Verso Paper Corp. (VRS) came public midway through the month of may with a pricing of $12.00 per share. After many other successful launches of IPOs in April, underwriters were trying to make the most of the new-found liquidity and get as many deals priced as possible in order to collect their fees while they could. Verso Paper, however, didn’t possess many of the same characteristics that made IPOs such as Visa and Intrepid Potash successful.
For starters, the company is operating in a very stale sector. As a manufacturer of coated paper, the company is very much at the mercy of the overall economic environment. Most of Verso’s business comes from the direct mailing and catalog industries which are seeing volumes decline as weak consumer spending makes this type of advertising much less effective. Industry statistics showed a 4% decline in catalog circulation in the first quarter which is certainly not good news for the company. While many analysts are optimistic that these dynamics will change, an optimistic viewpoint seems more based on hope than on the current evidence in the market.
Another headwind that the company must face is a certain amount of competition from abroad. While the last several years have witnessed a decline in the North American manufacturing capacity, there is still a bit of a glut as far as supply from Europe. According to one source, there is still 500 thousand to 1 million tons of excess coated paper on the European market. While shipping costs may begin to take their toll on imports, it should be noted that as much as 23% of the coated paper is supplied by imports.
A weakening dollar has kept this issue from coming to the forefront as the weak dollar makes it more difficult for companies to import. But as the dollar begins to stabilize and the potential for interest rate hikes comes into play, imports will likely become more attractive and increase the number of participants that Verso must compete with. In a commodities type of marketplace where there is little or no differentiation between competitors products, producers must simply take the “going rate” for their products and that rate has a long-term tendency to fluctuate based on the cost of production. Hence, margins often get squeezed to the point where profitability is very difficult.
Apollo is the majority shareholder in Verso and still owns roughly 73% of the company. Shares will likely remain under pressure until it becomes clear exactly what Apollo plans to do with its remaining position. If the shareholder were to liquidate some or all of its position, the glut of stock hitting the market would most likely push the price even lower. As long as this possibility remains out there, it is unlikely the stock will trade significantly higher.
Looking ahead, JP Morgan has set estimates for the next two years. They are calling for earnings of $0.50 per share in FY 2008 and $1.60 in 2009. The assumption is based on 1) higher selling prices, 2) stronger volumes, and 3) lower interest expense. These three assumptions all seem to have problems as higher prices are unlikely to materialize in a weakening economy, volumes are already seeing pressure and it is unlikely we have seen the worst, and interest rates could quite possibly rise fast enough to offset any savings from the company paying down debt.
I remain cautious on Verso Paper and would not initiate a long position. In fact, there may be opportunistic periods where shorting may be profitable. As mentioned, the stock could move significantly lower if Apollo makes any kind of liquidation announcement. In short, this is a difficult market for IPOs with a developing but yet to be proven story. Unless performance is already in the bag, stock prices will likely be volatile and more often than not trending lower.
FD: Author has a short position in VRS
Additional ReadingVerso Paper Corp. (VRS) –