 2012 was 9.2% (NSG, 2012g). The average risk free rate on a 10-year government bond in 2012 was 2.1% (Norges Bank, 2013b). Therefore, a credit spread in 2012 of 7.1% can be presented. Ideally, an examination of the development in the credit spread would have served this analysis well. However, consistent data hasn’t been found which troubles an analysis of the respective development.

As previously addressed, Standard and Poor`s downgraded NSG at the end of 2012 to a CCC+ rating (DN, 2012), which might suggest that the “market” perceive NSG as riskier compared to historical levels, which might increase the company specific risk of NSG in 2013 and ongoing future. If this proves to be the outcome, then the required rate of return on debt consequently will increase. Mishkin (2012, p.208) argue that when companies are more likely to run out of money, the spread between the interest on a corporate bond and government bonds rises dramatically, especially in weaker economies.

As highlighted in the strategic analysis, the Norwegian government decided to reduce the Norwegian corporation tax to 27% in 2013. Based on the above presented data, the required rate of return on NSG’ NIBD is calculated to be 8.4%:

rd = 0,0321 + 0,071 * (1 – 0,27) = 0,0839

5.4 Required rate of return on equity Petersen and Plenborg (2012, p. 249) suggest that the Capital Asset Pricing Model (CAPM) is commonly used in most financial textbooks when estimating owners required rate of return. CAPM can be defined as:

Where: rf = Risk free rate βe = Systematic risk on equity (beta) rm = Return on market portfolio

“Expected return on a given asset should be positively related to it`s risk” (Ross, Waterfield and Jaffe, 2013, p.357), and the CAPM assumes that the expected return on a single asset “is linearly related to its beta” (Ross et al., 2013, p.359). NSG’ beta is expected to be greater than 0; consequently it is expected that investors require a return greater than what can be extracted from a risk-free asset, such as a Norwegian government bond. A government bond is not believed to be an investment completely without risk; however such an investment

seems to be the best proxy for a risk-free investment. The chance that a Norwegian government bond defaults is considered highly unlikely.

5.4.1 Systematic risk (Beta) Systematic risk is risk in which affects a large number of assets with varied degree, opposite to unsystematic risk in which specifically affect single assets or smaller groups of assets (Ross et al., 2013, p.348). Changes in GDP are typically defined as systematic risk, and as the strategic analysis uncovered, the newsprint and magazine paper business have suffered from poor economical conditions. As previously highlighted, NSG’ management believed that only a fraction of the two digit decline in revenues in 2012 could be allocated to the effects of digitalization, the rest to poor economical conditions in Europe and Australasia.

Beta can be calculated as the co-variation between a single stock`s return and observed returns for the market portfolio (Koller et al., 2010, p.24). However, it must be noted that systematic risk usually is estimated based on historical returns, which might not represent the future of NSG, therefore it should be treated with care. Data on the co-variation between NSG and the market portfolio has been extracted from Datastream. Oslo Børs Benchmark Index (OSEBX) as well as the MSCI world index has been applied as representatives for the market portfolio. The data series consists of 116 monthly observations in the period between 03.10.2003 and 02.06.2013 (appendix 8; 9). The reason why monthly observations was chosen is that Koller et al. (2010, p.246) argue that more frequent return periods “leads to systematic biases”. It should also be noted that the recent years of global financial crisis are included in the data series, which might distort the values. It should be questioned whether observations in this specific period should have been excluded from the dataset in order to normalize the findings on systematic risk.

Based on the historical findings on co-variation between NSG and the OSEBX/MSCI index, it can be concluded that the historical beta lies in the range between 1.05 and 1.32 as highlighted in table 14. A beta of 1 would indicate that an investment in NSG would have the same systematic risk as the market portfolio (Petersen and Plenborg, 2012, p.251). However, turning back to the drawbacks of using historical data to interpret the future, a qualitative assessment of NSG’ operational as well as financial risk has been constructed, in order to provide a closer estimate to the “true beta” for the future.

