Asia Pacific: learning about 'country risk': to predict demand growth in Asia Pacific, first examine the infrastructure.

The Asia Pacific paper industry, having been through one major "boom and bust" cycle, is now evaluating its more realistic, long term growth potential. There is no doubt a large and growing underlying demand for paper products in Asia. Annual per capita consumption of paper of all kinds ranges from 4-30 kg throughout most of Asia. By comparison European and U.S. consumption is 180 and 350 kg respectively. In fact, in places such as Europe, the United States, Japan, Canada, and Australia, per capita consumption of sanitary tissue products alone exceed, 25 kg per capita. Those figures lead forecasters to say there is vast "pent-up" demand for pulp and paper products in Asia. Indeed, while paper and board consumption is growing 1%-2% annually in mature markets, it is not unusual in Asia to see growth rates of 6%-8%.

For pulp and paper manufacturers, capital equipment suppliers, chemical companies, and consultants, it would appear that the race is on to see who can secure the Asian market the fastest. For who to better develop this market than those who already are leaders in their respective fields? Indeed, this would be the case if the expertise possessed by the aforementioned specialists were the ones that are needed. Unfortunately, they are not.

INFRASTRUCTURE NEEDED

In over a decade consulting with pulp and paper manufacturers, financiers, and others, often in our practice we have stated that the priorities for a successful enterprise in the paper industry involve three simplistic factors, prioritized as follows:

1. Markets,

2. Raw materials, and the

3. Technology to place between 1 and 2.

Taking this simplistic approach, it would seem that everything is in place in Asia to begin satisfying demand, providing producers are willing to import the majority of the raw materials. Looking under the surface, though, it is clear that many areas in Asia Pacific are missing a critical component.

In places such as the United States and Europe, market analysis has been shortened to only "demand," with supply being assumed. This is truly a misnomer for the Asia Pacific region. While the region has strong demand, large areas within Asia Pacific lack the infrastructure needed for demand fulfillment. These items include:

* Safe and efficient channels of distribution from manufacturer to consumer;

* Locally stable currency and currency transfer protocols;

* Legal infrastructure that recognizes ownership of real property, goods in transit and the documentation that goes with them;

* Functioning, liquid stock exchanges.

* General security for employees and goods in transit or in situ.

In fully developed economies, these systems work seamlessly, behind the scenes. The lack of these systems, however, can cause major problems.

CASE IN POINT

One has to look at only one press release to reinforce many of these points. Reuters, on July 9, 2001, dateline Kuala Lumpur, reported:

   "A Sino-Malaysian project to build a Ringgit 4.6 billion
   (US$1.2 billion) pulp and paper mill in
   Malaysia's Sabah state is in jeopardy because of
   "equity problems," a government official said ...

   "... In May, [mill officials] said the mill would begin
   operating in Kalabakan, Tawau, on Sabah's east coast
   in 2004...

   "... Malaysia imports about Ringgit 2.4 billion worth,
   pulp and paper products annually, and produce
   about 125,000 tonnes of pulp. The new mill is supposed
   to produce 750,000 tonnes of raw pulp."

From this, it is obvious that in this particular case demand has been defined, and a technological solution proposed to satisfy it. Unfortunately, others, called upon to inject the equity, after examining the situation, may not feel that the project has the basic security (in a financial sense) to protect their investment. Flaws exist that apparently cannot be fixed within the confines the project: this can be defined as "country risk."

Additionally, it's often reported that, as a typical example, the Chinese stock market has a mentality "trade" not "invest." The relatively small number of 60 million retail "investors" in this market are said to trade frantically on whims or rumors. The concept of long-term investment has not appeared to have caught on yet. The proposed solution to this problem is to develop domestic mutual funds with professional managers. With a new trust law that was passed in April 2001, this will be possible for the first time. If the first funds expected to be opened in August 2001, are successful, it is hoped that others will quickly follow. This should help bring rationality and liquidity to a potentially very large market.

In 1998, the "Asian Crisis" was in its infancy, it's age being measured in months. I was called upon to be the keynote speaker at the TAPPI Engineering Conference, in Miami, delivering "The Asian Crisis: A Western Hemisphere Perspective." At that time, the prognosticators were stating that the crisis would be over by 2000. This, in hindsight, appears to be because they looked at it through Western eyes, ignoring infrastructure issues. Since that time, we have seen how serious the infrastructure issues can be--one only has to look at the final matters that pushed Beloit Corp. into bankruptcy and liquidation. Had Beloit been able to collect monies owed on Indonesian projects, it might not have saved the company from bankruptcy, but it possibly would have let them formulate a re-organization plan rather than a liquidation plan.

