The Asia Pulp & Paper debt default 5 comments

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The 2001 bond default of Asia Pulp and Paper, among the world's ten largest pulp processing and paper manufacturing companies, was the largest such case in corporate Asia and led to a collapse of confidence and consequently prices of assets in Southeast Asia, and Indonesia in particular, in the starting years of the new millenium. To many, it was a shock given the reputation of the management-owners (the well-connected Widjaya clan, owners of Indonesia's third largest conglomerate Sinar Mas), as well as the underwriters involved in the erstwhile bond deals (big Wall Street firms, eg JP Morgan, Goldman Sachs).

The plight that Asia Pulp and Paper landed itself in was a classic case of excessive leverage to fund expansion. In the early 1990s the Widjayas had raised capital primarily on the Jakarta exchange to fund domestic growth but in the mid-1990s decided to embark on an aggressive expansion strategy to turn their pulp and paper operations into a truly global player. To fund this expansion, they needed billions of dollars. The HQ was moved from Indonesia to Singapore in 1994 (explanation: "If one portrays oneself as Indonesian, money costs a lot more than it does for a Singaporean") and operations consolidated under Asia Pulp and Paper. The company commenced a global drive for funds and managed to issue billions of dollars worth of bonds starting 1994, with the help of the eager Wall Street investment banks, and a story that sold with investors: an emerging market blue-chip, with competitive advantage in fast-growing Indonesian hardwood, and operating in low-cost Indonesia while collecting revenue in dependable US currency. The company's ADRs (American Depository Receipts) were listed on the NYSE in 1995, another coup for the company.

When did things start to go wrong? The signs were there early, the effects only apparent when recession struck in 2001. The company did expand its manufacturing and marketing operations prodigiously in Indonesia, China and India using the raised funds, but at high financing costs. In 1995, the company's interest payments were US$448 million. By 1999 annual interest payments had climbed to >US$650 million. That year the company lost $23 million. APP's interest coverage--the ratio of cash flow to interest costs--averaged only 1.5 from 1996 to 1998, far below that of blue-chip debt issuers in the global pulp and paper industry. That meant that the company generated only one and a half times the cash it needed to meet payments. In February 1997, S&P rated APP notes a B+. By May 1998, they were downgraded to CCC+, junk bond status. Although the company had survived the Asian financial crisis relatively well, the collapse of confidence in Asian assets must also have drained liquidity to Asian markets and caused debt refinancing for APP to become more expensive. Indeed, by 2000, APP raised funds for its China unit promising a 17% bond yield; this was followed by another private placement promising a 30% yield.

The company's debt-related cash flow problems were compounded in 1999-2001 first by imprudent operations in China where APP's paper turned out to be too luxurious for the China market whose demand for for simple low-grade paper, and then the collapse in paper prices by about 50% from just a few months from 2000 to 2001.

The inevitable happened in March 2001 when the company unilaterally declared a debt moratarium and stopped servicing its debt since then. By then, APP's debt was a staggering US$13 billion. Amid accusations of fraud by sceptical investors (primarily fund managers who had bought into APP's bonds earlier) who wondered where all the money had gone (reasonable given the magnitude of the funds raised and the fact that Sinar Mas' other operations had suffered badly from the Asian financial crisis and needed funds badly), the Widjayas moved their base from Singapore back to Indonesia. Investigations made by separate auditors for the creditors and for APP later uncovered suspect or questionable transactions and balance sheet entries made by APP's Indonesian subsidiaries in preceding years, such as provisions for receivables and doubtful debts, as well as reported derivative losses, to the tune of US$5 billion. It is quite surprising that there does not seem to be any official follow-up action to trace the route back to where all this money ended up, though one might be able to deduce with a high degree of probability.

Ultimately, the debt repayment issue came to a partial close with APP and its creditors agreeing to a repayment scheme that would see APP return creditors almost US$7 billion over 10 years, covering the debt of its Indonesian subsidiaries. The debt of its non-Indonesian subsidiaries were not covered by the arrangement. The APP ADRs had long been delisted from the NYSE; it had fallen to <20 cents in 2001 when it declared the moratarium, from an IPO price of $11 in 1995.

As for the Widjaya family, ultimate owners of APP, there was no forced pledging of their personal assets, nor any injection of assets to prop up the company for debt restructuring. The family and their associates were still left as the operational managers after the whole debacle. The bondholders and ADR holders were the ones who suffered the most, the former suffering haircuts as high as 50% or more, the latter probably more looking at the abovementioned collapse in APP's ADRs on the NYSE prior to delisting.

If one is wondering why Golden Agri-Resources or Asia Food & Properties are trading so far below their NTA (50-60% of NTA) even though they have substantial revenues and have been making good reported operational profits, one has only to look at the ownership -- they are both subsidiaries of Sinar Mas. Investors do not forget easily. Fool me once, shame on you; fool me twice, shame on me.

References:
(1) BusinessWeek article Aug 2001: Asia's Worst Deal
(2) AsiaTimes article Oct 2002: Asia Pulp&Paper to cough up cash to creditors
(3) Bloomberg article Mar 2001: Asia Pulp & Paper to Default on $12 Billion in Debt