A qualitative assessment of risk is based on a framework presented by Petersen and Plenborg (2012, p.262), more closely illustrated in appendix 10. NSG’ operating risk is considered to be high. Demand for newsprint has proven to be strongly cyclical, strong rivalry among competitors, negative market growth and the threat of a continuously expanding digital world, justifies the characterization of NSG’ operational risk to be high. The latest downgrading of NSG to a CCC+ rating by Standard and Poor`s (DN, 2012) as well as a debt to equity ratio of 12.28 (table 12), signals that NSG is “currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments” (Standard & Poor`s, 2013). It is therefore concluded that NSG’ financial risk is high. Overall, it is concluded that NSG’ total risk is very high, and that the beta should lie in the range of 1.4 or above, according to the framework presented by Petersen and Plenborg (2012; appendix 10). For simplicity, this analysis applies a beta of 1.4, even though it might be argued that it should be higher. Historical data seems not to be a good future estimate.

5.4.2 Market risk premium The market risk premium can be described as the difference between the market’s expected return and the risk-free rate, however “no single model for estimating the market risk premium has gained universal acceptance” (Koller et al., 2010, p. 238). There are two different approaches in which might help determine the risk premium, namely the ex-post and ex-ante approach (Petersen and Plenborg, 2012). The ex-post approach investigates the difference between historical market returns and historical risk-free returns, looking at data, which ranges between 50 and 100 years back in time. However, “the expected return on the market is unobservable” (Koller et al. 2010, p.238), which seems to suggest that a backward-

looking approach such as the ex-post method may not be suitable in terms of estimating the future risk-premium. In this thesis, the ex-ante approach has been chosen as the proper method, since it relies on analysts` consensus about the risk premium level (Petersen and Plenborg, 2012). However, such a consensus does not exist, which for this reason motivates an assessment of different estimations provided by well-known references.

For the purpose of this valuation, an average market risk premium of 5.3% will be applied as input to the WACC. Based on the above-presented inputs to the CAPM, a required rate of return on equity of 10.63% has been calculated. re = 0.0321 + 1.4 (0.053) = 0.1063

Now it is time to conclude on an estimate for the weighted average cost of capital, which financiers of NSG on average require in return. The estimation of market value of equity was rather straight forward to calculate as price per share * number of outstanding shares. However, an estimation of the market value of NIBD was considered as more challenging. Koller et al. (2010, p.263) argue that book values in most cases “reasonably approximate the current market value”. Based on the findings presented so far in chapter 5, the weighted average cost of capital has been estimated to be 8.6%. WACC = 0.92 * 0.084 + 0.08 * 0.106 = 0.086

Based on the findings above, it is concluded to apply a long term WACC of 8.6% throughout the complete forecast period. However, even though a WACC of 8.6% intends to represent the estimated WACC of NSG, a sensitivity analysis will be provided, in which investigates changes to equity value when different assumptions about the WACC are used as input to the DCF-valuation.

CHAPTER 6 – FORECAST AND VALUATION The previous chapters of this paper have established the foundation for the upcoming budget period as well as future expected performance of NSG. The strategic analysis uncovered the history of NSG, the markets in which the company operates, the core development of the products in which is the lifeline of the company, as well as the competitive landscape in which surrounds NSG’ daily operations. In addition, the financial analysis has provided data on the historical performance of NSG as well as NSG’ ability to manage invested capital in the period between 2007 and 2012. The creation of a strategic as well as a financial analysis is believed to create a solid foundation for the provision of reliable estimates to NSG’ future cash flow potential and risk. Chapter 6 in this paper emphasizes therefore the forecasting and valuation of NSG.

According to Petersen and Plenborg (2012) the three most frequent approaches to valuation by practitioners are the present value approach, the relative valuation approach (multiples) and the liquidation approach. The main model of application in this thesis is the DCF-model, which is a present value approach, and also the most commonly used model among practitioners (Petersen and Plenborg, 2012). However, as argued by Jennergren (2013), the objective of the discounted cash flow model is to “value the equity of a going concern”. Based on the latest years development in NSG’ market value of equity, it may be argued that a liquidation approach should be added to the analysis. However, a valuation of NSG based on the liquidation approach will not be included in this analysis, which is considered to be a significant limitation. The author of this paper strongly encourages further research within this field of study.

