1) J.H. Stone & Sons was founded in 1926 and later became Stone Container Corporation, a leading producer of containerboard and corrugated containers. 2) Stone grew significantly through acquisitions, which it paid for through cash, borrowing, and an IPO in 1947. However, debt grew substantially through leveraged acquisitions. 3) By the 1990s, Stone had over $4 billion in debt, placing its future in jeopardy.

1. Presented For Presented By
Sagar Sen Md. Mainul Haque 09 (45 E)
Lecturer Poonam Barua 100
Institute of Business Administration
1 Farhan Imtiaz 112
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2. Background of the company
• J.H. Stone & Sons, a cardboard container and paper
products manufacturer
– was founded by Joseph Stone in 1926
• After World War II, it reincorporated as Stone
Container Corporation
• In 1993, it was the paper and forest products
industry’s leading producer of containerboard and
corrugated containers.
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3. Background of the company
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4. Background of the company
Grew significantly through acquisition.
Paid for its acquisitions either entirely in cash or
borrowing funds with early repayment.
In 1947, it became publicly-owned, issued its first
250,000 shares of stock
After its first IPO, the company began acquiring
even more to better diversify itself in the paper
industry.
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By 1987 Stone had quintupled its production
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capacity, borrowed heavily to do so

5. Background of the company
Stone Forest Industries was created to relieve some of
this debt
$3.3 billion of debt in 1989 when it acquired
Consolidated-Bathurst Inc
In 1993 Stone Containers future was a shaking one-
$4.1 billion of debt.
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6. Background of the Industry
Price Cyclicality Capital intensive Industry
Most products in the paper • The industry is very much capital
industry have exhibited intensive.
pronounced price cycles • It requires to incur huge amount of
fixed costs.
• Therefore, operating leverage of
Unbleached Kraft Paper (1987 dollars)
the companies in the industry is
$550.0
$525.0
high by the nature of the business.
$500.0
Price per ton
$475.0
$450.0 Price/Ton
$425.0
$400.0
$375.0
$350.0
Year
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7. Background of the Industry
Operating leverage
• A magnification of profits (EBIT, or net operating income) that
results from having fixed operating costs in the cost structure
of the company.
• Operating leverage increases as the ratio of fixed costs to
variable costs increases.
• With a high ratio of fixed costs to variable costs, a small
percentage change in sales will lead to a large percentage
change in operating profits. In other words, the percentage
increase in EBIT is magnified.
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8. Background of the Industry
Degree of Operating leverage (DOL)
• Degree of operating leverage is defined as the percentage
change in EBIT divided by the percentage change in sales
• It measures to what extent operating profit will vary with the
given change in sales for a given level of fixed costs
• The higher the DOL, the higher the volatility in EBIT due a given
change in sales.
• A change in sales may result from external factors such as price
movements, state of economy etc.
• The higher the DOL, the higher the business risk – the chance
that external factors may be unfavorable causing decreasing
sales.
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9. Background of the competition
Competitor Analysis
Company Products
Stone Container Corporation Container board, corrugated
containers, kraft paper, bags, sacks,
newspaper manufacturing products,
wood pulp
Willamette Inds.
Chesapeake Corporation Commercial tissues, kraft paper,
corrugated containers
Union Camp Corporation Pulp, uncoated white papers, paper
bags, corrugated containers
Westvaco Corporation Paperboard, Containerboard
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10. Expansion strategy of the company
Acquisition
 A corporate action in which a company buys most, if not all, of the target
company's ownership stakes in order to assume control of the target firm.
 Acquisitions are often made as part of a company's growth strategy whereby
it is more beneficial to take over an existing firm's operations and
niche compared to expanding on its own.
 Acquisition turned out to be a profitable technique for Stone because-
 They acquired the plants during industry ‘troughs’ which allowed them
to expand at low cost and with greater speed.
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11. Expansion strategy of the company
Vertical Integration
 The process in which several steps in the production and/or distribution of a product
or service are controlled by a single company or entity, in order to increase that
company’s or entity’s power in the market place.
 When a manufacturer owns its supplier, it’s a backward integration.
 When a manufacturer owns its distributor, it’s a forward integration.
 One of Stone Corporation’s acquisition objectives was to form strong backward
integration. Stone acquired plants and/or companies that produce its raw materials -
• Mills producing jute linerboard and corrugated medium-raw material for
corrugated containers.
• Producers of kraft linerboard – raw material for containers.
• Canada’s fifth largest pulp and paper producer, Bathurst.
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12. Expansion strategy of the company
Conglomerate
 It is a combination of two or more corporations engaged in
entirely different businesses
 All corporations called subsidiaries - fall under one corporate
group called parent company
 Often, a conglomerate a multi-industry company
 E.g. Beximco group in Bangladesh. This conglomerate has
subsidiaries such as Beximco Synthetic Ltd. (textile), Beximco
pharmaceuticals Ltd. (pharmaceuticals), Shinepukur Ceramics
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Ltd. (ceramic), Independent Television (media) etc.
