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Rating Action:

MOODY'S ASSIGNS B2 TO SENIOR SUBORDINATED NOTES OF LONGVIEW FIBRE COMPANY

10 Jan 2002
MOODY'S ASSIGNS B2 TO SENIOR SUBORDINATED NOTES OF LONGVIEW FIBRE COMPANY

Approximately $185 Million of Debt Securities Affected.

New York, January 10, 2002 -- Moody's Investors Service assigned a B2 rating to Longview Fibre Company's proposed $185 million senior subordinated notes due January 15, 2009. At the same time, Moody's assigned a senior implied rating of Ba3 and a senior unsecured issuer rating of B1. The rating outlook is stable. Moody's last rated this company in 1998, at which point its P-3 commercial paper rating was not renewed.

Proceeds of the senior subordinated note offering will be used to refund a like amount of the company's existing revolving credit facility, which has a current balance of $317MM. The remaining balance of this facility will be refunded with proceeds of a new $250MM revolving credit line that the company is obtaining. Moody's is not rating this new revolving credit facility.

The senior subordinated notes will be in the form of a seven-year bullet issue that is non-callable for four years and will not be guaranteed by any of the company's subsidiaries. However, 99% of all cash flow and assets reside at the parent company level.

The ratings are supported by the significant value represented by the company's fee timber resources and by the completion of capital spending initiatives and a recent dividend reduction that should augment free cash flow going forward and permit improvement in the company's financial profile. However the ratings also reflect that two of the company's three segments-paper and paperboard and converted products-have been unprofitable on an operating income basis over the six-year 1996-2001 period, although they have generated positive EBITDA in each of those years. This has led to substandard returns over the period, especially considering the moderately heavy debt leverage employed. As a result, EBIT coverage of interest has been erratic and thin.

The company owns 572,000 acres of fee timber in Washington and Oregon, with 85% of its nine tree farms located west of the Cascades and 60% of the timber being Douglas Fir. Roughly one-third of this segment's sales in 2001 were derived from the export market, principally log exports to Japan, where the demand for logs of the age and quality of Longview Fibre's product permits price realizations 50-60% higher than in the U.S. market. Although Japan is now taking some converted lumber products rather than exclusively whole logs as it did in the past, Longview Fibre continues exporting high margin whole logs to Japan. (The company has only one sawmill in its timber operations, which generates approximately 18% of this segment's revenues and is primarily oriented to domestic markets). The housing market in Japan, while weak over the past few years, is still quite sizable at around 1.2MM starts per year. However, this weakness has translated into softening log prices, with a 10.6% price decline experienced by the company in 2001. Although carried on Longview Fibre's books at a cost of $222MM, its timber holdings are believed to be worth substantially more. The timber segment accounted for $498MM in operating profits from 1996-2001, or 120% of total company operating profits of $414MM over this period. Operating margins have ranged from the low 40% range in the past two years to the mid-50% range in the mid-to-late 1990's. The company manages its timberlands on a 60-year harvest cycle vs. an average industry rotation of approximately 48 years, and notes that speeding up to a 55-year cycle would throw off an incremental $52MM of annual EBITDA for up to five years.

The company's paper and paperboard operations consist of a single pulp mill and 12 paper machines on a 350-acre complex located in Longview, Washington, with more than 3300 tons average daily paper and paperboard production capacity. Its annual rated capacity exceeds one million tons. The company is the second largest North American producer of unbleached kraft paper, behind IP, with an estimated 14.3% share of the market based on production capacity. Approximately 60% of output is transferred at cost to the company's converted products operations, with the balance sold to a small number of export customers and to a large number of geographically diversified domestic customers. The company produces all of its own unbleached pulp, representing 90-95% of total pulp requirements, and is a net buyer of bleached pulp, representing 5-10% of total pulp requirements. The Longview mill contains six steam-driven generators with the capacity to produce 40 mega-watts of power and one natural gas-fired co-generation facility with 60 mega-watts of capacity. In 2001, owing to the power shortages in California, the company was able to sell $77MM of electric power (9% of total company revenues in 2001), which generated operating income of $35MM. Approximately $16MM of this operating income was allocated to the paper and paperboard operations and $19MM was allocated to the company's converted products operations.