In order to secure that the valuation of NSG based on the DCF-approach is free from mechanical errors or errors in economic logic, the model is supplemented by another present value model, known as the economic value added model (appendix 15). Finally, the DCF and EVA model are supplemented by a relative valuation approach based on multiples extracted from the companies within the defined peer group.

6.1 Discounted Cash Flow Model (DCF) The present value approach estimate the intrinsic value of a company based on the cash flow projections discounted at the weighted average cost of capital (WACC), which reflects the risk related to the cash flow as well as the time value of money (Petersen and Plenborg, 2012, p.212). Enterprise DCF is the favorite among practitioners and academics because of the model`s reliance lays at cash flows in and out of the company, rather than on accounting- based earnings. However, WACC-based models, such as the DCF, works best when it is expected that the company will remain at a relatively stable debt-to-value ratio. If the debt-to- value ratio is expected to change, then Koller et al. (2010, p.101) recommend the application of the adjusted present value model, which forecast all cash flows associated with capital structure separately rather than embedding these values in the WACC, which the DCF-model does.

As previously highlighted when estimating the target capital structure, it is considered unlikely that the current capital structure will remain “as is” at time of valuation. However, a constant WACC will be applied throughout the forecast period, without adjusting for future changes to financial structure. According to Koller et al. (2010, p.119) most analysts apply a constant WACC throughout the forecast horizon. However, this is not intended to justify wrongful inputs to the model. The DCF-model can be characterized as a two-stage model as displayed in the mathematical expression below:

The budget period (explicit forecast period) consists of free cash flows forecasted individually year by year, and can be thought of as “a transient phase during a turn-around or take over”, and it is a requirement that the explicit forecast period should as a minimum have the same length as the expected economical life of property, plant and equipment (Jennergren, 2013). Koller et al. (2010, p.186) later referred to by Jennergren (2013), argue that the explicit forecast period should at least consist of a period between 10 and 15 years.

It is considered challenging to estimate the future economical life of NSG`s PPE. Therefore, an explicit forecast period of 10 years has been chosen. It is also considered challenging to estimate reasonable yearly individual cash flow estimates in the period after 2022. As previously described, NSG has gone through massive restructuring, and it should also be expected that some downsizing will take place in order to adapt to declining demand of newsprint and magazine paper in the time to come. Jennergren (2013) adds that the explicit forecast period should be long enough to capture transitory effects, in example during a turnaround process. This analysis assumes that a 10-year period is sufficiently long to capture the transitory effects related to NSG’ operations, as it is believed that demand as well as the competitive climate will stabilize in the period between 2013 and 2022. The expected stabilization during the period lays the foundation for the terminal period, which according to Jennergren (2013) estimates free cash flows by a constant percentage from year to year, “hence satisfying a necessary condition for infinite discounting”.

6.1.1 Discounted cash flow model structure A typical valuation often presents a variety of scenarios, from positive to negative cash flow outcomes, during the budget and terminal period. However, as presented in figure 21, this analysis relies on two models, namely the “AS 2012” model and the “Expected” model, which latter intends to answers the main problem statement of this paper. The blue boxes represent the inputs to the forecast of NSG’ future cash flows, primarily based on the findings from the strategic and financial analysis of this paper. The red boxes represent the output or the result of the inputs presented. A thorough strategic and financial analysis is considered important for the estimation of NSG’ future cash flows, because it increases the reliability of the assumed forecasts presented. However, it must be pointed out that the author of this paper believe that the valuation process in many ways could be considered as an art rather than a science, and that it is hardly unlikely that future cash flow predictions will be fully reliable.

6.1.1.1 “As 2012” - Model The overall purpose of this model is to answer the main problem statement assuming that NSG remains operating at the same path and pace as observed in 2012. A detailed budget is presented in appendix 11.

What is the fair value of the NSG stock pr. 17.07.2013?

