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Chandan Dubey
Chandan Dubey
Articles (150) 

Jockey Angle: Fortress Paper

October 18, 2013 | About:

$=Canadian $

LT+ST Debt: $227M

Market Cap: $87M

Provisions+Employee Benefits: $5.5M

Cash: $136M

EV: $183.5M

Book Value: $364M

FCF: -$125M (2012)

Share price: $6 (Oct 18, 2013)

Book per share: $25

Shares outstanding: 14.5M

Fortress Paper (TSX:FTP), founded in 2006, is a Canadian company. It operates in two business segments: the dissolving pulp (DP) segment and the security paper products segment.

Business: The company owns and operates the following facilities (a) A DP producing mill called Thurso, in Canada (b) Landqart mill producing banknotes, secure papers for Visa, Passport, etc., in Switzerland, (c) a high security research facility in Canada producing optically variable thin film material, and (d) a recently acquired mill in Lebel-sur-Quévillon, Québec which the company intends to convert into a DP producing mill.


DP is produced from pulpwood and is used to make textiles (e.g. Rayons), cellophane and other cellulose products. DP is a high-volume, low-margin business and has some interesting price correlations to the much larger cotton market. The Thurso mill produces DP which is then shipped and sold in China. The mill also started a cogeneration facility to provide up to 18.8 MW per annum, supplying electricity to Hydro-Quebec for a 15-year term. This will provide an additional $14 million to $18 million in income, making the Thurso mill one of the lowest cost DP producers in the world.

LSQ is planned to be the next Thurso with nearly double the DP production capacity and the energy production capacity. Due to crash in the price of DP, the management seems to be reassessing its plan to retool the facility by 2015. The management has made it clear that LSQ will only go ahead if the management can find sponsors to fund the capital needs at the plant.

Printing banknote, and other secure papers for Visa and passport is a sticky business. Winning new business is the hard part, but once a country signs up with a manufacturer, they tend to stay customers for lengthy periods. Landqart is the sole supplier for the Swiss franc and prints euros for 10 countries. The strength of the Swiss franc has adversely affected the demand and production costs at the Landqart facility. After bleeding cash for the past few years, the management has been able to slowly turn the mill EBITDA positive.

History: The company was established as a wholly owned subsidiary of Mercer, one of the largest market softwood kraft pulp producers. In the fall of 2006, Mercer transferred two mills Dresden and Landqart for $15 million, $7.5 million in face value of preferred shares and convertible note of $7.5 million. A Canadian entrepreneur, Chad Wassilenkoff, reviewed and negotiated the transaction. Mr. Wassilenkoff became the CEO of the new company and he installed experience European management, led by Dr Alfonso Ciotola as COO and Erich Sulser as CFO.

The company was then capitalized by sale of 2.75 million common shares. The first 2 million were sold in a private placement at $4 each. Wasslienkoff bought 446,000 shares from this placement, for an aggregate of $1.78 million of his own money. The rest i.e., 750,000 shares, were awarded to Wassilenkoff as incentive. Out of the proceeds of $8 million, the company retired the preferred shares of Mercer and kept the rest, i.e. $500,000, as working capital. The company made two additional private placement in early 2007 with 453.5K shares at $4 each, for an aggregate sum of $1.7 million.

The company raised $46 million by selling 5.75 million shares at $8 each in its June 2007 IPO. Wassilenkoff was awarded 1 million shares in the process. The company raised $42 million in by equity offering during the 2008 to 2009 period and then sold another 1.9 million shares in July 2010 at $23.5 each. Proceeds, among others, were used to repurchase the convertible notes of Mercer, and rebuilding one of the machines at Landqart to increase its production capacity four fold.

The management completed acquisition of the Thurso mill for $1.2 million in April 2010. They entered into a $102 million project financing and $15 million convertible debentures to convert the mill into a DP manufacturer. The $15 million debentures were converted into 750,000 common shares in Jan 2011 at $20 apiece.

On Jan. 4, 2011, Fortress completed the acquisition of assets of Bank of Canada’s Optical Security Material division, which were relocated to Thurso in October 2011. They paid $750,000 for two machines with replacement costs of $15 million each and the intellectual property rights and patents developed over the years at the cost of millions. This division helps make the Landqart mill more competitive.

