Asian Credit Watch- AP & P

Another article from the competitive intelligence group. =20

Jeff
----- Forwarded by Jeffrey A Shankman/HOU/ECT on 02/09/2001 12:55 PM -----

=09Robert Johnston
=0902/09/2001 12:50 PM
=09=09=20
=09=09 To: Jeff Kinneman/HOU/ECT@ECT
=09=09 cc: Paul Pizzolato/HOU/ECT@ECT, Seung-Taek Oh/NA/Enron@ENRON, Brenda=
n=20
Fitzsimmons/NA/Enron@Enron, Gary Hickerson/HOU/ECT@ECT, Darren=20
Delage/AP/Enron@Enron, Kimberly Landry/NA/Enron@Enron, Scott=20
Tholan/Corp/Enron@Enron, Jeffrey A Shankman/HOU/ECT@ECT
=09=09 Subject: Asian Credit Watch- AP & P

Per our conversations with most of you this week, Brendan and I have=20
developed the following information on Asian Pulp & Paper and its potential=
=20
to trigger widescale credit problems in Asia. In the past week, APP has co=
me=20
close to default through complex trigger clauses in a mass of junk bond=20
issues. Prospects of an APP default have already sent tremors through the=
=20
Asian bond market and could have larger implications for emerging market=20
debt. This week, the Indonesian government further complicated the picture =
by=20
attaching assets of the Sinar Mas group, including APP, to guarantees of=20
Sinar Mas group=01,s $1.5 billion debt to Bank Internasional Indonesia (BII=
),=20
Indonesia=01,s fifth largest bank and formerly part of a Sinar Mas group. =
The=20
Wijaya family is likely to postpone payments until the last possible minute=
,=20
before seeking a workout and corporate restructuring.

RJ

The Immediate Problem

o $1.6 billion in bonds are due in 2001, on top of $1.5 billion owed to the=
=20
Indonesian government through the Sinar Mas group
o Between now and April 30, the APP group must come up with $145 million fo=
r=20
nine separate coupon payments coming due. APP itself will owe $87 million i=
n=20
interest payments on four bonds over the next month
o APP missed a February 1 deadline for two bond payments of $43 million; on=
e=20
payment has been made but the other, of $13.5 million, is still hanging

Risks are formidable, with management playing a cat and mouse game with bon=
d=20
holders in order to maximize their negotiating position in a restructuring:

o Assets are encumbered by complex cross-guarantees that make it difficult =
to=20
impossible to separate out individual properties
o The New York Stock Exchange has threatened a de-listing unless APP stock=
=20
rises above the US$1 level; de-listing will trigger immediate redemption=20
clauses in some classes of bonds
o The company=01,s Indonesian assets are diseased. Despite APP=01,s apparen=
tly=20
sound business model, it is being corrupted by crime that is systemic withi=
n=20
the Indonesian forestry and forest products industry
o Inventory dumping by APP, particularly in China, has been a major factor=
=20
depressing paper prices since mid-2000
o APP=01,s management has failed to offer transparent explanations for thei=
r=20
cash shortages. It has not reported third quarter earnings for 2000, due la=
st=20
November, to the US Securities and Exchange Commission (although, as a=20
foreign company it has six months to report earnings, versus one month for =
US=20
companies). Inter-company transfers may be masking serious problems within=
=20
the APP group.=20
o Indonesian political instability is worsening with the threatened=20
impeachment of Indonesia=01,s President Wahid, lowering prospects for a=20
government bailout of APP=01,s parent company, the Sinar Mas group, and its=
=20
owners, the Wijaya family.
o There are clear prospects for collateral damage to Asian capital markets,=
=20
with S&P already cutting ratings and a consequent shrinkage of liquidity.=
=20

APP Risk Profile:

APP=01,s only immediate hope of meeting its debt payments is through asset =
sales=20
or a sell-off of pulp and paper inventory. Neither has much chance of=20
success. APP=01,s current strategy is to muscle its bond-holders into a=20
restructuring agreement as soon as possible, most likely before an early=20
March deadline for its next coupon payment falls due. There are significant=
=20
obstacles to evaluation of assets in a restructuring, from cross-guarantees=
=20
of bond issues that range across classes of bond holders and various=20
jurisdictions, to inter-company transfers that present a false picture of=
=20
financial health in some of its operating companies. Such obstacles ensure=
=20
that a restructuring exercise will be lengthy. APP is the fifth largest=20
issuer of junk bonds in the world, and has been regarded as a benchmark bon=
d=20
for Indonesia. Until the last few months, it was the only bond in the world=
=20
that traded at a premium to its own government=01,s bonds, and was the only=
=20
Indonesian issuer to raise funds successfully from capital markets in the=
=20
depth of the Asian crisis. A pronounced ripple effect is likely on Asian=20
bonds in the event of a default, as investors wait to see what happens to=
=20
unsecured creditors who account for 40 percent to 50 percent of APP=01,s US=
$12=20
billion in debt. At the moment, systemic fallout seems likely to be limited=
=20
to the Asian region, as investors revert to the hostile stance adopted duri=
ng=20
the Asian financial crisis.=20

APP Key Decision Makers:

The key decision makers at APP are CFO Hendrik Tse and CEO Teguh Ganda=20
Wijaya. No others in the company are privy to all the Group=01,s Affairs, o=
r to=20
corporate strategy. Information is extremely closely held. Sources say that=
=20
the APP situation is so complex that no one individual has a comprehensive=
=20
understanding of all the potential ramifications of a decision on any one o=
f=20
the assets of APP or its subsidiaries, so complex are the cross guarantees=
=20
and trigger clauses in the debt paper issued over the last few years.