If NSG remains operating at the same level as observed in 2012, then the company will end up in bankruptcy. As the DCF-model depicts, an estimated share price of NOK -32.09 is the result. In other words, the present value of all future free cash flows is not sufficiently large to cover the current market value of NIBD. In general, a negative share price is not possible. However, this way of presenting a scenario illustrates that NSG must initiate certain actions in which stimulate an improvement in the future free cash flow level. The detailed budget as presented in appendix 11 proves that NSG’ operations generate negative NOPAT throughout the complete forecast horizon, implying that a negative spread between ROIC and WACC is the ending result, consequently deteriorating economic value. If this scenario had been the expected outcome of NSG’ future operations, then it may be suggested that the company should: a) Be up for liquidation b) Merge/consolidate or sell in order to extract positive gains from the assets

However, alternative b) was highlighted in the introduction of this thesis as a troubled alternative. As Hans-Erik Jacobsen in First Securities announced: “unlikely that anyone would like to buy NSG due to the current stands of the company” (Nationen, 2012) and announcements made by NSG: “difficult to accomplish these things in a low cycle when everyone is pessimistic” (Euroinvestor, 2013).

6.1.1.2 Expected - model

Revenue A detailed revenue forecast is presented in appendix 12.

In this section, data extracted from the strategic as well as financial analysis will be used as input when forecasting future revenue. An estimation of future demand as well as the future expected price level is up for discussion. Previously it was announced that an explicit forecast period of 10-years had been chosen. This should ensure that NSG’ growth rate is less than or equal to that of the economy. Koller et al. (2010, p.186) argue that higher growth rates would lead to unrealistically high company value compared to the aggregate economy. NSG’ total operating revenue in the terminal period is expected to increase 2.3% which equals the expected real GDP growth witnessed in Europe in 2018 provided by IMF (2013b).

NSG characterized newsprint demand as strongly cyclical (NSG, 2013b). It is clear that 2009 was a turbulent year for NSG, as real GDP growth hit rock bottom in Europe. However, positive GDP growth in the following years have not reaccelerated NSG’ newsprint production volume. It is rather suggested that NSG’ production of newsprint displayed a continuous decline in the period between 2008 and 2012 (appendix 4). Magazine paper on the other hand seems to display a significantly better performance, with higher production volumes in 2012 compared to 2011. In general it is expected that the total production volume will decrease in the time to come, both in terms of newsprint as well as magazine paper. It may be argued that the expected positive growth in GDP (IMF, 2013b) will stimulate paper consumption, thereby slowing the decline in demand/production. Kotler (2003) argued that companies tend to cut advertising expenses in recessions, which may explain the poor performance of NSG in 2009. A new recession is not expected to take place, thereby

predicting that a massive drop in demand/production as witnessed in 2009 will not reoccur. RISI (2012b) argued that the odds for a return to positive growth is considered to be slim, indicating that newsprint consumption levels will remain rather flat in the next couple of years on a global scale. However, as the strategic analysis uncovered, the stabilization in demand seems to be supported by positive growth in developing economies, while more advances economies most likely will experience lower paper consumption in the time to come. NSG’ announced development from being present globally to focusing on Europe and Australasia (NSG, 2012c; NSG, 2013b) seem to suggest that NSG will not harvest significant gains from positive growth expectations in emerging and developing economies in the time to come.

The strategic analysis uncovered that incursion of digital media was of great significance and threat to NSG’ future existence. It was suggested that digital media threatened the newsprint segment the most, based on certain characteristics of newsprint content compared to magazine paper. It is therefore expected that electronic media will influence newsprint demand to a greater extent in the time to come, thereby explaining why it is believed that newsprint demand will decrease at a higher rate compared to magazine paper demand, towards stabilization in 2020 (appendix 12). It is expected that there always will be a need for newsprint and magazine paper, supported by NSG (2012, p.6); “digital media has created challenges for the paper industry, yet it is clear that paper and digital media will exist side by side in the future”.

Chapter 2 of this paper presented the peer group, which consisted of several strong competitors in Europe, however being the leading player in the Australian paper market. The five forces analysis revealed that existing rivalry equaled a significant threat to NSG, and remained perchance one of the single largest threats to the company. Despite this, several of NSG’ leading competitors have announced capacity closures in the European market as well as seeking potential in growth markets. This may ease the competitive climate in Europe, potentially stimulating a larger NSG proportion of the future total European market.

Reported figures for the first half of 2013 signals a somewhat lower production volume both for newsprint and magazine paper compared to the first half of 2012 (NSG, 2012h; NSG, 2013h). According to NSG, the outlook for the second half of 2013 is positive, supported by

seasonably higher sales volumes (NSG, 2013j). For this reason, it is assumed that total production volume in the second half of 2013 will mirror the observed level in the second half of 2012.