In February 2011, the company completed a secondary offering of 1.1 million shares at $47.5 each, raising close to $50 million. The company bought the LSQ mill in January 2012 with an intention to convert it into a DP mill. The price was $1 plus commitment of up to $10 million in environmental remediation payments, spread over five years. The conversion will be financed by a 10-year loan of $134 million from province of Quebec at 5% interest rate and $25 million five-year convertible debentures from a Quebec financial institution at a 7% interest rate.

In July 2012, the company raised convertible debentures for $69 million, which can be converted into common shares any time prior to Dec. 31, 2019, at a price of $31 each. After many missteps and setbacks the company started its cogen facility in Thurso and is now providing electricity to the Quebec Hydro grid. The effects of this will be seen in the report of the next quarter.

The Jockey Angle/Management: The CEO Chad Wassilenkoff has displayed excellent capital allocation skills as a contrarian investor. He describes his investment philosophy as follows.

“I look at the media for areas that are going through tough times. Very challenged, and very depressed, with no blue sky whatsoever, and where people aren’t looking for investment opportunities. That’s how I started building several of my previous companies, investing in gold mines when gold was $2.75 an ounce. I bought and sold oil and gas properties, copper deposits, and uranium, which we got when it was $8 a pound.”

Paper and forestry companies are heavily depressed in North America and Europe. There are lots of layoffs and mills are being dismantled, because even after significant capital expenditure in the past decade they are not globally competitive. Handling operations becomes a problem if one does not have a background in pulping. Wassilenkoff hires world class management to run the operations.

“Management is critical to everything I do. I’m not an expert in pulp, any more than I was in gold, uranium, or oil and gas. [...] If you’re looking at industries that are out of favour, it’s easier to attract world-class management teams.”

While other companies, burdened by debt as a byproduct of losses and capital intensiveness of the business, are laying off employees, closing mills and concentrating on cost cutting - Fortress acquires them on the cheap. Unburdened by debt, it brings fresh, out-of-the-box thinking and gives the management a lot of free reign.

“[...] we rely on these industry experts as partners. After all, who am I to tell a guy how to run a mill? We’re really a holding company. We’re the rainmakers. We find an asset in a downed industry, and put together those assets to work well together.”

The Dresden mill, one of the first assets bought by Fortress, is a fitting example of this process. Dresden and Landqart together were bought for $15 million. The company sold the Dresden mill in March 2013 for an aggregate sum of CAD$213 million [src:wsj]. The net sum will be smaller after taxes but that is still a phenomenal return. The story is as follows. Dresden was a manufacturer of wallpaper with deep understanding of the industry, sales cycle and customers. Unfortunately, they were making simplex paper, which is like a photocopy paper and can be made by any paper machine in the world.

“The purchase price was $1, so we had nowhere to negotiate on that side. We evaluated that consumers could buy the same paper from Indonesia, shrink-wrapped in bundles of 500 sheets, with their own logo on it, shipped to Rotterdam harbour, for less than the price this German company was buying pulp for. There was no competitive advantage. It never had a chance, no matter who we put in there or what we tried to do. The only way to make it work would be to shift it completely into a new product.”

Efficiency was not a solution because they would have lost money even if they were among the most efficient simplex paper producers in the world.

“Through research and development, we developed a non-woven type of product. We intermixed more than 20 per cent synthetic fibres with the paper. We make two sheets of paper at once. The top sheet has ideal print characteristics, and the bottom sheet has ideal strength and other characteristics, so now the wallpaper is dry strippable. People do not have to tear it off in 200 or 300 little pulls or steam it off the wall. Once they loosen a corner, it comes off in one pull. We felt this was the challenge in the wallpaper industry. Whenever people were making the decision to buy it, they said, I am not going to put it up because I never want to have to take it off the wall.”

With this one “out of the box” thinking the company started growing between 15% to 20% in a 1% to 2% declining global wallpaper industry. They upgraded the mill three times and more than doubled the capacity. Dresden represents 55% of the global non-woven wallpaper segment and command 20% profit margin.

