Investment write-up on Bracell (1768.HK), dated 8/19/2015.

1. 1
Bracell, Part II: Hidden Jewel in a Challenged Dissolving Pulp Industry
Drew Peng, Independent investor
drew_peng@yahoo.com
August 19, 2015
SUMMARY KEY THESES
1) Despite extremely challenging dissolving pulp industry conditions, Bracell stands out as a market
share gainer over time due to its unique competitive advantages that are nearly impossible to replicate
by competitors.
2) Rayon grade DWP prices are showing signs of a rebound.
3) BRL-USD currency movement continues to be a tailwind to the business, given supply contracts are
priced in USD.
4) The DWP industry’s capacity additions have slowed and new investment has virtually ceased.
5) Cellulosic specialties (“CS”) end markets are experiencing low growth and, over time, favoring low cost
suppliers like Bracell that are able to meet stringent quality standards.
6) Separation of viscose staple fiber (“VSF”) business allows Bracell to focus on growth and margin
expansion opportunities, instead of operating as a captive supplier of commodity product.
7) Bracell’s majority shareholder has every incentive to continue supporting the Company’s business
through a pulp supply agreement to the disposed VSF business, while enabling it to pursue higher
margin CS opportunities.
8) Bracell’s current market valuation supports highly attractive current cash flow yield and opportunity for
meaningful dividend increases in the future.
9) Given all of Bracell’s unique advantages, the current valuation makes it a highly attractive target for
industry consolidation or a leveraged buyout.
As an addendum to my earlier piece introducing the “new” Bracell (the “Company”), this writeup takes a
closer look at Bracell, its competitive position and cost structure, a summary industry overview, its ongoing
relationship with Sateri, and prospects for shareholder returns. This write-up assumes a base level of
familiarity with Bracell’s story, including the disposal of the VSF segment in late 2014 (“Sateri”) and the existing
pulp supply agreement (“PSA”). If you have not already read it, part (I) of my analysis can be found here.
Consequently, this write-up will be much more focused on presenting additional data points and exhibits with
minimal commentary, unless further explanation is considered helpful.
Hopefully, what this write-up lacks in style and brevity is compensated for by clarity and additional
industrywide perspectives.

2. 2
Bracell is one of the largest dissolving pulp manufacturers globally. Although the chart below is dated
(Sappi, Rayonier, and Tembec all increased capacity over the last five years), relative rankings among
major players remains fairly constant.
Source: Sateri IPO prospectus (11/26/2010)
Source: Global and China Dissolving Pulp Industry Report, 2014-2017
Bracell (aka “Bahia Specialty Cellulose”) has the lowest production costs of dissolving pulp among all
competitors. While this chart is several years old, the advantages of scale players in low-cost and
favorable currency countries can be assumed to be even greater today and is apparent in the large
differences in operating margin between Bracell and its peers.

3. 3
Source: Sateri IPO prospectus (11/26/2010)
One major driver of Bracell’s low cost structure is captive forestry assets; few players have the ability
to source wood raw inputs at such a low cost basis.
Source: Bracell FY2014 Annual Results Presentation (3/2015)

4. 4
Not only can Bracell internally source its own wood, it uses Eucalyptus timber, a fast-growing species
that takes a mere 6-7 years to mature and is only found in certain regions of the world.
Source: Bracell 2014 Annual Report
Most of Bracell’s competitors rely heavily on traditional hardwood species such as aspen and maple
that require much longer to mature (15-35 years, depending on the species), adding to costs.
Source: Rayonier 2014 Annual Report

5. 5
Multiple competitors have suggested that prices for rayon-grade DWP may have already bottomed and
are beginning to rise.
Source: Sappi Q3 2015 Results Presentation, Slide 16 (8/7/2015)
Source: Tembec Q3 2015 Earnings Transcript (7/30/15)

6. 6
Source: RYAM Q2 2015 Earnings Transcript (7/30/2015)
Source: Fortress Paper Q2 2015 Earnings Release (8/11/15)
Currency continues to be a tailwind for Bracell in 2015, as the Brazilian Reai (BRL) continues its
descent against the US Dollar. Sappi also benefits from a strong US Dollar, as most of its CS
production is located in S. Africa (ZAR).

7. 7
Source: Google Finance
Capacity additions in CS have declined and in the case of RYAM, recently added CS capacity is now
being converted back to commodity product (primarily fluff).
Source: Sappi FQ3 2015 Earnings Presentation (8/7/2015)

8. 8
Source: Sappi FQ3 2015 Earnings Transcript (8/7/2015)
Source: Tembec FQ3 2015 Earnings Transcript, referring to RYAM’s strategic repositioning (7/30/2015)
Source: RYAM Investor Relations (7/30/2015)
CS demand growth (particularly acetate tow) has moderated, causing key customers (Eastman,
Celanese, Daicel, Nantong) to focus much more on operational efficiency and raw materials pricing to
preserve margins on these “cash cow” segments (most of which earn >30% operating margins). On a
relative basis, these dynamics are good for Bracell, as Bracell has competed successfully to earn
market share from key CS competitors (including RYAM) in the recent past.

