Law and Order: Containerboard Makers Fight Antitrust Suits
Investors should pay attention to courtroom proceedings.
In September 2010, North America's containerboard makers were slapped with a class action lawsuit under the Sherman Act alleging price fixing from 2005 to 2009. During the last several months the case has slogged its way through Judge Shadur's courtroom in the Northern District of Illinois division of the United States District Court system. We have been regular attendees of the status hearings held on the case.
While we are not legal experts, we want to frame a range of possible outcomes for this most recent bout of antitrust lawsuits using the containerboard industry's previous battle with price-fixing allegations. Should history repeat itself, legal costs and settlement payments could have a slight negative impact on the valuations of firms like Packaging Corporation of America (PKG), Temple Inland (TIN), and Smurfit Stone, which have significant exposure to the North American containerboard market. We believe investors should keep these risks in mind when considering the containerboard companies.
North American Containerboard Makers Are Currently in a Courtroom Battle Fighting Accusations of Price Fixing
Kleen Products, a small Minnesota-based manufacturer of floor care products, is the lead plaintiff in the case, seeking treble damages plus fees and expenses from North America's largest containerboard makers (including Packaging Corporation of America, Temple-Inland, International Paper (IP), Smurfit-Stone, and Georgia Pacific) for allegedly fixing the price of containerboard products from August 2005 through 2010.
According to Kleen Products' complaint, the containerboard industry is highly susceptible to collusive behavior due to the highly concentrated supply base, inelastic product demand, and commodity nature of the products. The plaintiffs allege that beginning in 2005 the defendants conspired to restrict containerboard supply, thereby helping to raise prices and profits to a greater extent than what competitive markets would dictate.
Upon reading the 10-Ks filed by Temple-Inland, Packaging Corporation of America, and Smurfit Stone, it's clear that the defendants plan on vigorously defending themselves and, for the most part, cannot reasonably estimate a range of possible loss. International Paper, however, did not mention the Kleen Products lawsuit in its 2010 10-K filing. Rather, it first mentioned the lawsuit in its first quarter 2011 10-Q filing, where it also brought to light a similar price-fixing case filed against the firm in Cocke County, Tenn., covering the years from 2005 through the present.
On April 8, 2011, the court dismissed all of the defendants' motions to dismiss the case.
Previous Sherman Antitrust Lawsuits Against the Containerboard Companies Have Lasted Years and Cost the Industry Hundreds of Millions of Dollars
For approximately 10 years from 1999 to 2008, containerboard makers vigorously defended themselves against a price-fixing lawsuit spanning the time between October 1993 and November 1995. However, the firms paid out a total of more than $390 million in settlement and opt-out payments between 2005 and 2008. In the end containerboard makers paid out settlements equivalent to about 2% of containerboard revenues during 1994 and 1995.
In the early years of the lawsuit, containerboard makers downplayed the potential financial impact of the lawsuits.The Company believes that the plaintiffs' allegations have no merit and intends to defend against the suit vigorously. The Company does not believe that the outcome of this litigation should have a material adverse effect on its financial position, results of operations, or cash flow.
However, in later years the firm's SEC filings started discussing tens of millions of dollars of settlement costs. International Paper even commented that it was better to settle the cases than to risk greater costs as a result of a jury verdict.In recent years, several antitrust class action lawsuits have been filed against companies in our industry. Damages sought in these types of actions are often substantial and, even where no wrongdoing has occurred, companies must often settle rather than risk an adverse jury verdict.
IP also emphasized in its 2005 10-K that it had adopted antitrust compliance training requiring all U.S. employees to read the company's antitrust compliance manual.
Going further back, in January 1978 a grand jury returned with a felony conviction toward International Paper (United States vs. International Paper; H-78-11) for price fixing in the corrugated container market (east of the Rocky Mountains) from 1960 through the seventies. In this case, IP pled nolo contendere (no contest) and was fined $617,000.