The only profit making mill in Fortresses portfolio, Dresden, was sold recently. The reasons were not hard to figure out. Even though the non-woven wallpaper was generated internally, it was not exclusive to Dresden and there were already a few players making it. Dresden was efficient and aggressive in its pursuit and hence captured market share and reputation. But this was a commodity product still and the margins were only going to go down in the long term.

The Thurso story is still playing out, but it is instructive to look at the thinking behind the project. This is a capital intensive business. If something breaks, the bills are in millions and the cost escalates because one is still paying for labor, lease etc. If a mill wants to be globally competitive, the price starts at close to billion dollars. In a sector with depressed investor sentiments, it is incredibly difficult to arrange the funding for such a project. The situation at the Thurso mill was not very different. It was bankrupt and not competitive with its commodity product - Northern Bleached Hardwood Kraft (NBHK). NBHK is used to make freesheet paper – paper that has higher brightness than groundwood paper. The previous owner of Thurso had a new business plan. This was to still make NBHK, losing $8 million a year but offset it by making electricity in the cogeneration facility. With government subsidies for green energy, this would make up for the loss in the core product.

“I viewed that approach as a fundamental flaw in the business plan. Why not solve the core problem first? Cogeneration can then be the ancillary product. [...] We have been converting it to make a specialized product with much higher profit margins, and a significant barrier to entry, and good long-term prospects for its underlying product, which is rayon. It is a cheaper and better alternative to cotton. Most of that will be sold to China. It’s the largest and fastest-growing market.”

Thus, they were interested in only the asset side of the business. The Thurso plan was a chemical plant, being operated as a NBHK mill and was not a low cost producer. They acquired the assets for $1.2 million -- a sum which many people thought was too expensive a price for it.

“However, their replaceable insurance cost is $851 million. These assets are more than 95 per cent ideally suited for our new product, dissolving pulp. As we turn this project around and convert to dissolving pulp, we are able to take these $1.2 million assets that were heavily underutilized by the previous owner, and, once we are fully converted to dissolving pulp, even at the initial stages, given the current or spot price of dissolving pulp, the mill will generate just over $200 million in profit. It (also) came with 320 hectares of land on the Ottawa river. Again, the land is worth more than that. People say it’s risky. We don’t think so.”

The DP story is not too outlandish to believe. Cotton production has large environmental impact and rayon is a very worthy replacement. It has double the absorbency of cotton and has more breathability. The growing middle class population in India and China will form the core market for DP. The byproducts are used to make sugar, electricity, cigarette filters and other products. The concept is similar to petrochemical refineries, where multiple products are produced from a single raw material.

“By putting in this cogeneration facility, we burn them (biomass), getting rid of our by-product, and also helping the environment. We eliminate the smells, greenhouses gases and landfill. We signed an agreement with Hydro Quebec for it to buy the power.”

The Landqart mill had a similar thesis. It was the only mill making Swiss francs and was in a niche business to begin with. They have two paper machines, producing paper, and lose $2 million a year -- no matter what they do. Landqart also has a banknote machine -- which loses another $2 million a year. It should be losing $5 million but Landqart makes visa stickers for India and China, bringing the margins up a bit.

After the acquisition they put in $50 million to rebuild the banknote machine, quadrupling its capacity. Although not great, the margins are better for banknotes than paper. Something else was needed to make the operation highly profitable.

“[...] we have a large research and development team that has evaluated the market. We have committed $14 million to a new product. We will bond two thin sheets of banknotes with a polymer layer in the middle. The finished product has more than double the durability of a banknote but has the same feel as a cotton banknote so one cannot tell the difference. We have transparent windows that add significantly more security. We can pick a number out of the air for what we will charge. We decided to charge double. Because of the double durability, it is significantly more cost-effective for the banks.”

They have been successful in creating this new kind of banknotes -- called Durasafe. The smaller machine is already fitted and ready to roll out this high end product which is much more difficult to counterfeit. They already have Moroccan National Bank as their new customers. A second order is to be filled anytime soon -- the customer remains unknown. The Landqart mill is now EBITDA positive.

The LSQ mill has a very similar theory as Thurso. It will have the cogeneration facility and owing to the fact that the machines and assets are much newer than Thurso, will be a lower cost producer than Thurso. But this is all on paper yet. See risks for more discussion.

