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

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Nine Dragons Paper 2009

The market waits for no one.
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 companys 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?

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NDPs sales and profit growth had been exceedingly good until now

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

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Mrs. Cheungs appetite for growth capital expenditures was far beyond the companys operating cash flow capabilities to self-fund

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

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

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Nine Dragons Paper -- 2009: Case Questions

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?

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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 industrys value chain which have the larger margins. And choosing not to own all links in the value chain Mrs. Cheungs approach is one which she believes will reduce all significant risks in the companys ability to grow rapidly, not being dependent on Chinas infrastructure or other business-based product and service providers for critical elements of NDPs 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 thats just part of being great

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Nine Dragons Paper -- 2009: Case Questions

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 companys 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 semicommodity based business NDPs rate of profitability, however, has been sliding, reflecting rising input prices and greater competitive markets for its products The companys 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

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Nine Dragons Paper -- 2009: Case Questions

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 NDPs 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 NDPs cash flows are under a lot of pressure given the fall in expected operating cash flow combined with Mrs. Cheungs 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!

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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. NDPs 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 companys 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 companys 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
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Earnings, Cash Flow, and Debt Analysis of Nine Dragons Paper: 2009 Actual
Rmb (millions) INCOME Net sales Cost of goods manufacturing EBITDA Percent of sales Depreciation & amoritization EBIT Percent of sales Interest Pre-tax Profit (EBT) Percent of sales CASH FLOW EBITDA Less taxes paid Less net financial Less working capital Operating Cash Flow Capex Acquisitions Disposals & other Investing Cash Flow Equity raised Debt raised Dividends Other Financing Cash Flow Net Changes in Cash FREE CASH FLOW Operating Cash Flow Less capex Free Cash Flow (FCF) 755 (5,345) (4,590) 1,396 (9,601) (8,205) 1,368 (4,450) (3,082) 3,921 (3,739) 182 2,637 (93) (272) (1,517) 755 (5,345) (208) 28 (5,525) 2,011 1,795 (199) 119 3,726 (1,044) 2,773 (263) (102) (1,012) 1,396 (9,601) (208) (9,809) 8,594 (495) 171 8,270 (143) 2,185 (345) (1,057) 585 1,368 (4,450) 31 (4,419) 2,000 (224) (17) 1,759 (1,292) 2,505 (175) (886) 2,477 3,921 (3,739) (3,739) (224) (12) (236) (54) 9,838 (7,201) 2,637 26.8% (370) 2,267 23.0% (105) 2,162 22.0% 14,114 (11,341) 2,773 19.6% (507) 2,266 16.1% (102) 2,164 15.3% 14,517 (12,332) 2,185 15.1% (648) 1,537 10.6% 233 1,770 12.2% 13,129 (10,624) 2,505 19.1% (760) 1,745 13.3% 92 1,837 14.0% Sales were even lower than expected, but costs were significantly lower than predicted. KEY. EBITDA was therefore about 20% better than expected. 2007 2008 May 11, 2009 2009e Actual 2009 Discussion

Net interest income rather than expense from repurchase. Profit slightly better than analyst expectations.

Tax strategy benefits appear large and real.

OCF three times what analysts expected. Did not execute all that leadership had indicated.

Final investing cash flow smaller than expected.

Did not raise more debt as expected.

Net paydown, slightly, of debt, rather than an increase. Negligible in the end.

FCF ended positive; strong result all things considered.

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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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