Rolling Rock

How Jim Rubright and paper-packing maker Rock-Tenn are creating results for shareholders

Drew Ermenc, Senior Writer

August 1, 2008

Website exclusive: Hear Jim Rubright describe the deal that made Wall Street take notice of Rock-Tenn.

I n an era of unabashed CEOs, Jim Rubright doesn't mind if you've never heard of him. Uncomfortable around a camera, he's not really one for publicity. He doesn't make many of the overblown "Most Influential" lists that float around town, generally motored by PR machines. His conservative demeanor may be better characterized as that of a CFO or perhaps even your CPA.

But the chairman and CEO of Norcross-based Rock-Tenn loves to talk about the intricacies of paper packaging, an industry of which his company is positioning itself as a manufacturing market leader. He can break down how Rock-Tenn is creating opportunities in high-growth areas, maximizing capacity, minimizing cost and building on its growing momentum.

But when the conversation turns to focus on his own leadership qualities, his silence - preceded by a delicate dance of selfless adjectives - represents his modesty, a trait that may just be trickling down to the humble company that is Rock-Tenn.

And that's OK, because as Rock-Tenn quietly churns out big numbers and bigger profits - like an eight percent net sales gain from March 2007 to March 2008 (14 percent if you include the Southern Container acquisition) and a 14.5 percent return on sales in merchandising displays in the same quarter - Rubright doesn't have to concern himself with media requests and other irritants. As long as his company continues to fly under the radar, he can focus on his growth strategy, a long-term plan eight years in the making that finally is paying dividends today, especially to shareholders.

But the secret may soon be out. With Rubright's goals firmly in place, his paper-packaging manufacturer is a profit engine, with a three-year stock price resembling the upward climb of the broad, hiking-trail side of Stone Mountain. If you had invested in Rock-Tenn in 2005, you would have returned three times the amount today.

"He's been a very methodical and conservative CEO," says Bill Hoffmann, high-yield analyst for UBS. "He makes strategic acquisitions for good assets and he has good discipline to make these acquisitions to help grow his business over time. It's that discipline of acquisition activity that has given his company success.

"It's a combination of decision making and being relatively financially conservative as he builds this business," Hoffmann continues, who follows Rock-Tenn and its paper-and box-packaging competitors. "Other companies make acquisitions, but he has been very disciplined about borrowing money to make acquisitions and paying it down, and keeping his credit risk profile in good shape before he'll go onto the next opportunity. It's that discipline and ability to seek out the right assets to his business that differentiates him so much."

Rock-Tenn - as the entity is known today - has a history of playing the M&A game. Formed in 1973, the result of - you guessed it - a merger between Tennessee Paper Mills Inc. and Rock City Packaging, two companies steeped in Southern-based paper and box manufacturing dating back to the 19th century. Arthur Morris, owner of Rock City Packaging, served as the industrious cupid, growing his empire through acquisition and in the creation of new and completely independent companies that later would be merged under Morris' umbrella of manufacturing-related industries.

In the 80s and 90s, additional acquisitions fueled growth with a handful of purchases that placed them near the top of the recycled paperboard business. "Rock-Tenn had done very well in the 70s, 80s and early 90s with a strategy of acquiring mature, underperforming assets and installing better managers and allowing those managers to succeed," Rubright says. "And through that process they had created a lot of value over a 20-year period. They took a company that might have been worth $5 million in 1972 when the company was created ... to a company that they took public in 1994 for $400 million of equity value. Five years later, it was still worth $400 million. So the question was, 'What do we do with this business?'"

Rubright's answer was a slow and steady approach of fixing internal issues first. A former M&A attorney and partner with King & Spalding for more than two decades, Rubright left the legal representation game in 1993, jumping into corporate life with Sonat, Inc., a Birmingham-based energy company. In 1999, Sonat was acquired and Brad Curry, CEO of Rock-Tenn at the time, recruited Rubright to come and take over his stagnant paper packager. "I had no experience in the paper industry when I came to Rock-Tenn and no experience in packaging, but the board thought that [was] a strength," Rubright says.

"I really was brought in with developing a strategy for the future and attempting to grow the company," he adds. "There was a bias that an outside view would be better than adopting an accepted industry structure or the historic business model that really wasn't working."

Today, Rubright may be taking on the personality of the company he leads - quiet, pragmatic, hard working, tough and deadly serious about fine-tuning processes to maximize capacity and minimize cost. With just under 10,000 employees across the world, Rubright has narrowed Rock-Tenn's focus down to four core areas: paperboard products, merchandising displays, corrugated packaging and packaging products. He's investing additional dollars into high-growth areas such as merchandising displays and folding cartons for the company. And he made the largest acquisition in the company's history with Southern Container, an $851-million deal that made rare headlines for the company and fit perfectly into Rubright's game plan.

As Rock-Tenn continues to roll, Rubright explains to Senior Writer Drew Ermenc the details behind his plan of success for Georgia's 25th largest public company (by revenues), his thoughts on the current economy, and the changing market climate.

