U.S. Paper Industry Gets an Unexpected Boost (The Wall Street Journal)

Americans renew their relationship with paper, ditching the cheap stuff for reading news to buy expensive stock for photo-based cards and albums.

High-end paper from the Mohawk paper company in Waterford, N.Y., supplies online juggernaut Shutterfly for photo-based cards and albums. Michael Rubenstien for The Wall Street Journal

COHOES, NY—For three generations, Mohawk Fine Papers Inc. ran a mill at the juncture of the Mohawk and Hudson rivers, selling paper to IBM, IBM -0.92% Exxon Mobil, General Electric and other corporate giants for annual reports.

But as business moved online, company President Thomas D. O’Connor Jr. was left to rescue the firm his grandfather founded 83 years ago in a former Civil War-era ax-handle factory.

Mohawk, the town’s largest private employer, was fast losing revenues as companies cut back on paper for brochures, reports and marketing materials. Operations at its 350,000 square-foot mill shrank from seven days a week to five to four. “For the first time in hundreds of years,” Mr. O’Connor said, “paper had to justify itself.”

Then, in 2004, Mr. O’Connor made an extraordinary bet, given the digital revolution that appeared ready to crumple Mohawk and every paper firm like it: His company borrowed millions to expand into the fine stationery business.

The investment is now paying off as Americans renew their relationship with paper—consuming less of the cheap stuff for reading news, bill-paying and record-keeping and, in Mohawk’s case, buying more expensive stock for personalized holiday cards, announcements and photo books from online juggernauts such as Shutterfly Inc. SFLY -0.98%

Since the market low in March 2009, the stocks of paper companies have grown about five times as much as the S&P 500, according to the Dow Jones index of publicly traded paper companies.

A line worker at Mohawk Paper. Michael Rubenstein

International Paper Co. IP -0.65% , the world’s largest producer, is among the companies profiting from new digital habits. It bought several makers of corrugated cardboard boxes, which now fill with goods shipped by online retailers like Amazon. The Memphis-based paper company said it has a 35% market share.

“We’ve been able to increase margins and profitability,” said John V. Faraci, International Paper’s chairman and chief executive, by relying less on the shrinking copy-machine paper business as it stakes out more lucrative territory.

The company last month announced a nearly $70 million investment to double the size of an Ohio plant making food-industry paper products like the coffee cups used at Starbucks. It has retrofitted one mill for fluff pulp, the material in diapers, for export mostly to China.

IP’s reinvention, engineered by Mr. Faraci in 2005, was funded by the sale of 6.8 million acres of forestland for nearly $7 billion to multiple buyers over two years, the largest U.S. land transfer since the 1803 Louisiana Purchase, the company said.

Profits from IP’s paper business operations grew 44% to $2.6 billion in 2013 from $1.8 billion in 2004, officials said, compared with 9% growth in revenues over the same period.

There is no question U.S. paper industries have suffered over the past 10 years, and consumption may never return to the peak volume of 2000, when 94 million tons of paper and paper-based packaging were produced. Last year, volume was off 14.5% from the high, according to the American Forest & Paper Association.

Lower demand for newsprint, printing and writing paper account for about 85% of the decrease. Measures by the U.S. government to go “paperless” landed earlier blows, said Elaine Kamarck, of the Brookings Institution.

A worker at Mohawk Paper. Michael Rubenstein

From 1993 to 1997, Ms. Kamarck oversaw Vice President Al Gore’s initiative to make the federal government more efficient. New government websites surfaced and taxpayers were permitted to file income tax returns online. “I don’t remember any lobbying from the paper industry,” she said.

Tension at the time was over committing government resources to services seen as mostly accessible to upper-middle-class Americans. “There was huge talk about the Internet gap, the gap between rich and poor, the Internet is only for rich people,” Ms. Kamarck said. “No one really saw in the 1990s how quickly home computers would become affordable.”

The paper industry, caught flat-footed, has since rebounded by tracking shifts in American culture. Mohawk, for one, is taking advantage of paper’s transformation from commodity to keepsake, supplying high-quality paper in a market “where paper really matters to people,” said one company official—and where the margins are as high as 40%.

In 1998, sales of paper to digital companies comprised $10 million in revenue, Mohawk officials said. In 2012, sales to digital customers reached $100 million in sales, about 40% of company revenue.

A decade ago, when the company was in free fall—and Mr. O’Connor’s father, then-chief executive Thomas D. O’Connor Sr., took ill with esophageal cancer—Mohawk sought to buy seven fine paper and stationery brands from International Paper for $61 million.

A Shutterfly finishing lead operator inspects book pages. Will Seberger

The deal, which included the well-known Strathmore brand, would give Mohawk access to new markets in the U.S. and Europe and a chance to replace its disappearing annual report business. “We couldn’t just downsize and hope to survive,” Mr. O’Connor said. “We knew we had to change our product completely.”

To make the shift, Mohawk sought more than $100 million in credit lines and loans. A year earlier at a board meeting, Mr. O’Connor recalled, “I announced our debt was at $8 million. My father, in front of everyone there, called me out. ‘How did you let our debt get this high?’ “

To buy the stationery companies, Mohawk’s debt would balloon to $103 million. “I still can’t believe we got a loan that size,” Mr. O’Connor said. “Our debt is now about a third of that.”

Mr. O’Connor, Sr., died on Nov. 30, 2004, a day before Mohawk signed a letter of intent for the deal. Mr. O’Connor Jr., then president, took the role of chief executive and kept the mill open.