9. 9
Source: Celanese Q2 2015 Earnings Transcript (7/17/2015); Note: “cellulose derivatives” refers to the
Consumer Specialties segment which includes acetate tow product (a CS derivative)
Source: Celanese Q1 2015 Earnings Transcript, referring to Consumer Specialties segment (4/17/2015)
• Bracell itself has stated multiple times that it is positioned to win CS market share from key competitors
when customers reopen supply contracts and that preliminary work to compete in these contract bids
is already in progress.
• Two major factors favor Bracell’s ability to win additional market share: (1) Desire by key customers to
diversify their supplier base; (2) Competitive pricing which competitors will have difficulty in matching,
due to Bracell’s lowest cost position.
• One pushback against Bracell’s ability to win market share in CS is that for the largest segment of this
market, acetate used in cigarette filters, price has only been one factor in supplier evaluation (in
addition to quality, purity, service, taste, etc.); however, given Bracell’s continual quality enhancements
and the slowdown in the end markets, competitive pricing will likely become a bigger factor going
forward.
An 8-K filed by RYAM on 8/18/2015 disclosed that Eastman Chemical (RYAM’s largest customer as of
2014 10-K, see below) had filed a declaratory judgment action on August 4th
, 2015 against RYAM
concerning certain supply contract clauses related to pricing and volumes.

10. 10
Source: RYAM 2014 10-K
• The 8-K suggests an ongoing dispute between RYAM and Eastman regarding economic terms of the
specialty cellulose supply contract. It will be worth monitoring this situation closely to understand how
it could benefit Bracell (and perhaps other specialty competitors) going forward.
• Eastman’s business with RYAM is substantial; 2014 revenues from Eastman were ~$300m (inferred
from table above); translating to volume of ~170k MTs (at RYAM 2014 average CS price of
~$1,750/MT).
• Importantly, RYAM likely does not have as much room to negotiate on price as several of its CS
competitors (most notably Bracell), given its production facilities are entirely based in the U.S. and it
does not own forestry assets.
• Bracell has over 230k MTs of available capacity (350k of total CS capacity less 113k of current
production) to switchover to additional CS production, and would be a logical candidate to win
business from Eastman.
Separation of VSF business enables Bracell to focus on growth and margin expansion opportunities in
the CS market, instead of operating as a captive supplier of commodity product (rayon grade DWP).
• Sateri has large ambitions to become the top global VSF supplier by volume, as evidenced by its
recent press release, announcing Sateri’s further investment in Jiangxi to take its annual VSF capacity
from 160k MTs to 1,000k over time.
• In Bracell’s former position as a captive supplier of DWP to Sateri, there was an inherent conflict of
interest between Bracell’s desire to maximize returns on capital via pursuit of additional CS market
share vs. Sateri’s desire to secure low-cost rayon-grade DWP for its growing VSF mills in China.
• Separating the two entities enables each to independently pursue profit maximization and investment
strategies.
• As discussed in my earlier writeup, in the interest of giving Bracell time and flexibility to cultivate
additional CS business, Sateri’s 3-year PSA (commenced 1/1/2015) assures Bracell of consistent
demand for rayon-grade DWP from a single customer over the near-term.
• Recall that the PSA is effectively a put agreement from Bracell to Sateri which ensures that Bracell can
keep its factories full, regardless of fluctuations in volumes on the CS side.
• Bracell is ~84% owned by Gold Silk Holdings, an affiliate of RGE Group owned 100% by Sukanto
Tanoto and his family (also controlling shareholders of RGE).
• Bracell appears to be the only business in the RGE Group with a publicly-listed equity ownership stub,
the result of a HK stock exchange IPO in late-2010 that raised US$430m to finance the subsequent
buildout of the Brazilian DWP and Chinese VSF operations.
• In a market environment in which rayon-grade DWP is in oversupply on a global basis,
controlling shareholders RGE/Tanoto know that they can easily source rayon grade DWP at
reasonable prices in the open market, allowing Bracell to pursue highest returns on capital by
taking CS market share. From this perspective, enabling each business to pursue its own
profit maximization strategy creates conditions for the highest total return to the controlling
shareholders.
In a conservative case, hypothetically assuming that Bracell does not win any additional CS volumes
and that rayon-grade DWP pricing improves only modestly with cost inflation, the Company’s rapidly
de-leveraging balance sheet and healthy cash flows provide highly attractive cash flow yield today, and
support meaningfully higher dividends in the future. There is sufficient reason to believe that actual
results could improve upon this conservative case, particularly if Bracell wins additional CS market
share.

