MC01Eiteman743464_13_MBF_MC01.ppt

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Nine Dragons Paper and the 2009 Credit Crisis

Was the global credit crisis about to claim another victim?

"This time is really different. Large and small are all affected. In the past, the big waves would only wash away the sand and leave the rocks. Now the waves are so big, even some rocks are being washed away."

– Cheung Yan, Chairwoman, Nine Dragons Paper


• Publicly traded privately controlled Chinese company incorporated in Bermuda with major subsidiaries in the United States

• Aggressive expansion of production capacity which has required massive amounts of capital and debt financing

• Aggressive vertical integration and horizontal integration, including acquisition of assets and enterprises associated with the company’s core value chain and supporting its massive energy, water, materials, and transportation needs

• Rapid sales growth while maintaining excellent margins for a company in this industry globally

• Rapid capex investment has resulted in rising leverage and a continuous degradation of its credit quality to junk bond levels

• Has NDP sacrificed financial stability for profit pursuit?

Nine Dragons Paper – 2009The market waits for no one.

– Cheung Yan, Chairwoman, Nine Dragons Paper


NDP’s sales and profit growth had been exceedingly good … until now


Nine Dragons sourced pulp and OCC from a variety of sources and countries, but sold its containerboard within China


Mrs. Cheung’s appetite for growth – capital expenditures – was far beyond the company’s operating cash flow capabilities to self-fund


NDP’s share price had been sliding continually since September 2007. The recent profit warnings and growing concerns over rising debt had pushed it further down.



Exhibit 6 The Evolution of Earnings, Cash Flow, and Debt Analysis of Nine Dragons Paper (cont.)


1. How does Mrs. Cheung think? What does she believe in when it comes to building her business?

2. How would you summarize the company's financial status? How does it reflect the business development goals and strategies employed by Mrs. Cheung?

3. Is NDP in trouble? How would your answer differ if you were an existing shareholder, a potential investor, or an analyst?

Nine Dragons Paper -- 2009: Case Questions


1. How does Mrs. Cheung think? What does she believe in when it comes to building her business?

• Mrs. Cheung believes in a rapid growth strategy in which she is building productive capacity, which she hopes and expects, to dominate her industry segment in years to come

• Her strategy of vertical and horizontal integration is “old style,” most companies today choosing to focus on specific activities in an industry’s value chain which have the larger margins. And choosing not to own all links in the value chain

• Mrs. Cheung’s approach is one which she believes will reduce all significant risks in the company’s ability to grow rapidly, not being dependent on China’s infrastructure or other business-based product and service providers for critical elements of NDP’s business

• She believes that corporate productive capacity comes first; if that requires a longer-term horizon for investment, bearing greater debt burdens along the way – well that’s just part of being great



2. How would you summarize the company's financial status? How does it reflect the business development goals and strategies employed by Mrs. Cheung?

• NDP has been investing at an incredible pace – best demonstrated by comparing the company’s cash flows from operating activities in 2007 and 2008 with the cash flows from investing activities. The short-fall in operating cash flow must then be made up by financing activities – which has been both raising equity and debt – but mostly debt

• NDP has clearly been profitable in recent years, and demonstrates a high rate of profitability one would not ordinarily see in this type of semi-commodity based business

• NDP’s rate of profitability, however, has been sliding, reflecting rising input prices and greater competitive markets for its products

• The company’s growing debt burden is large and getting larger; most analysts and investors clearly wish Mrs. Cheung would slow her capital expenditure plan – at least a bit – to take growing cash flow and debt-service pressure off the company during the global recession and credit crisis



3. Is NDP in trouble? How would your answer differ if you were an existing shareholder, a potential investor, or an analyst?• Although the analysts are constantly updating their forecasts on NDP’s

current year financial results, the company still appears to be marginally profitable in this difficult business environment.