The strategic analysis uncovered that surplus capacity in the market place accompanied by weak demand, were main contributors to the steep drop in paper prices observed in 2009, beginning of 2010 (NSG, 2010; Figure 11). The announcement made by Holmen (2013) signals a total European capacity closure of 2 million tonnes of newsprint in 2013 among the European peers. The announced closures mirror fairly well NSG’ total newsprint capacity as the second largest player in Europe in terms of newsprint (Figure 8). Due to the announced closures, it may be suggested that there is a potential for a price increase, as supply more closely is believed to match demand. The findings from the strategic analysis (Figure 11; Figure 12) displaying newsprint delivery to capacity ratios in Western Europe and publication paper prices in Europe, suggest that the price level mirrored utilization levels fairly well, however with some lag.

NSG (2013f) announced that management expected a long-term European newsprint reference price of 550 EUR or 4209 NOK per tonne9. The average price per tonne at the end of the second quarter of 2013 displayed an average newsprint price per tonne of NOK 4039 (NSG, 2013h), somewhat higher than reported figures for the first quarter of 2013 (NSG, 2013f). This development suggests that prices for newsprint are heading towards the expected long-term European reference price. The president and CEO of NSG, Sven Ombudstvedt, also announced that low prices in the first quarter reflected “the second dip of the European macro” and that this was the “low point, the bottoming out of the paper market” (NSG, 2013f).

It is predicted that the price for newsprint will increase towards the expected long term European reference price. In terms of the price for magazine paper, it is expected that the historical average will represent the future as a suitable proxy. Even though NSG has experienced volatile prices in the market for magazine paper (figure 11), it is considered reasonable to apply the historical average price of 5060 NOK per tonne (appendix 4). This is

9 9 1 EUR = 7.6535 NOK  550 EUR = 4209 NOK (Norges Bank, 2013)

somewhat higher than the observed price level witnessed in the last 18 months for magazine paper, however assuming that the paper market is at the low point, the bottoming out, this seems to be a fair estimate. However, it must be noted that the price development calls for a tighter relationship between supply and demand. For the prices to increase, producers of paper must be able to quickly respond to declining demand, either by idling paper machines or through complete closure initiatives. As previously highlighted in the strategic analysis, buyers bargaining power seems to be high, at least in the current scenario of surplus capacity. Finally, the products in which NSG sell, are found to be commodities with few differentiation possibilities.

Cost A detailed cost budget is presented in appendix 13.

Findings presented in the strategic and financial analysis, have facilitated the estimation of NSG’ future cost drivers. As previously highlighted, the main valuation model applied in this paper is the DCF-model. The DCF-model discounts all future free cash flows to the firm (FCFF) by the weighted average cost of capital (WACC). FCFF can be calculated as:

Net-operating profit after tax (NOPAT) + Depreciation and amortization +/- Change in net working capital +/- Net investments (Fixed assets)

The pro forma statement is constructed based on a sales-driven forecasting approach (appendix 13). According to Petersen and Plenborg (2012, p.175), this approach assumes that accounting items such as operating expenses and investments are driven by the expected level of activity within the firm. Also Koller et al. (2010, p.194) recommend this approach when forecasting operating expenses. The financial analysis uncovered that NSG’ operating profit margin before special items decreased from 14% to 7% in the period between 2007 and 2010 (figure 17). However, a gradual recovery can be witnessed, mainly supported by a lower cost of materials ratio. It seems reasonable to expect that the positive trend will continue, seen in light of the announced efficiency programs and targeted investments, which seeks to stimulate

the competitive power of NSG in Europe (NSG 2012; NSG, 2013g). The common-size analysis (figure 18) concluded that typical operating expenses remained fairly stable as a percentage of revenue in the historical period examined. It is expected that NSG will approach the 2007 profit level of 14% before special items are taken into account. Mainly this is supported by the belief that NSG will maintain and harvest positive outcomes from their ongoing efficiency programs.