Tee and Teguh Wijaya are to a large extent playing a bluff game, engaging i=
n=20
brinkmanship with their bond holders. It signaled the market that it could=
=20
move into a default situation on February 1 when its paper making subsidiar=
y,=20
Pabrik Kertas Tjiwi Kimiah, failed to make payments on two different bond=
=20
issues worth $43 million. On February 6, APP finally paid the coupon on one=
=20
of the bonds, a US$600 million note issued by Tjiwi Kimia Finance Mauritius=
,=20
just within a grace period of five business days. If Tjiwi Kimia had failed=
=20
to meet the deadline, it would have triggered cross default clauses on a=20
series of other bonds. The second coupon payment, of $13.5 million, for a=
=20
US$200 million issue of guaranteed senior notes due in 2001, is now late. W=
e=20
expect APP to wait until the last possible moment to make the payment. The=
=20
group is husbanding its cash in advance of an expected restructuring. The=
=20
better its cash position is, the more APP will be able to operate from a=20
position of strength in a restructuring negotiation.=20

According to one source: APP is =01&signaling the market and its bond holde=
rs=20
that it is in their best interest to help with a restructuring before=20
everything collapse. The idea is to squeeze the bondholders now, while they=
=20
still have some negotiating leverage rather than wait until there is nothin=
g=20
left.=018 APP is trying to play off one set of bond holders against another=
=20
because the interests of the bond holders in the operating companies, some =
of=20
which have significant cash flow, is different from those in the parent. Th=
is=20
is obviously a dangerous game, but one in which APP feels it has no choice=
=20
but to engage. The earlier it can restructure the better of it will be, and=
=20
the greater its chances of survival in some form. Trying to keep control of=
=20
the situation so that it doesn=01,t unravel is the name of the game at this=
=20
point. Tee and Widjaja are thinking quite far ahead and have targeted their=
=20
non-core subsidiaries for disposal in a debt restructuring. They have been=
=20
actively shopping their China assets for several months, and sources indica=
te=20
that their packaging assets will also go on the block. APP is still hopeful=
,=20
however, of engineering a debt restructuring so that it is on their terms.

One of the issues that adds greatly to the complexity of the situation is=
=20
that much of the sales from both companies come from within the group, and=
=20
often these go via another APP company or Sinar Mas. Another source said,=
=20
=01&This is a vertically integrated group and one of the worries is that if=
you=20
start messing with the structure, let=01,s say one group of bond holders wa=
nts=20
to wind up one of the subsidiaries that is a primary customer, you could=20
threaten the whole group.=018=20

The Wijayas are well regarded by foreign investors, and are not in the=20
category of Suharto cronies such as forestry magnate Bob Hassan, who was=20
sentenced this past week to two years in jail for financial wrongdoings and=
=20
corruption. They are not saints =01) the Indonesian government removed the=
=20
Wijayas from the board of Bank Internasional Indonesia after it was=20
nationalized in 1999, based on evidence that they exceeded the 30 percent c=
ap=20
for lending to affiliates. However, they depend heavily on international=20
capital markets for funding and cannot afford significant steps that would=
=20
bar future access. At the moment, they have few alternatives to raise cash =
to=20
meet their debt payments other than through asset and inventory sales. The=
=20
company has built up substantial paper inventory, and according to one=20
source, it could use inventory sales to meet current cash obligations if it=
=20
could find a buyer. This is a big if, however, since current prices are=20
depressed and releasing further inventory to the market would only make=20
matters worse.

Asset Sales and Other Alternatives to Meet Debt Repayments:

An executive from a major international pulp and paper company confirmed th=
at=20
APP was actively trying to sell its Chinese assets. These assets include:

o PT Ekamas Fortuna
o PT Purinusa Ekapersada
o Ningbo Zhonghua Paper
o Gold Hongye Paper
o Gold Hai Paper (Kunshan) Co.
o Jin Yu (Qingyuan) Tissue Paper Industry

The executive said that his company had looked at attractive parts of the=
=20
assets on offer, but had held back because of the impenetrable cross=20
guarantees between companies and reluctance of their bankers to finance an=
=20
acquisition at a discount that would offer no cover for their equity. The=
=20
executive believed that all the banks would have to agree to asset sales in=
=20
the context of a general restructuring before any individual bank would=20
finance an acquisition. Yet another issue is that the financing of the Chin=
a=20
factories was based on access to Indonesian pulp at intra-company prices.=
=20
Once the company is broken up into pieces, it will have to rely on the worl=
d=20
market and will no longer be able to produce at a profit. =20

Stora Enso made a formal bid for the assets last year but was rejected. It =
is=20
said to remain interested although the price it is willing to pay will be=
=20
considerably less. One of the problems with APP=01,s brinkmanship strategy =
is=20
that it is lowering the value of its assets. Companies will not be willing =
to=20
pay book value when it comes time for the company to sell off its non-core=
=20
assets.=20

Restructuring is imminent, creating opportunities for investors:

o A restructuring of the company in the near term seems inevitable and will=
=20
produce returns for existing bond holders if they bought at low enough pric=
es=20
and if their debt is secured by APP assets outside Indonesia
o A restructuring will release some of APP=01,s assets, which are considere=
d=20
attractive except for those in Indonesia. APP is the world=01,s low cost=20
producer of pulp and paper, with substantial assets in Indonesia, China, an=
d=20
India. Its Chinese factories are attractive despite current over-capacity i=
n=20
the domestic Chinese market. APP accounts for 20 percent of the Chinese=20
market for printing and fine paper.=20
o Some play is available from price volatility as APP continues to tease=20
investors by keeping them guessing about its actual cash situation