11. 11
• Key modeling assumptions include:
o CS volumes flat in 2015 at 113k MTs (consistent with 1H 2015 results) and remain at this
volume going forward (despite Bracell’s unique position to win additional CS market share)
o Pricing of CS at $1,325/MT in 2015, followed by 2% annual increase
o Rayon-grade DWP volumes constant at 352k MTs going forward
o Rayon-grade DWP prices at $825/MT beginning in 2015 (despite the current market price
rebound), followed by 2% annual price increase thereafter; to reiterate, the PSA assures
Bracell of a consistent buyer for rayon-grade DWP through 2017, but at prevailing spot prices
o Production cost decline per metric ton of (10)% in 2015 driven by efficiencies and currency,
followed by 3% cost inflation going forward
o Operating expense decline of (10)% in 2015 driven by efficiencies and currency, followed by
3% increase going forward
o Sales of surplus electricity (captured in “other income” per 2014 annual report) consistent with
2014
o Total CapEx (includes additions to PP&E and replanting of forestry assets) at 15% of sales in
2015 and going forward (note 1H 2015 was 11% of sales and 2014 included a one-time
increase for equipment purchases to improve CS product quality)
o Changes in net working capital have neutral impact on cash flow from operations
o Effective tax rate of 34%
o Continued use of deferred tax asset to offset taxable income over the next several years
o Continued payment of HK $0.035/share dividend annually, including 1H 2015 interim update
dividend of HK $0.01/share
o Interest rate on gross debt held constant at 4.75% with no future refinancing (an unlikely
scenario)
BRACELL FINANCIAL PROJECTIONS - Conservative Case
Actual Actual LTM Act Proj Proj Proj
(in millions of USD unless noted otherwise) 2013 2014 6/30/2015 2015E 2016E 2017E
Net sales $456 $479 $456 $440 $449 $458
% growth 5.0% (8.0%) 2.0% 2.0%
Gross Profit $170 $179 $174 $162 $162 $163
% gross margin 37.3% 37.3% 38.2% 36.8% 36.1% 35.5%
Adj EBITDA $177 $200 $197 $188 $187 $186
% margin 38.8% 41.7% 43.3% 42.8% 41.7% 40.6%
% growth 12.8% (5.7%) (0.6%) (0.7%)
Adj EBIT $89 $99 $99 $91 $89 $87
% margin 19.5% 20.7% 21.7% 20.6% 19.8% 19.0%
% growth 11.2% (8.4%) (2.1%) (2.3%)
Adj Net Earnings $50 $57 $58 $49 $50 $51
% growth 14.7% (13.7%) 1.7% 1.4%
FCF (before dividend payment) $78 $98 $213 $82 $81 $79
Net debt $275 $209 $208 $142 $78
/ Adj EBITDA 1.4x 1.1x 1.1x 0.8x 0.4x
VALUATION
Current share price (HKD) $0.90 $0.90 $0.90 $0.90
Market Cap (USD) $397.2 $397.2 $397.2 $397.2
/ Adj Net Earnings 6.8x 8.1x 7.9x 7.8x
/ FCF 1.9x 4.8x 4.9x 5.0x
Enterprise Value (USD) $606.2 $605.2 $539.7 $475.7
/ Adj EBITDA 3.1x 3.2x 2.9x 2.6x
/ Adj EBIT 6.1x 6.7x 6.1x 5.5x