As previously announced, Petersen and Plenborg (2012, p.50) claim that increased competition often put pressure on profit margins. However, it might be argued that the European competitive climate forces NSG to implement actions, which maximizes their cost effectiveness. The Norwegian government has signaled that NSG presumably will be faced with greater national conditions in the future, among others related to increased cargo weight allowed when transporting timber across the Norwegian landscape (E24, 2013). Not only is this believed to reduce NSG’ yearly distribution costs, this initiative is also believed to increase NSG’ competitive power. The Norwegian political framework is starting to match conditions witnessed in Sweden and Finland (Bjørnestad, 2013), in which Holmen, Stora Enso and UPM Kymmene currently are benefiting from.

When constructing the initial financial analysis, an analytical income statement as well as analytical balance sheet were formulated (appendix 1; 2). This enabled a clear separation of typical operating revenues and expenses from what was classified as operating special items. As highlighted in appendix 13, the share of profit in associated companies has fluctuated widely in the historical period. It seems reasonable to apply an historical average as a yearly forecast assumption. In terms of restructuring expenses, also these levels have fluctuated in the historical period. However, it is assumed that NSG will not experience levels similar to the ones witnessed in 2009 and 2011 (appendix 13), years in which could be characterizes as especially challenging for the company and the industry. NSG has already carried out massive restructuring, and taken a significant step towards new market conditions. Sven Ombudstvedt stating also confirms this: “although the market remains challenging, we have carried out such powerful changes in NSG during the past few years that I look to the future with optimism” (NSG, 2012, p.6). NSG’ strategy formulation, highlighting Europe and Australasia as main markets, suggests that greater stability can be expected in the time to come, seen in

light of the historical resignation from certain markets outside NSG’ area of future interest. However, it seems evident that some restructuring will need to take place in the future, as demand for newsprint and magazine paper is expected to fall towards stabilization and steady state. Within the first six months of 2013, NSG reports a loss of 195 MNOK related to the disposal of a mill in Brazil (NSG, 2013h). NSG does not disclose information in which suggest that other gains and losses will increase or decrease in 2013. For the future, it is expected that other gains and losses will not reappear, however this is considered unrealistic based on historical observations. On the other hand, an estimation of future gains and losses would be based on pure speculation with no solid support for such a forecast.

So far in 2013, the company has not disclosed any expenses related to impairments. When NSG estimated the fair value in use of intangibles and non-current assets, it was argued on the 30th of June: “…no indication that further impairments should be made” (NSG, 2013h). It is quite clear based on the historical development that the company will be faced with impairments also in the time to come. However, it is highly challenging to estimate such a level, and the company`s future expectations supported by their auditor, should serve as a proxy in this analysis. To conclude, it is expected that NSG’ EBITDA margin will accelerate from 8% in 2013 towards 14% in 2022 (appendix 13). This is primarily supported by two expectations:

1) A lower “typical operating” expense to revenue ratio 2) A lower total “special items” level in the accounts

When estimating future investments, Koller et al. (2010, p.200) argue that net PP&E should be forecasted as a percentage of revenue, and that PP&E to revenue over longer periods tend to be quite stable. NSG’ latest development in the period between 2007 and 2012 signals a massive drop in PP&E to revenue, represented by intangible and tangible assets in appendix 13. However, this period is not considered sufficiently long, nor does it serve as a good proxy for the future, due to the turbulent characteristics of the historical period examined. However, it is considered unlikely that PP&E to revenue will keep falling at the rate observed in the historical period due to greater expected stability in the market in the years to come. A rather stable yearly capital expenditure (CAPEX) level of 500 MNOK can be observed in the latest

years, as well as an announced CAPEX level of 600 MNOK to take place in 2013 (NSG, 2012d). The increase in CAPEX in 2013 relates mainly to magazine paper conversion from newsprint as well as expenditures related to energy efficiency measures (NSG, 2012d). The board of directors has announced that the board will grant management a relatively low CAPEX frame in the future (NSG, 2012). The depreciation level in 2013 is expected to end at 800 MNOK (NSG, 2012d), and based on the first six months of 2013, NSG reports a depreciation level close to 400 MNOK (NSG, 2013h). Based on these figures, expected depreciation as well as CAPEX for 2013 have been forecasted (appendix 13). It is considered reasonable to apply the 2013 PP&E to revenue ratio in the explicit forecast as well as terminal period. In other words, it is assumed that PP&E changes corresponds to changes in operating revenue, a relationship which seem to be supported by Koller et al. (2010, p.200). It seems also reasonable to apply a rather stable depreciation rate throughout the forecast period, similar to the one expected for the financial year of 2013 (appendix 13).