Longview Fibre's converted products operation owns and operates 17 converting plants in 12 states and produces corrugated shipping containers, specialty packaging, and kraft merchandise bags. These plants received 98% of internal paper and paperboard requirements in 2001, at cost, from the Longview mill. Considering the degree of integration between the two operations, i.e., between the paper and paperboard operations and the converted products operations, as well as the intersegment pricing policy (at cost), the two segments should be viewed together in the financial analysis to follow.

Over the six-year 1996-2001 period, the paper and paperboard segment and the converted products segment had combined operating losses of $84MM, despite a general domestic uptrend since 1997 in unbleached kraft linerboard prices and in corrugated fiber box prices and generally strong pricing in unbleached shipping sack throughout the period. In addition, while the two segments combined did register operating income of nearly $9MM in 2001, this occurred after allocation of $35MM in operating income to the two segments from power sales. (After netting out the estimated $10 million of increased power costs to the paper operations from purchasing power externally rather than using self-generated power, roughly $25 million of operating income from power sales was allocated to the two segments).

The combined revenues of the two segments in 2001 was $638MM on a net fixed asset base of over $800MM. Moody's notes that many paper companies have a higher revenue to fixed assets ratio. During the single best year of performance for these two segments in the six-year period, which was 2000, the combined operating margins of the two segments was under 4%. Again, Moody's notes that many of the other industry participants generate higher operating margins. The profitability of these operations must be dramatically improved in order to justify the substantial asset values.

Longview Fibre has completed a heavy capital spending cycle in which some of the early benefits realized are increases in EBITDA per ton in both the paper and paperboard and in the converted products segments. Capital spending should fall to less than half of the recent annual levels. Combined with a recent dividend reduction from 12 cents per share to 3 cents, the company should begin to generate growing free cash flow in the next few years, which it has indicated will be largely devoted to debt reduction. The debt/capitalization ratio at the current time, however, pro forma for the subordinated note offering and the new revolving credit facility, is 58.7%. Coupled with single digit returns on assets and on equity, this has resulted in a thin EBIT interest coverage figure of 2.4x for 2000 and 1.9x for 2001. These results, i.e., poor returns and thin interest coverage, would have been even weaker if it had not been for the following three factors:

1) The company has changed its accounting standards by extending the depreciable lives of its fixed assets in order to approximate more closely the current industry norms. Moody's notes that the $66MM of depreciation expense taken in 2001 (vs. $80MM expensed in 1999) on a gross fixed asset base of $1.8 billion represents a lower rate of depreciation than that of others in the industry. (Alternatively, if the company were to have restated its numbers when it changed its depreciation schedules or were to have used its new depreciation schedules from the very beginning, the depreciation number in fiscal 2001 would likely have exceeded $75 million.)

2) The not-likely-to-be recurring power sales in 2001 augmented operating income by $35MM (by $25MM, after netting out increased power costs to the company's paper operations).

3) Pension gains of $19MM taken in 2001, or 25% of reported operating income, represent a non-cash contribution to income and may not necessarily recur. Separately, Moody's notes that while Longview Fibre has an overfunded pension plan, it, like others in its industry, benefits from assumptions regarding future returns which may have to be reduced given the current environment.

Longview Fibre Company is approximately 20%-owned by the founding Wollenberg and Wertheimer families and their descendants, with the largest individual ownership position being 6%. Although the company maintains that it is not obligated to repurchase any additional shares that may be offered by the founding families, it did purchase 600,000 shares in 2000 and in 2001 from one of the estates pursuant to a stock redemption agreement.

Started in 1926 and headquartered in Longview, WA, Longview Fibre Company is an integrated forest products, paper, and packaging company.

New York
Robert N. McCreary
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Joseph A. Snider
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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