You had no experience in the paper industry prior to becoming CEO in 2000. Were you the right decision at the time? I definitely think it was the right decision. The strategy of acquiring mature, underperforming investments really did work in the 70s and 80s, but by the middle 90s, the number of opportunities to employ that strategy had been reduced. And, in fact, it had not worked. The last couple of acquisitions the company had done had not performed as expected and they needed a different approach and a different strategy. The history of the paperboard industry has been to build capacity in excess of the needs of the marketplace, and/or to make the wrong acquisitions. I thought we shouldn't adopt either strategy.

So when I came to Rock-Tenn, I had a transaction background, and I had done a lot of M&A work and the expectation of the employees was, "What's the next deal? We need to make this company great, so what are we gonna buy next?" My answer was, "The next acquisition is none. We're not good enough at what we do. We've got to be great at what we do."

We focused on getting better at our core businesses and dramatically reducing our costs. Over time, we were able to focus our business on areas in which we could be successful; through really smart investments and getting the best people, we were able to get the lowest cost asset position in our legacy businesses. That would take us to 2005-2006, where we would, in fact, make some acquisitions that would give us tremendous value.

You saw record profits in 2007. Other than your acquisitions, what do you see as the keys driving this performance? We have achieved the lowest cost position in all of our positions. These are businesses that have been under significant stress, particularly with cost inflation across the board with the basic inputs in our businesses. This has put a lot of pressure on what I refer to the right side of the cost curve; the high-cost people in our businesses and the stress they are under has resulted in significant capacity reduction since 2000. As capacity comes out, the remainder of the guys who are left have pricing power. We've been able to increase prices at a rate faster than the increase in the basic inputs. Since we're the low-cost guy - in our business - all of our margins actually are the highest.

Secondly, we positioned our business to anticipate the current environment in which we do have pricing power. Let's go back to 2004. If we had this conversation [back then], I would tell you the current business environment was unsustainable, meaning the industry was not returning the cost of capital. The high-cost players were under extreme stress and we expected to see some capacity closures. So then we actually traded volume for price and traded certainty of contractual duration for the flexibility to respond to what we believed would be a forthcoming improvement in the basic business. We were operating at utilization rates in our coated recycled board mills that were lower than industry averages, and we were very aggressive in allowing contracts to terminate and not entering into long-term fixed contractual commitments.

Again, people are asking me, "What are you doing? Why is it you have the lowest operating rates in this business when you tell us you have good assets?" My answer is, we are positioning ourselves in the belief that our business is going to improve and when it does, we want to take advantage of it. So when you compare Rock-Tenn's results to our competitors in the last couple of years, including 2007, our results and theirs are in a different trajectory. It was the strategic decisions that [our management team] made for our folding carton and paperboard business in 2004 and 2005 that have produced those results.

This is several years in the making. Oh yeah, we're playing a long-term game here. These are long-term decisions. That's how it works in our business.

How's this year shaping up? How is the economy affecting Rock-Tenn today? We're doing very well. On the demand side, our businesses are pretty resilient to an economic downturn. We package food beverage, paper, consumer non-durables; all of those things are pretty resilient during a recession. So our demand - while not robust - has held up better than other industries. For example, our first quarter volumes were up seven percent in our largest business, folding cartons. And part of that was price but 2 to 2 1/2 percent of that was volume and that was done in what many consider to be a recession.

We package dry and frozen food. As the household - particularly the low-income household - becomes under pressure ... they are going to go to lower-cost food sources. They don't stop eating, but they take down the cost of what they eat. A sit-down restaurant may turn into a quick-service restaurant meal and fresh food may end up being dry food or frozen food. This is really bringing the consumers into the areas that we package. And this is actually seen in some of our lines of business growth that are associated with the consumer's choices in the current environment.

The current environment is pretty unique. Energy cost increases and chemical cost increases and freight transportation cost increases are dramatic. DuPont, for example, raised chemical prices 25 percent last month and another 20 percent this month. That's unprecedented.

And we use a lot of chemicals. Freight rates are off the chart. We burn nine billion cubic feet of natural gas equivalent in our business today. A $5 increase in natural gas is $45 million for us. The marketplace is very aware we are in an area of dramatic cost pressures.

And you have to raise prices to reflect what your suppliers are doing. We are attempting to pass through to our customers the significant cost increases that we are seeing in all our businesses.

What are your thoughts on today's economic climate? The economy is pricing into its expectations the risk of a Democratic victory in the fall, which would occasion a significant increase in income tax rates. My problem is that I've lived through the 70s, so I know what high tax rates do. I've seen stagflation and I believe there's a significant risk that we're going to get it. Clearly inflation today is being built into economic expectations that are based on assumptions that may not turn out to be true.

In the next five years, which of your four main segments do you envision the most opportunity? We acquired Southern Container for a couple of reasons. They fit our business model. They are the lowest-cost, highest-margin business of any major corrugated manufacturer in the United States.

But we also think the corrugated packaging business has better growth opportunities and more acquisition opportunities. In addition, Southern Container had grown very significantly over the last decade both in its top line and its profitability, leveraging their very low-cost position from their Solvay mill. We intend to continue that growth. So we look for both internal or organic growth as well as further acquisitions.