The financial analysis uncovered that NSG increased its capital efficiency, among others increased the yearly spread between cash generated from operations and cash burned in operations (table 9). It is expected that NSG will remain at the operating working capital level as observed in 2012, which equals 7% of operating revenue (appendix 13). However, if the company is able to increase its capital efficiency further by tightening inventory levels and reduce the number of days which customers are granted credit, as well as negotiating better conditions with current suppliers, then it could be argued that an improved working capital level could be expected.

The expected revenue and cost forecast presented above have facilitated an answer to the main problem statement of this thesis:

What is the fair value of the NSG stock pr. 17.07.2013?

Based on the findings extracted from the forecast as well as the related DCF-valuation (table 17), it can be concluded that the fair value of the NSG stock pr. 17.07.2013 is estimated to be NOK 9.43. Testing the plausibility of the findings by comparing the estimated fair value of the NSG stock with the market value at the time, signals that the estimation is significantly higher than what was the perceived value of the stock in the market, equaling NOK 2.85. Koller et al. (2010, p.290) strongly suggest that a conclusion should not be rushed, with the notion that the market is wrong, rather suggesting that: “Your default assumption should be that the market is right, unless you have specific indication that not all relevant information has been incorporated in the share price”.

The author of this paper has not found any indications, which suggest that information hasn’t been incorporated in the share price. It is rather suggested by the author that key inputs to the DCF-model may differ, such as the applied WACC or the expected growth rate in the terminal period. A sensitivity analysis will therefore be presented in the following section, which test the estimated fair value of NSG had different levels of WACC and different growth rates in the terminal period been the expected scenario.

It is important to stress, that the estimated share price derived from the expected model (table 17) is assumed to hold and represent a fair estimate to NSG’ value of equity pr. 17.07.2013.

6.1.2 Sensitivity analysis The findings presented in the previous section of this paper are based on data extracted from internal and external sources presented throughout the paper as well as a subjective interpretation of these data. It is therefore argued that the data and expectations are subject to uncertainty. Petersen and Plenborg (2012, p.241) argue that “a valuation should always be accompanied by a sensitivity analysis” which in this case examines the effects in which different growth rates as well as a variety of WACC levels have on the estimated value of NSG’ equity.

As the DCF-model portrays, only the free cash flows to the firm and the WACC affect the market value of the company (Petersen and Plenborg, 2012, p.216). The sensitivity analysis displayed in table 18 and appendix 14 confirms the positive relationship between market value of equity and a lower WACC. Based on the findings, estimated market value of equity is less sensitive to changes in growth rates in the terminal period. According to the calculations presented in table 18, it is evident that estimated market value of equity decreases as growth expectations rise, assuming that the WACC is 9.5% or higher. A very likeable explanation is that ROIC becomes lower than WACC when WACC equals 9.5% or exceeds this level, which implies a negative EVA. This is also confirmed in appendix 14, which indicates that the present value of EVA in the terminal period weakens as growth within the WACC intervals of 9.5% - 11.5% accelerates. According to Petersen and Plenborg (2012) the EVA-model is similar to the DCF-model characterized as a present value model, which enterprise value is the product of invested capital at time of valuation + present value of EVA throughout the complete forecast horizon (appendix 15). If the DCF and EVA approach are applied correctly, they should yield the same value estimate, which also should ensure that the fair value assessment of NSG’ equity is free from mechanical errors or economic logic. As highlighted in appendix 15 identical value estimates are confirmed when applying the DCF and EVA-model in regards to the fair value assessment of NSG’ equity pr. 17.07.2013. Based

on a subjective assessment of the different value estimates presented in table 18, it may be argued that a probable equity estimate lies in the range of NOK 9.24 and NOK -1.98. This subjective interpretation is believed to be liable based on the following arguments:

o NSG’ long-term growth is not expected to exceed that of the European economy o A WACC of 8.6% as estimated in chapter 5 may be considered artificially low

6.2 The Relative Valuation Approach As previously highlighted, the DCF-model is based on inputs which are subject to uncertainty, and according to Koller et al. (2010, p.303), any analysis is only as accurate as the forecasts in which it relies upon. Therefore it is suggested to supplement the DCF-analysis with a relative valuation approach, also known as multiples, which compare NSG to similar companies within the industry. Among others, multiples can make the DCF-predictions more accurate, testing the reasonableness of the cash flow forecasts (Koller et al., 2010, p.303).

