De La Rue Terminates Agreement with Portals; Latter to Close Banknote Paper Mill

On 26 July, De La Rue announced that it is terminating its ten year supply agreement with Portals Paper five years early, an agreement that formed part of private equity-backed management buyout of the paper maker in 2018.

On the same day, Portals announced that it is undertaking an orderly closure of its paper mill in Overton. The announcement not only brings to an end over 300 years in papermaking on the banks of the River Test in the UK. It also marks the end of independent commercial banknote paper manufacture.

De La Rue acquired the Portals paper business in 1995. In 2018 it decided to exit paper production and 90% of the company (with an enterprise value of £68 million) was sold to the management team, backed by the private equity firm Epiris. De La Rue retained 10% of the shares and a seat on the Board.

As part of that transaction, De La Rue agreed to a minimum annual banknote paper substrate volumes agreement for ten years. This was intended to meet most of the group’s anticipated internal requirements for finished banknotes and security documents. In addition, De La Rue was to be Portals’ preferred supplier for security features (which it retained under the agreement).

Both De La Rue and Portals stated in their announcements that paper substrate, which represents one of De La Rue's largest raw material costs, had been hit hard with the rising costs of energy. This, combined with a trend from paper to polymer, left De La Rue with minimum annual volume commitments of paper from Portals in excess of its market requirements, and consequently paying fines for the shortfall.

By reaching an agreement to terminate the supply arrangement, De La Rue says it is now free to seek the most competitive paper substrate from the market and not be liable to fines (which have averaged £3.3 million annually for each of the last two financial years). It estimates that the £16.7 million settlement payment relieves it of the £119 million in fixed charges, profit contribution and volume shortfall payments for the remaining five years of the agreement, which would have adversely affected its competitiveness.

The termination of the agreement also removes the expected total committed spend of £364.2 million (the above £119 million fixed charges plus the expected cost of paper manufacture) for the remainder of its term. Going forward, De La Rue will only pay for the actual volumes of paper required, significantly de-risking it from exposure to paper banknote market volume fluctuations.

The settlement agreement also has strategic value in that it enables De La Rue’s goals to better meet the needs of its central bank customers converting to polymer banknotes, as in doing so, there will no longer be an offsetting payment for lower paper volumes. According to the company, the banknote market continues to convert to polymer, growing from 3.1% of all banknotes at the start of its Turnaround strategy (launched in early 2020) to 4.4% today and with expectations of 5.5% in the next 12-18 months, albeit that the company still expects 50-70% of its banknotes to be printed on paper for the foreseeable future.

The company has stated that the decision to terminate the relationship agreement was necessary due to changing market conditions and only taken after an extensive review of the market and the ability of alternative suppliers to service its needs and those of its customers. It indicated that the vast majority of central banks wishing to purchase paper banknotes will be able to place orders and repeat orders with the company without any disruption.

De La Rue will also be able to sell all banknote security features freely to customers through any paper supplier.

Although the agreement has not changed De La Rue’s full year operating profit guidance, it is expected to result in a £4 million annual cash flow improvement from year ending 2023/24 onwards.

Exit from banknote paper production

The announcement by Portals that it is to effect an orderly winding down of banknote paper production at its Overton million followed shortly after the De La Rue announcement. It was accompanied by the statement that it had worked hard to develop a sustainable business, having invested substantially to increase its efficiency and grow its customer base, but that the global pandemic and other recent world events have had a significant adverse impact on the banknote paper business.

In particular, it stated that the rising input costs of energy and the change in strategy (to support polymer) by De La Rue, all in the context of the highly price-competitive banknote paper marketplace, means that banknote paper business at Overton is no longer viable.

It will be winding down the Overton operations, which have an annual production capacity of c. 12,000 tonnes of paper, in an orderly fashion with as little disruption as possible, whilst guaranteeing that all obligations to its customers, employees, suppliers, and creditors are met. This, it says, will allow it to fully focus going forward on the remaining, successful parts of the business – the paper mill in Bathford, Somerset, which supplies high security non-banknote paper, and the security features business in Milan, Italy. Both are unaffected by the announcement.

There was much optimism, back in 2018 at the time of the buy-out, that Portals would be able to steer an independent course after years of what it termed underinvestment.

Since the buyout, it has invested some £25 million on a refurbishment of its PM1 line and on energy and material efficiencies. It also signed a licencing agreement with Banque de France for the latter’s EverFit composite substrate and – critically – acquired the security features business of Fedrigoni.

The latter in particular was seen as going against the spirit of De La Rue being its preferred supplier for security features. As noted, under the terms of the initial agreement, De La Rue kept its paper security features business; but there was no reciprocity in terms of Portals, leaving the latter without its own portfolio but free to source from elsewhere.

However, one of the keys to the success of papermakers in what has become an increasingly commoditised and competitive market has been their IP portfolio of substrate-borne and applied security features, and Portals didn’t have one. It filled this gap by acquiring the security features business of Fedrigoni, one of the largest commercial supplies of threads and foils for banknotes, in 2021.

The move made complete sense from the point of view of Portals acquiring its own features portfolio, which is has subsequently added to with the launch of Motus™ – a micro-optics thread to rival MOTION – earlier this year. But perhaps less so from the perspective of the relationship with De La Rue, putting it in direct competition with its major customer and provider of around 50% of its revenues.

The spin-out of Portals as a standalone papermaker was also, as it transpires, going against the tide. The leading commercial papermaker, Arjowiggins, went into liquidation in early 2019, with one of its papermills and its threads and features subsequently snapped up by Oberthur Fiduciaire, enabling the French banknote printer to join the ranks of Giesecke+Devrient and Crane Currency as fully vertically-integrated private banknote suppliers.

Fedrigoni has also effectively exited banknote production – its mill in Salto, Brazil (itself bought from Arjowiggins) was sold in 2019 and, along with the sale of its security features business to Portals, paper production in Italy has essentially come to a halt.

As for other independent papermakers, Radice Papir had long exited the banknote paper market whilst Landqart, which is still going strong, has been 90% owned by the Swiss National Bank since the end of 2017.

The demise of both Arjowiggins’ and Fedrigoni’s banknote paper operations were undoubtedly hastened by the emergence of new state-owned paper mills to supply euro paper – Europafi in France and Validoricarta in Italy.

But there are a number of other factors too behind their demise and that of Portals. These are covered in more detail in this month’s Comment, but they include the growth of polymer, increased durability across the board, indigenisation of supply in some of the major markets, over-capacity, a more active presence by state-owned mills and, lurking over all of this, the gradual shift in some markets to non-cash payments and the overall decline in cash for transactions versus digital alternatives.

In the first year of operations, 2018/19, Portals had sales of £138 million. Last year, this had fallen to £122 million, with EBITDA of £8 million. De La Rue accounted for around 50% of turnover. The withdrawal from banknote paper production will result in the loss of around 300 out of over 500 jobs at the company.

Whilst the currency industry has been aware of the challenges of the banknote paper market over the last decade and the commoditisation of the substrate market more generally, it is clear that there is still, for now, a fundamental need for banknotes and for the security features that protect them. This will be a reassurance for the unaffected parts of Portals, who says it continues to invest heavily in both the Motus platform as well as other product lines.