The Containerboard Makers' Early Attempts to Have the Current Lawsuits Dismissed Have Failed; We Expect a Vigorous Defense That Could Take Years
A class action lawsuit (No. 10 C 5711) has been brought about by Kleen Products, LLC et al., against Packaging Corporation of America, International Paper, Cascades Canada, Norampac, Weyerhaeuser, Georgia Pacific, Temple-Inland, and Smurfit-Stone charging violation of the Sherman Act. The plaintiffs allege that from August 2005 to September 2010, the defendants reduced production capacity through plant closures, capacity idling, and production downtime during a period of high demand. It is also alleged that the defendants raised prices shortly after company representatives attended various industry conferences. The plaintiffs allege that the defendants' actions exhibit a conscious parallelism as part of a plan to reduce supply and increase price.
In April 2011, Judge Shadur rejected all of the containerboard makers' motions to dismiss the case. During the May 9, 2011, status hearing we learned that the plaintiffs have asked for the discovery process to start and will be looking to get access to company emails via a preservation order. The next status hearing is scheduled for Aug. 16, 2011.
We note that while many procedural courtroom events can be rather mundane, the status hearings for this case are anything but. Judge Shadur frequently shares his pearls of wisdom and sharp wit with legal council from both sides, and the courtroom is packed with attorneys. The most recent status hearing featured eight lawyers representing the defense and three attorneys representing the plaintiffs (slightly fewer than in earlier hearings), to which Judge Shadur quipped that the economy must be doing well seeing as how many high-priced attorneys are ably employed.
On May 2, the defendants each filed 80-100 page "answers to the complaint." These legal filings provide a paragraph-by-paragraph dispute to the plaintiff's allegations, and at the end of each document defense attorneys provide 8-10 points of defense. The most frequent and salient points of defense include:
On April 15, 2011, one of the plaintiffs (Thule) voluntarily dismissed its charges against the containerboard makers. It appears that they have settled out of court with the defendants. However, terms of the settlement were not disclosed and the containerboard makers have not provided any commentary in the subsequent events sections of their most recent quarterly filings.
We believe that if the court rules in the containerboard makers' favor, the impact will be negligible. However, if the plaintiffs either win a verdict or agree to a settlement their stock valuations could be negatively impacted by 1%-8% of the firms' market capitalizations. If we treat the 1993-95 Sherman act lawsuits as a precedent, we see that the cost per year per share point ranged from around $2.2 million for International Paper to $5.4 million for Weyerhaeuser, with the average payout equating to roughly $4 million per year per share point. Furthermore, in Temple-Inland's 2006 10-K, the firm reported that settlements had ranged from 0.2% to 7% of corrugated sales (our calculations indicate the average cost to Temple-Inland was roughly 1.8% of sales).
We believe any settlements paid in relation to the Kleen Products lawsuit could be adjusted upward because the price of containerboard has risen and the consolidation level within the industry has also increased during the past 15 years. From 1993 to 1995, the price of containerboard varied between roughly $300 and $500 per ton. From 2005 through 2010, the prices fluctuated between roughly $600 and $775 per ton. Additionally, in 1995 the top six makers of containerboard had about 60% market share and by 2010 the top five manufacturers of North American containerboard controlled 77% of total capacity.
Legal Battles Can Result in a Range of Possible Outcomes
If things go the containerboard makers' way, these lawsuits will be a nonevent and the valuation impact will be negligible. However, if penalties land in the same ballpark as the last round of antitrust lawsuits, we believe it will result in a 1%-2% reduction to the companies' fair value estimates. On the other hand, if the plaintiffs successfully argue their case and squeeze out higher settlement payouts, the impact on valuations could range from around 3% for International Paper to about 8% for Temple Inland and Smurfit Stone. We note that the impact on IP is muted compared to its peers because it is a more diversified company--both in terms of products and geographic mix.
Legal cases such as this one have a plethora of variables that are difficult to predict. Currently, we are not adjusting our fair value estimates given that the range of possible outcomes falls well within our margin of safety bands. However, we will remain vigilant in observing the court case proceedings and the evolution of language in the legalese used in the companies' SEC filings to determine whether any future changes to our valuation estimates will be justified.
Thomas Mullarkey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.