Some of the most commonly used multiples are P/E, EV/EBITDA, EV/EBIT and EV/Revenue10 (Petersen and Plenborg, 2012). This approach to valuation is popular among practitioners, mainly because of its low complexity and speed. However, it might be argued that multiples are not as precise as present value techniques, and that this technique relies heavily on the true comparability of companies. As highlighted in the introduction to the peer- group analysis, many of the existing competitors are much more diversified than NSG, characterizing these as not completely or truly comparable. However, in order to illustrate different methods for valuing a company, the paper includes multiples as a valuation approach, comparing NSG to some of its closest European competitors.

10 P = Price, E = Earnings, EV = Enterprise value

The relative valuation approach yields two quite different value estimates. It can be concluded that these multiples do not support the DCF/EVA-estimate of NOK 9.43 per share. Nor do these multiples support the trading price of 2.85 NOK per share at time of valuation. One reason might be that true comparability as key criteria may not be fulfilled. Secondly, with the exception of NIBD, which is gathered from the second quarter 2013 report (NSG, 2013h), ORBIS has been applied as input reference. Companies might report data differently based on different accounting standards and procedures, in which might distort the presented values.

CHAPTER 7 - CONCLUSION The main purpose of this paper was to conclude on a fair value of the NSG stock pr. 17.07.2013. In order to derive at such a conclusion, it was considered essential for the analyst to apply findings presented in the preceding chapters of this paper, thereby increasing the reliability of the forecast assumptions presented. In addition, an analysis of the competitive environment was conducted, in order to separate NSG from its closest competitors, thereby facilitating a profitability and product portfolio comparison. The presented “as 2012” model as well as “expected” model, highlighted the necessary features of future performance, in which was considered crucial in order for NSG to secure future existents.

7.1 Conclusive remarks The challenges in which NSG has been faced with during the time of historical study will most likely also define the future playing field of NSG. The company is expected to face a decline in consumption of newsprint and magazine paper in the time to come, followed by an expected state of stabilization, which is believed to represent the future minimum need for NSG’ product range. It is held that printed and digital media will live side by side in the future, thereby justifying a future survival of the core products in which is the lifeline of NSG today. However, the future survival of NSG is assumed to be dependent on several events throughout the highlighted forecast period, among others:

 A total decrease in revenues less than 30% in the explicit forecast period o Stable reference price for magazine paper o Improved European reference price for newsprint, due to capacity closures o Average yearly total decline in demand of 3.3 % (slightly higher for newsprint) o A terminal growth similar to the aggregated European economy

 An improvement in EBITDA from -6% to 13,6% o Supported by ongoing efficiency programs o Lower restructuring costs due to a lower future expected closure rate

 A stable net working capital level of 7% of total revenues o Supported by recent improvements in capital efficiency o Supported by recent positive development in the spread between cash generated and cash burned in operations

 A relatively low and stable CAPEX frame in the future o Supported by restrictions announced by NSG’ board of directors in order to improve future cash flow o Historically low R&D rates (in general low across the industry)

The events presented above are considered to represent the “expected” outcome of NSG’ future operations, highlighted in appendix 13. Consequently it is expected that future free cash flows to the firm will display a significant performance improvement compared to the “As 2012” scenario highlighted in appendix 11. However, the fair value assessment of the NSG stock pr. 17.07.2013 of NOK 9.43 assumes a NIBD level which mirrors the observed level witnessed on the valuation date, as well as a weighted average cost of capital equal to 8.6%. Based on the fair value assessment presented, it can be concluded that the theoretical share price displays a significantly positive assessment of the NSG stock, compared to the actual trading price in the market of NOK 2.85.

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