EXPORT CULTURE

The Asia Pacific region has other problems as well. The most developed countries in the region are also the most open in the world, with exports, on the average, accounting for about 50% of GDP. What do they export? About everything electronic that the developed world loves. And, if they don't make that electronic wonder dangling from your belt or kept in your purse, they at least make most of the electronic chips inside of it. Thus, the electronic and technology slump we have seen in the West starting in March 2000 has directly affected the incomes of these countries. When incomes are affected, the whole financial system suffers. Hence, a cascading effect: one will choose food over toilet paper, incivility to sending thank you notes, when there's not enough income to go around. These decisions affect individual purchases and individual purchases affect the overall demand for paper products.

As the Asian economies devalued currencies in the late 1990s in response to their own crises, Western economies exported their continuing boom-in the form of demand for electronic goods-to these very competitive economies. But today, with the West in a "technology recession," if not a general recession, the downturn has been exported to Asian economies as well. Ironically, China, less dependent on technology exports and experiencing healthy internal demand growth, is in much better shape than other Asian economies. And, although China does not have an elaborate highway-based distribution system like the United States, its "repression-heritage" government fosters a more secure and efficient supply chain distribution network than often can be found elsewhere in Asia.

But why did many Asian countries turn to exports rather than developing domestic markets? Because it was easier to earn income satisfying this demand rather than domestic demand. Local financiers and business leaders recognized that fulfilling export demand would be simpler than creating the basic-but expensive-economic infrastructure outlined above.

For example, a company that builds an electronic chip factory (surrounded by a high, well-guarded fence) near a port, sells to Hewlett-Packard or Nokia, and accepts payment in U.S. dollars or euros, does not have to deal with complex supply chain issues. Contrast this with building a tissue mill in the interior of a country near a developing eucalyptus plantation, creating a consumer brand name, and selling a case of product every other week to stores in 2000 different villages. However, the export business is not risk free. The downturn in electronic goods sales has hurt enterprises like these directly and dramatically.

WINNING MARKETS

As we look to the future, what is the promise for the pulp and paper industry in Asia? It appears for certain that tissue product demand will skyrocket. The case for containers manufactured from linerboard and medium (fluting) is also a strong one-since the mid-1980s there has been an ever-increasing proclivity to package electronic goods for export in the final consumer container (instead of bulk shipping for breakdown and repackaging in the importing country). Certain grades of printing and writing paper can also look forward to rebust growth as laser-jet printers and glossy magazines become ubiquitous in developing Asian economies.

However, the grade for which we believe many prognosticators are missing the mark is newsprint. Several years ago, staff researchers in our practice determined that it would cost US$100 billion to place computers with 56K-wired Internet connections in China at the density of one unit per four people. Today, the price is probably half that. In five years, this same feat will likely be possible in wireless from for US$25 billion. Under these conditions, we believe that China may have no need for more newsprint, and, in fact, it would be economic folly to install it. Unlike Westerners, most Chinese do not have a tradition of reading their own newspapers each day; it is more likely that they will take to electronically delivered news just like an American teenager takes to cars without bothering to learn to drive a horse and buggy.

An article in the online version of The Economist seems to verify this newsprint theory in a back-handed manner. Titled "China: You've got mail," the article documents a June 2001 partnering of AOL Time Warner with leading Chinese computer manufacturer Legend. It goes on to say that AOL will take over Legend's portal, www.fm365.com. The article further states that AOL's presence will be legally somewhat limited until China achieves membership in the WTO (World Trade Organization). However; AOL plans a "war of attrition" with the long term objective to be a major player in the Chinese market for Internet Service Providers (ISPs). (Imagine what might happen when AOL starts distributing billions of software CDs in China as they have over the past decade in the United States!)

GRADE BY GRADE GROWTH

There is definitely long-term, promising demand growth in the Asian paper market, but this potential must be evaluated objectively on a grade-by-grade basis. Gaps in infrastructure-including physical, legal, and safety issues-cannot be ignored. Near term prospects are likely to remain rocky, with this situation exacerbated by economic problems in developed nations. Finally, the concept of long-term equity investment must be adopted if sustainable industrial enterprises are to be developed.

James R. Thompson is president of Talo International, an Atlanta-based consulting company. He is also a member of the TAPPI Editorial Advisory Board. Address correspondence to Thompson at [e-mail]