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13. Expansion strategy of the company
Conglomerate
 Conglomerate has businesses in various industries.
Therefore, its risk can be well diversified
 It can enjoy the benefits of vertical integration
 However, it may lose its focus on its core businesses and not be
able to manage unrelated businesses equally well

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14. Expansion strategy of the company
Horizontal Integration
 The acquisition of additional business activities that are at the
same level of the value chain in similar or different industries.
 E.g. Acquiring a competitor entity is a horizontal integration
 Stone Corporation acquired Light corrugated box company in
Philadelphia – a competitor in the region – to expand the
business beyond Chicago.
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15. Current situation of the company
Financial Leverage
 The company made many highly leveraged acquisitions.
 This made the financial leverage of the company very high.
• The use of debt funds in a profit-making and tax-paying business
improves the equity returns (ROE).
• Financial leverage is the effect that the use of debt funds
produces on returns
• Financial leverage refers to a firm's use of fixed-charge securities
like debentures in its plan of financing the assets.
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16. Current situation of the company
Financial Leverage
 Financial leverage is a double-edged sword.
 It magnifies returns and
 Increases their volatility as well.
 Increased volatility implies greater financial risk – the chance that the
company may not be able to meet its debt obligation and go bankrupt.
 The higher financial leverage, the more it magnifies profits as well as
losses.
 It is measured by Debt to total capital ratio or by Debt to equity ratio
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17. Current situation of the company
Degree of Financial Leverage (DFL)
 It measures to what extent net income will vary with the change
in operating profit (EBIT) given a certain level of debt.
 It is calculated by dividing %change in net income by %change in
operating profit.
 The higher the DFL, the higher the impact of financial
leverage, and the more it magnifies profits as well as losses
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18. Current situation of the company
Degree of Combined Leverage (DCL)
 It measures the total impact of DFL and DOL.
 It is calculated by dividing %change in net income by %change in
sales.
 The higher the DCL, the higher the impact of total leverage, and
the more it magnifies profits as well as losses
 Companies with high DOL should maintain low DFL to reduce risk
– so, companies which require to incur high fixed costs to carry
out businesses should go for low level of debt
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19. Current situation of the company
Cross sectional comparison: year 1992
Financial Stone Chesapeake Union Camp Westvaco Willamette
Ratios Corporation Corp. Corp. Corp. Inds.
Return on
(3.2%) 0.5% 2.5% 5.8% 3.4%
sale (NPM)
Return on
total capital 3.5% 4.4% 3.2% 6.6% 6.0%
(ROI)
Return on
(14.7%) 1.3% 4.1% 7.7% 7.0%
Equity (ROE)
Current Ratio 1.8 2.4 4.2 1.9 1.5
Debt to total
78.2% 51.1% 48.9% 37.8% 43.7%
capital
Interest
0.5 1.6 1.3 3.6 2.4
Coverage
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Earnings per
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(2.50) 0.17 1.10 2.06 1.52
share (EPS)
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20. Current situation of the company
Cross sectional comparison
90.00%
80.00%
70.00%
60.00%
50.00% Stone Container Corp.
40.00% Chesapeake Corp.
Union Camp Corp.
30.00% Westvaco Corp.
20.00% Willamette Inds.
10.00%
0.00%
Return on sales Return on total Return on equity Debt to total
-10.00% (NPM) capital (ROI) (ROE) capital
-20.00%
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21. Current situation of the company
Time series comparison: Stone Container
Financial Ratios 1992 1991 1990
Return on sales (NPM) (3.2%) 0.5% 2.5%
Return on total capital (ROI) 3.5% 5.2% 10.6%
Return on equity (ROE) (14.7%) (3.2%) 6.5%
Current ratio 1.8 1.8 1.4
Debt to total capital 78.2% 73.1% 73.7%
Interest coverage 0.5 0.8 1.4
Earnings per share (2.50) (0.78) 1.56
%change in sales 2.53% -6.46%
%change in EBIT -35.49% -49.14%
%change in net income -261.30% -151.47%
DOL 14.01 7.61
21 DFL 7.36 3.08
DCL
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103.15 23.46
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22. Current situation of the company
Time series comparison
90.00%
70.00%
Return on sales
50.00% (NPM)
Return on total
capital (ROI)
30.00%
Return on equity
(ROE)
10.00%
Debt to total capital
-10.00% 1990 1991 1992
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-30.00%
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23. Problem in Question
• High financial leverage and high operating leverage with cyclical
downward movement in prices of output
• This situation left the company with the uncertainty on how to pay back
the large amounts of debt that were due in the coming year.
• Operating leverage cannot be decreased since high operating leverage is
the essence of the business
• Therefore, financial leverage must be brought down
• They now face the problem of which of the 5 alternatives available to
them is the best plan of action to take to arrive at a sound financial plan.