A good cover story of Chad Wassilenkoff was published in the Globe.

Capital Structure: Current Shares Outstanding: 14,504,337 [src:fortress]. The calculation for number of shares in case of full dilution is as follows.

1) Dec 31/2019: 7% $69M, Conv @ $31 (2,225,806 shares - 15.29% dilution)

2) Dec 31/2016: 6.5% $40M, Conv @ $37.5 (1,066,667 shares - 7.33% dilution)

3) June 30/2017: 7% $25K, Conv @ $32.28 (775 shares - 0.005% dilution)

Total potential dilution : 3,293,248 - 22.7%.

The management has indicated that they will loathe diluting the equity holders further. Their words hold credence because the CEO Mr. Wassilenkoff holds 16-17% of the company stock and has already lost a lot of money since 2011. The company’s price collapsed by 90% from $60 to $6.

Debt: The fiscal quarter ending June 30, 2013, the company has $227 million in LT+ST debt and $136 million in cash. After the sale of Dresden mill the company is in a sound financial position.


Even with the current cost overruns and losses the company can run itself for the next 8 quarters with the money it has on its balance sheet. The repayment schedule is also mild.4XcIBTPB7hW7PcoAyRbxj8UQueK3BYVKjMF311qI

Competitive Advantage: Canada has a well established forestry industry with extensive experience in producing wood related products. They cannot be outcompeted by Chinese companies because of the kind of mills and wood you get in China (see the risks section). Brazil and South Africa do pose some competitive threat. The Thurso mill has very high grade DP and is among the lowest cost producers in the world. If completed, LSQ is predicted to have lower cost than Thurso.

The supply addition in DP does not necessarily imply lower prices because the cotton market dwarves the DP market. So, in essence, the DP additions are additions in the cotton+dp market and hence unlikely to make much of a pricing difference.

A good DP mill costs in billions, conversions take a fraction of the cost. Thurso was converted for around $100 million and the bill for LSQ will be around $200 million. Not all mills can be converted and you need significant expertise to pull it off. Fortress has shown that it can do it. Fortress is the first new DP entrant in the last couple of decades.

Paper currency wears out and they have to replace it with new ones. Even with cashless transactions, which will imply an industry in declines, the amount of notes increase 3% to 4% a year instead [src:youtube].

Risks: The risks are many. This is not for the faint of heart.

The Chinese government has announced an anti-dumping investigation beginning Feb. 6, 2013, against all foreign DP manufacturers, including Brazil, Canada and U.S. The investigation will extend for a year and depending on the initial findings, can be extended further. Seven domestic producers of DP have alleged that the named companies prices their products well under “fair” prices at significant injury to Chinese DP producers. The domestic producers want a 15 percent import duty to make them able to compete.

Although not well versed in laws from China, the theory is riddled with holes. If the foreign companies are not selling at a loss (justifying the duty) then they are not dumping. The only adverse impact which may result from the investigation is the import duty. In this case, there is significant risk because most of the DP which Fortress ships is to China.

Wassilenkoff, although very good at financial side of things like capital allocation, is not so good at the business side of the pulp manufacturing. He has been underestimated and under delivered on his promised timelines from Thurso and its Cogen. The cogeneration facility, for example, had numerous setbacks and was switched on at least three to four quarters later than planned. There were also cost overruns. They will need to pay a penalty to Hydro-Quebec for not supplying electricity at the contractual time. This may be a couple of millions. The management has decided that they are not going to take the risk of upgrading LSQ on their own, which shows the acumen of Wassilenkoff on the capital allocation front.

"This is a capital intensive business, and we like that. Well, we like it when it's someone else's capital."

The only profit making mill Dresden has been sold. When it was not sold, it was worth something and this provided a floor to the price of the stock. Given that it is now represented as cash on the balance sheet, which can be spent, this floor is essentially gone. If the cost overruns continue and the price of DP does not improve, the company may end up spending all the cash it has on the balance sheet.

The rising Swiss franc has adversely impacted the profitability of the Landqart mill. The situation may continues. Thankfully, it is EBITDA positive and the Swiss government has promised to keep the Eur/CHF rate pegged at a floor of 1.2.