Second, the volumes in the display businesses are up 14 percent year over year for our most recent quarter. The demand for in-store promotions is very strong and the value proposition for consumer goods companies is very strong. As TV advertising continues to be more difficult to produce value for a consumers products company because of the diversity of channels and so forth, you have the continuing trend of big-box retailers like Wal-Mart. The Wal-Mart's of the world want to you to promote goods in their stores, and it drives the marketplace toward all point-of-sale materials, including promotional displays. That's driving significant growth in that business. Industry data would suggest that in-store point-of-sale marketing materials are going to grow 6 to 7 percent as they have grown over a fairly long period of time, and we expect continued growth in that business.

There's a counter-cyclical element to the display business where consumer products companies will increase their promotion budgets in response to diminishing consumer demand. In turn, they are less motivated to spend promotional dollars in a very strong economy. Some of the growth in display today is associated with that counter cyclicality. But over the long term, it still will grow 6 to 7 percent. And Rock-Tenn has exceeded those growth rates because we really have the best value proposition for customers at the high end of the display market.

What are the challenges facing your industry, excluding the rising costs of supplies you've mentioned? We have very high fixed costs, so you have to operate very high utilization rates. What that means is the supply-demand balance is critically important. When you get excess supply, it puts extra pressure on pricing. The shape of the cost curves is important to us. The fact that high-cost players have significantly higher costs than Rock-Tenn is a critical value driver to our business.

The corollary to that is this: In order to make money in our business, you have to be much better than everybody else. And that's what I'm out preaching to our people all the time. You'll never hear me say, "Let's adopt the best practice. The best practice is simply the way everyone else does it." Well, if we do it the way everybody else does it, that's a formula for disaster. We have to do it our way and our way has to be much better than everyone else's.

Another challenge is simply the industry structure. Our customers are typically household-name, consumer-products companies. As a result, they are much larger than we are and they are very powerful customers relative to their supply chain. That ends up being a challenge we end up having to deal with.

How is consolidation affecting the industry today? There's been a lot of consolidation across our industry, most of which has generally been positive. Concentrating the productive capacity in the hands of a fewer number of larger competitors certainly has been helpful from an industry structure standpoint, but that's balanced by the size of the customers on the other side.

I would say consolidation generally has been good. In an industry like ours where inefficient capacity has to be retired, you need competitors who are large enough that they can retire their own capacity and be better off because they can benefit for pricing for the remainder of their capacity. So consolidation has been good because it has contributed to the reduction in capacity in our business.

You divested your plastics business several years ago. Do you see yourself entering plastic packaging again or are you focusing on diversifying your paper offerings? No. We made a strategic decision to exit the plastic packaging business. We concluded the opportunities were just as good in our larger businesses, and we would be better off selling off the plastic packaging business and redeploying that capital in our paper-based packaging businesses. There is a lot of opportunity in North America and this is where we want to be.

Let's talk about innovation. With consumer goods manufacturers, you're seeing trends like beer companies creating coolers out of their packaging. What is Rock-Tenn doing in terms of innovation? Our innovation is focused on the major initiatives today of sustainability, particularly as driven by Wal-Mart. They want to reduce their business' environmental impact, so we are very focused on the ability to use and make recycled products; to make reusable products; and to reduce the size and cost of our environmental impact.

An example is something we call the Max PDQ [pretty darn quick], which is a temporary promotional display used by Wal-Mart, where we've reduced the shipping space of a packed display by more than 40 percent, thereby by reducing fuel, freight and paper waste associated with these displays. We also are currently working on a modular display that would replace the palette display that appears in big box retailers and would dramatically reduce the total cost of palette display programs. It would reduce the shipping volumes freight costs and costs associated with palette displays.

Excluding acquisitions, what capital investments have you made where you expect long-term benefits? We've very consistently applied the best technology available in the world to our manufacturing facilities. ... There's no real silver bullet. We spend $80 million a year, but are really hundreds of individual projects that all are designed to improve the cost of our operations.

What are your strengths as a CEO? I think I see the world the way it really is. I'm very realistic and pragmatic and I try to avoid fooling myself. If you look at the history of Rock-Tenn, we're a success today by the mistakes that we didn't make as much as by the good moves we have made. You know when you're a CEO, it's awfully easy to talk yourself into doing a deal that will make your company, and it turns out you really didn't. I think I'm disciplined and willing to see things as they really are.

Rubright's Rules for Acquisition
Rock-Tenn, known in the manufacturing industry as a major player in growing its business through acquisition, has made several significant purchases since Rubright took over the company in 2000. The Rock-Tenn CEO has what he terms as a "screen" for making acquisitions, three qualifiers he asks before pulling the trigger:

"Are we acquiring assets that are better than the assets we've got? Are we going to be a better company after this acquisition than we are today?"

"Can we create value with the acquisition? You need to be able to create value in order to pay a market-clearing price for the asset and then have the acquisition actually benefit the acquirer."

"Have you paid a fair price that will actually deliver enough of the value of the transaction to the acquirer to justify the risk? Two-thirds of all acquisitions end up destroying value to the acquirer. If you're going to avoid that trap, you have to be very disciplined in your acquisitions strategy."