12. 12
• The forecasted decline in sales and profits in 2015E is in-line with the industry but primarily driven by
the fact that throughout 2014 the price of rayon-grade DWP sold to the now-disposed VSF operations
was fixed at a price that ended up above spot market due to an agreement that was struck with
China’s MOFCOM in April 2014 (“price undertaking” as per Bracell’s 2014 annual report). The price at
which it was fixed was ~$925/MT, compared to the end of 2014 market price of $800/MT. Starting
1/1/2015, the price at which rayon-grade DWP is sold to Sateri reverted back to a market price
framework. This pricing reset was a one-time event.
• My 2015E forecast already appears somewhat conservative, considering the Company has vastly
outperformed my expectations for net earnings, free cash flow, and debt paydown in 1H 2015.
• The Company also announced an interim dividend of HK $0.01/share (for the first time ever).
Together with the final dividend of HK $0.025, the dividend yield on Bracell equity is currently
~4%.
• Management indicated this action was taken by the board as an “unusual step” which demonstrates
“confidence in the pureplay [DWP] business model”.
Beyond the conservatism of the above assumptions and forecast, if Bracell continues to maintain its
current depressed market valuation, the Company would become a highly attractive acquisition target
by a competitor, a tangential pulp player, a private equity firm, or RGE/Tanoto itself.
• Competitors would find it straightforward to consolidate CS volumes at Bracell given its low-cost
advantages, thereby immediately achieving EBITDA synergies.
• The predominant usage of wood pulp is for paper and commodity pulp-derived products (e.g. napkins,
tissues, copy paper). Large players in these segments (e.g. Fibria) might find it compelling to acquire
Bracell to further leverage costs and move higher in the pulp industry value chain. See the excerpt
from RYAM’s investor presentation below.
• Cash flow yield alone and opportunity to re-leverage the asset would provide highly attractive returns
for a strictly financial buyer.
• At the current valuation it is much more likely that RGE/Tanoto are buyers of the equity instead of
sellers, given they already own ~84% of the Company and have previously shown themselves quite
capable of engineering value (the VSF disposal). Current free float of shares is “only” $60m USD.
o Given the Hong Kong stock exchange rules about minimum % free float traded on the
exchange, if RGE/Tanoto sought to buy shares, they would effectively have to make a take-
private offer for the whole Company.
o While there would be some risk of a “take under” approach in this scenario, the HK Stock
Exchange has very clear rules about the need for an independent board and investment bank
to evaluate such a take-private offer by majority shareholders.

13. 13
In conclusion, note that key competitors are all trading at forward EV/EBIT multiples that are
meaningfully higher than Bracell despite having lower margins and arguably lower growth prospects.
• The most comparable peers to Bracell have been trading over 10x forward EV/EBIT (prior to RYAM’s
share price decline on 8/19/15).
• EV/EBIT is the preferred valuation metric because it normalizes for differences in vertical integration
(e.g. captive vs. non-captive forestry assets) and financial leverage.
• Combined with a low leverage ratio at the Company, Bracell’s low EV/EBIT multiple also suggests
meaningful upside upon a leveraged recapitalization of the Company’s balance sheet.
Investment risks and mitigating factors
• Chinese market demand for VSF and acetate tow begins to decline
o While overall GDP growth in China has weakened and contribution from export industries has
declined, Chinese consumption has never been stronger, leading to growth in DWP product
end markets such as clothing, pulp and paper products, etc.
• Chinese rayon-grade DWP competitors become more competitive
o The Chinese DWP market is currently undersupplied, and local competitors cannot match the
low production costs of imported suppliers, partly due to lack of technical know-how,
increasing labor costs, and general unavailability of wood pulp. Fortress Paper has discussed
extensively the fact that local suppliers are operating at 50% utilization despite antidumping
duties introduced by MOFCOM designed to favor local producers.
• Bracell fails to gain additional CS market share
o As mentioned above and in the previous write-up, Bracell has been a consistent share gainer
in CS markets. Even if Bracell wins zero additional CS market share (the conservative case
assumption above), the upside thesis still works. RYAM’s current dispute with Eastman
represents a major opportunity to capture additional share in the near term.
• Continued pricing declines in both rayon-grade DWP and CS markets
o Most major competitors are already competing at trough gross margins and several are
bordering on balance sheet distress; if the market has not already put in its low on pricing, it
should be rather close considering there is no major new source of DWP supply on the
horizon.
• Brazil political instability and potential tax rate increases
o While the Brazilian situation is tense and unresolved, it is a country which relies extremely
heavily on export of commodities. Whatever happens, I find it unlikely that critical, backbone
industries with global competitive advantages like the pulp export industry will be disrupted.
• BRL currency begins to rise against USD
o Unlikely in the near term, given challenged global growth and commodities markets. See this
article for one manifestation of the weak BRL – a crowding out of other global suppliers due to
Brazilian cost advantages.
• Further RMB currency depreciation
o As Bracell management indicated during the 1H 2015 update, in the near-term it is unlikely
that there will be any impact on the business given contracts with VSF mills are typically
priced in USD, and VSF prices themselves have risen significantly in 2015 YTD.
o Nevertheless, Chinese VSF finished product end markets are obviously priced in RMBs, so
any large depreciation in RMB over a prolonged period would squeeze margins at VSF mills,
thereby putting pressure on rayon-grade DWP suppliers to lower prices.
o As mentioned above, most major rayon-grade DWP suppliers are already operating at trough
gross margins; as the lowest cost supplier to these markets, Bracell stands to benefit from
competitive pricing, although initiating a pricing war would not benefit any DWP industry
participant given current market wide challenges.
[END]