Not a risk, but something worth discussing is management compensation. I feel ambivalent towards it. Although Mr Wassilenkoff deserves a lot of credit, his compensation has not been small. He gets $1M in salary and receives ample options which are performance related. He was awarded $16 million in 2010 and holds nearly 500,000 shares via options -- which were part of his compensation. The initial $1.6 million in he put in the company is dwarfed by the money he has taken out of the company, in terms of compensation.

The cotton angle is covered in more detail here [src:seekingalpha].

Valuation: Selling for quarter of the book value which is also twice the EV.

Does not really mean that they will be able to sell their assets at book The book also does not provide a floor for the stock price.

The company operates in a capital intensive cyclical industry.

The investment thesis is mainly jockey based. Wassilenkoff has promised and delivered and has shown excellent skills as a contrarian investor. The problems although many, are not insurmountable. The margin of safety is good. There is a lot of cash on the balance sheet to wait for the thesis to pan out. The price of DP will face significant challenge in going any lower. Being one of the low cost manufacturers is going to help Fortress in this respect, a position that is defensible in the near term because of the quality of wood in Canada and the extensive experience they have with the industry.

Additional Disclosure: I hold 200 shares of the company.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.9/5 (14 votes)


AlbertaSunwapta - 3 years ago    Report SPAM
Great write up. Thanks.

ABC Fundamental Value's web site also provides their value case for Fortress. Also a good read.

I'm also long Fortress but fortunately so far, inconsequentially so. (Just a marker position.)
Cdubey - 3 years ago    Report SPAM
Thanks. I have read the writeup on Fortress by ABC.

I am not going to add too much to my position. The risks are many. The company probably will behave like a call option on the price of DP.
Kfh227 - 3 years ago    Report SPAM

Why does it look like CEO Chad Wassilenkoff is treating this as a piggybank. Buy a company by issueing shares and toss some at Chad at the same time? Really?

Am I missing soemthing here.

Also, how much stock does Chad own?

Thanks for finding this gem. I hope the risks are not as bad as you think.
Kfh227 - 3 years ago    Report SPAM
And thank you for including the shareholder dilution risk. People often forget to look
Cdubey - 3 years ago    Report SPAM
As of April 9, 2013 Chad Wassilenkoff owns 16.74% of the shares outstanding.

It can be argued that Chad's compensation has been warranted. Look at his returns on Dresden mill. It can also be argued that this is unlike Buffett. But then, how many Buffett are there.

As I also observed in the article, this makes me uncomfortable. A good CEO, in my opinion, is worth paying for. And so far, Chad has performed admirably ...

The company, not so far in the past, was trading for a market cap of almost $1B. At 16.74% stake, this was worth $167M. The current worth of the stake is $13M instead. So, assuming that Chad suffers from anchoring bias (who doesn't?), he has lost nearly $154M -- which is a lot compared to what he was worth a few years ago.

I don't know how much of his net worth is in the company. But I would assume substantial.
Cdubey - 3 years ago    Report SPAM
A risk worth discussing: what if the jockey walks away. an excellent interview by Chad where he talks about his business, family life and regrets.

Kfh227 - 3 years ago    Report SPAM
Are there any annual reports available? I can't find anything other than a promising investment with little to no backing information.

Cdubey - 3 years ago    Report SPAM
Reports are available on their website.


For example, the full year 2012 report can be found in this pdf file.


Happy reading !
Kfh227 - 3 years ago    Report SPAM

Ya, it's the browser on my Nook that is causing problems.

Cdubey - 3 years ago    Report SPAM
The Chinese anti-dumping investigation has ruled unfavorably for fortress paper. They have levied a margin of 13% on the DP produced by Fortress.

For more information, please refer to the excellent discussion here.
Phil_Buffett - 3 years ago    Report SPAM

Hey Chandan,

great article! a big Price drop from your start Point to almost 4$. amazing Panic the last days. what are your thoughts on this? are you still Holding your Shares? adding?

i bought my first Shares the last few days.

Cdubey - 3 years ago    Report SPAM
I am adding. Bought a few at $4.2. I will not put more than 3% of my portfolio in it though.

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