Mohawk sales had first started declining in 1996, when the Securities and Exchange Commission began to phase in an electronic platform for companies to upload and make public their financial reports. That year, the company also bought a $6 million machine to cut paper into smaller-than-standard batches, a big investment with no immediate use. “People thought we were crazy for buying it,” Mr. O’Connor said.

The investment paid off a decade later. The annual-report business collapsed in 2007, after the New York Stock Exchange said its companies didn’t have to distribute the reports to shareholders. The change “had a dramatic effect on our first quarter, which had just a few years earlier accounted for almost a third of our revenue,” said Bart Robinson, Mohawk’s senior vice president for marketing.

The company successfully courted the emerging digital printing industry that needed smaller-than-standard batches of paper.

Within four years, Mohawk’s fourth quarter revenue—derived from sales to Shutterfly, Minted.com and others during holiday card season—would make up the shortfall from its former corporate customers.

A Shutterfly shipping employee prepares boxes for shipment. Will Seberger

In 2008, Shutterfly was a Mohawk client, but it wasn’t buying the company’s expensive paper. “We decided to beta test how digital printed photo cards would look with our Mohawk Superfine,” said Christopher M. Harrold, Mohawk’s vice president for business development and creative director.

So Mohawk paid $2 million for a photography software company that enabled Mr. O’Connor and his team to launch an online company, Pinhole Press, to experiment with personalized stationery and greeting cards. The idea was to better understand small-batch digital printers like Shutterfly. Mohawk asked employees to order their holiday cards through Pinhole, using Mohawk’s pricey Superfine grade of paper.

When employees reported a big reaction from friends and relatives, Mohawk took samples to Shutterfly, and now 40% of the paper Mohawk sells Shutterfly is Superfine, the company said.

“Mohawk is one of our main suppliers, they are a very important partner to us,” said Dwayne Black, senior vice president of operations for Shutterfly. The company’s 2013 fourth quarter earnings had a net revenue increase of 17% to $410.8 million from 2012, sales dominated by personalized holiday cards.

“It was a bet,” said Mr. O’Connor of the Pinhole Press experiment. “We didn’t know it was going to work—you never do. But it sure is fun when it does.”

Mohawk also supplies expensive stock paper to Moo.com, which in 2012 printed 100 million business cards. Customers pay as much as $30 for 50 heavy-stock business cards because “the more cheap and easy uses of technology permeate our culture,” said chief executive Richard Moross, “the more valuable are the moments of real-world interaction.”

Other paper companies are seeking their own ways to straddle the physical and digital worlds.

Arrigo Berni, the chief executive of Moleskine, MSK.MI -3.38% the notebook company, said market researchers found his customers were more likely to be heavy users of digital products than others. “Far from perceiving these two dimensions—the analog and the digital—as separate and opposite, they see them as a continuum,” he said of his customers.

In a joint-venture, Evernote, the cloud-based note-taking company, retooled its app to better read and search photographs taken of notes jotted in Moleskine notebooks.

Evernote also has joined with 3M, the St. Paul, Minn. conglomerate, to promote the idea that Post-it Notes can be easily photographed and stored online for easy access.

A Shutterfly employee loads envelope stock into a machine at the company’s Phoenix, Ariz. plant. Will Seberger for The Wall Street Journal

Paper’s resilience has its critics. Allen Hershkowitz, a senior scientist at the Natural Resources Defense Council and the director of its Paper Industry Project said the industry is a big energy user, a leading consumer of freshwater and a top emitter of greenhouse gasses. “Ecologically, the paper industry is one of most impacting,” he said.

Thomas J. Ryan, a spokesman for IP, said recycled materials are key ingredient in its boxes and paper, and the company’s U.S. mills run on 75% renewable biofuels. The paper industry plants 1.7 million trees a day, he said, more than it harvests.

Mohawk has placed a few bad bets, including chlorine-free paper the company thought would captivate environmentally-concerned consumers. It didn’t.

Looking ahead, Mohawk has invested in a research lab housing two industrial digital printers from Xerox and one from Hewlett-Packard. The company hopes to show designers, ad executives and printing companies new ways to pair digital printing with high-end paper.

“We need to engage at a much more base level than just being ‘the paper guy,’ ” Mr. Harrold said.

Among the lab’s future projects are printing Mohawk’s quarterly industry publication, “Maker.” With a circulation of 30,000, the magazine features stories and images connected with Mohawk—like the 100-plus-year history of its Strathmore brands. Each issue is published on a different type of Mohawk paper: Superfine; Loop, a recycled fine paper; and Strathmore watermarked cotton stationery.

“We are trying to inspire people to see that fine paper and stationery can be used in ways they hadn’t imagined,” Mr. Robinson said.

Mohawk’s purchase of the writing brands has been profitable but required tough decisions, the company said.

As part of the deal, Mohawk received two paper facilities, including a paper mill in Hamilton, Ohio. In 2011, Mohawk closed the mill, laid off 137 employees and transferred production to Cohoes and Waterford, N.Y.

Last year, the remaining Ohio plant in Ashtabula made 500 million stationery envelopes to match its letterhead and writing paper. This year, Mohawk plans to make 2 billion envelopes, and hire 125 employees.

Mr. O’Connor said he expected revenues from the plant this year to reach $46 million from $19 million in 2013.

The 57-year-old chief executive supports the stationery end of the business by writing letters each month to each of his four children. “It’s the only way I can be sure they listen to what I say, and they can’t delete it,” he said.

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