• The goal of this plan was to relieve the immense debt that was plaguing
them, help it get through the paper pricing trough, and also restore the
company to its former glory of financial stability.
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24. Option 1
Loan restructuring
• The borrower works with the same agreement.
• The terms of the agreement are altered, such as extending
the date by which balance must be paid off.
• This means the borrower does not create a new account and
continue to work with the same creditor as before.
• restructuring equates to modification.
• In the case of Stone Corporation, among the five
alternatives, one was loan restructuring
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25. Option 1
• Loan restructuring
– The terms on the bank loans could be renegotiated to
extend their maturities and ease some of the binding
covenants. Fees for this transaction would range from $70
to $80 million.
• The effects of this would be $70-80 million in fees.
• This option doesn't decrease the Stone's family's interest in
the company further
• However, it doesn't involve any new inflow of fund.
• It can be accepted.
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26. Option 2
• Assets or equity interest in a Stone Container Corporation
subsidiary could be sold for a cash flow of $250 to $500
million.
• Selling equity interest would decrease the Stone family's
interest in the company further below 30%
• Selling assets is not good for the future of the core business
• However, it would bring in the funds needed to help decrease
the company's debt
• It should NOT be accepted
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27. Option 3 & 4
Loan refinancing
• Borrower applies for a new loan and thus start working with a
new lender.
• Borrower may get better terms under the new contract, but
does not alter the terms of the original loan.
• Borrower uses the funds from the new loan to pay off the
original debt.
• refinancing equates to replacement.
• In the case of Stone Corporation, among the five
alternatives, two were loan refinancing
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28. Option 3
• Debt refinancing
– The bank debt could be repaid by selling intermediate-term senior
notes to the public. $300 million of 5-year notes bearing a coupon in
from 12% to 12 ½% could be sold.
– This is a bond that takes priority over the other debt securities sold by
the company. If Stone were to go bankrupt, this debt must be repaid
before other creditors receive payment.
– This would replace the debt that was due in the coming year. The
company would avoid a possible default
• without losing its creditworthiness,
• Without reducing Stone family’s interest in the company
• Without selling any asset of the company
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29. Option 4
• Debt refinancing
– The company could sell up to $300 million of convertible subordinated
notes. The notes would have 7 year life, bear a coupon of 8 ¾%, and
be convertible into Stone's common stock
– The other debt securities sold by the company take priority over this
bond. If Stone were to go bankrupt, this debt would be repaid only
after other senior creditors receive payment.
– This would replace the debt that was due in the coming year. The
company would avoid a possible default
• without losing its creditworthiness,
• Without reducing Stone family’s interest in the company
• Without selling any asset of the company
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30. Option 3 and 4 compared
Loan annual Net Total
EBIT Loan term interest EBT Tax
amount interest income ROE interest
(M) in yr rate (M) (M)
(M) (M) (M) (M)
Option 3 169.04 300 5 12.50% 37.5 131.54 46.04 85.50 7.10% 187.5
Option 4 169.04 300 7 8.75% 26.25 142.79 49.97 92.81 7.71% 183.75
From the table above,
• Subordinated notes offered the higher ROE and involved the lower
amount of interest charges.
• Additionally, subordinated notes had claim only after the claims of
other senior debts were met.
• Then, subordinated notes had longer maturity
• Therefore, convertible subordinated notes should be preferred to
the senior notes in this case
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31. Option 5
• Common stock of up to $500 million could be issued to the
public which would produce net proceeds for the company of
95% of the offering price.
• This option could potentially allow the company to put $475
million towards its debt.
• However, this would decrease the Stone family's interest in
the company further below 30%
• It should not be accepted
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32. Recommendation
Option 1
– Renegotiating the terms of loans would allow the company
more time to restructure its debt portfolio and give them a
chance to depend less on an alternative that decreases the
family's share in the company.
– This option outweighs the alternative to sell equity in the
company or its subsidiaries because there is no loss of
family stake in the company.
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33. Recommendation
Option 4
– The shareholders of the company could earn good return
on their equity.
– This alternative outweighs the option to issue senior notes
because the ROE is higher and the total interest paid is less
– The longer life of this option would allow Stone to spread
out its default risk farther than any of the other options.
– This option would also keep the Stone family's interest in
the company the greater than compared to option number
five.
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34. Conclusion
• If Stone Corporation wants to stay out of bankruptcy it needs to
restructure its debt.
• The company had a long time standing of not needing debt or paid it off
quickly but that changed because of large acquisitions.
• Five debt reducing alternatives were presented to the company in order
to
– relieve the immense debt that is plaguing them,
– help it get through the paper pricing trough,
– help restore the company to its former glory of financial stability.
• Two options offered the biggest rewards.
– The company should restructure its loan terms and
– issue $300 million in convertible subordinated notes
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