• But profitability is a concept which focuses more on the corporate income statement, not cash flows. And NDP’s cash flows are under a lot of pressure given the fall in expected operating cash flow combined with Mrs. Cheung’s pronounced commitment to continue to expand capital expenditure rapidly. The result is that it appears the company will need to borrow even more to survive the year.

• Existing shareholders are clearly down, and would like to see the company take measures to improve share price sooner rather than later. They are, however, minority shareholders, Mrs. Cheung and family holding more than 70% of the firm.

• Potential investors might see the company has a “good bet,” given the current share price low and the prospects for long-term competitiveness – if the company survives to be a player in the long run!



Nine Dragons Paper (NDP): What Happened … so far

• NDP finished 2009 with much better financial results than expected. Using the actual 2009 results on the following page, a few observations follow.

• NDP’s operating margin, EBITDA, was much stronger than expected. Although sales came in below analyst expectations, direct costs were much, much lower than expected. Basic business earnings were not down as significantly as expected.

• Repurchasing much of the company’s outstanding debt actually resulted in a net positive interest income line item. (This would raise some substantial questions about what the debt covenants had stated about the company’s ability to repurchase its own debt if distressed.) Tax obligations were also coming in lower than expected.

• In the end the company did not have to take on additional debt during the 2009 fiscal year, partly as a result of not actually investing at the levels of capex that had been publicized


Earnings, Cash Flow, and Debt Analysis of Nine Dragons Paper: 2009 Actual

May 11, 2009 ActualRmb (millions) 2007 2008 2009e 2009 Discussion

INCOME

Net sales 9,838 14,114 14,517 13,129 Sales were even lower than expected, but …Cost of goods manufacturing (7,201) (11,341) (12,332) (10,624) … costs were significantly lower than predicted. KEY.EBITDA 2,637 2,773 2,185 2,505 EBITDA was therefore about 20% better than expected. Percent of sales 26.8% 19.6% 15.1% 19.1%Depreciation & amoritization (370) (507) (648) (760) EBIT 2,267 2,266 1,537 1,745 Percent of sales 23.0% 16.1% 10.6% 13.3%Interest (105) (102) 233 92 Net interest income rather than expense from repurchase.Pre-tax Profit (EBT) 2,162 2,164 1,770 1,837 Profit slightly better than analyst expectations. Percent of sales 22.0% 15.3% 12.2% 14.0%

CASH FLOW

EBITDA 2,637 2,773 2,185 2,505 Less taxes paid (93) (263) (345) (175) Tax strategy benefits appear large and real. Less net financial (272) (102) (1,057) (886) Less working capital (1,517) (1,012) 585 2,477 Operating Cash Flow 755 1,396 1,368 3,921 OCF three times what analysts expected.

Capex (5,345) (9,601) (4,450) (3,739) Did not execute all that leadership had indicated. Acquisitions (208) (208) - - Disposals & other 28 - 31 - Investing Cash Flow (5,525) (9,809) (4,419) (3,739) Final investing cash flow smaller than expected.

Equity raised 2,011 - - - Debt raised 1,795 8,594 2,000 - Did not raise more debt as expected. Dividends (199) (495) (224) (224) Other 119 171 (17) (12) Financing Cash Flow 3,726 8,270 1,759 (236) Net paydown, slightly, of debt, rather than an increase.

Net Changes in Cash (1,044) (143) (1,292) (54) Negligible in the end.

FREE CASH FLOW

Operating Cash Flow 755 1,396 1,368 3,921 Less capex (5,345) (9,601) (4,450) (3,739) Free Cash Flow (FCF) (4,590) (8,205) (3,082) 182 FCF ended positive; strong result all things considered.


Our future path of development may remain thorny ahead, but armed with the shared confidence and courage throughout the Group to overcome and conquer, we are poised to act even more diligently and powerfully to prepare for the next global economic recovery…

– "Chairlady's Statement," 2008/09 Interim Report, Nine Dragons Paper (Holdings) Limited

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