Charles and David Koch are best known for their controversial political empire, where they ply their combined personal fortunes of nearly $96 billion into conservative causes and candidates across the nation.
They’re less known for the business empire that’s enabled that wealth: Koch Industries. One of the United States’ biggest companies – whose annual revenue of $100 billion is more than that of Goldman Sachs, Starbucks and Honeywell International combined – Koch owns brands that are fixtures of American households, such as Brawny paper towels and Lycra. But because it’s privately held, how it has grown so big has remained something of a mystery.
A year-long look into Koch Industries’ $21 billion purchase of wood and paper giant Georgia-Pacific, involving interviews with Georgia-Pacific employees from the factory floor to the executive suite, offers a rare view into how the brothers run their businesses. The company’s approach, examined for a forthcoming book, at times aligns with the brothers’ brand of economic conservativism, which stresses the power of the market and skepticism of government. At other times, its approach is at tension with their philosophy.
Charles Koch often frames his political giving in economic terms, saying that the free market is better able to solve society’s problems than the state. As chief executive of Koch, one of his strategies has been to shield his companies from the market pressures that many public firms face.
That shield also makes it difficult for outsiders to judge whether Koch Industries is a good steward of its investments. Outsiders are left to wonder: What does it mean to become part of Koch? What can public companies learn from Koch’s management techniques once it takes another company private? What can employees expect if Charles Koch becomes their boss?
Charles Koch, who declined to comment for this story, has implemented deep changes at Georgia-Pacific. Most of them exploit one of Koch’s key advantages: The company is privately held, with essentially only two shareholders: the brothers. This gives the firm flexibility to operate in a way that makes it more nimble than many publicly traded firms.
After it took Georgia-Pacific private, Koch jettisoned annual budgets and quit focusing on quarterly earnings targets. Reinvestment has skyrocketed. Strategic thinking has shifted years, if not decades, out.
The strategy makes Koch Industries somewhat of an outlier among major American corporations, fighting the tide of shareholder-return management strategies that many critics say have led to an excessive focus on short-term returns. Charles Koch perpetually reminds his managers they want to achieve the highest return on investment, but he’s willing to take 10 or 20 years to get it.
“If you need to wreck your budget to do what creates the most value, you should wreck the budget,” said David Robertson, president and chief operating officer of Koch Industries, summarizing his boss’s philosophy.
Yet to achieve success, Koch has at times had to compromise some of his principles. Koch has used his political power to crusade against what is sometimes called “crony capitalism” – the use of tax breaks and subsidies to benefit some companies over others. And yet Georgia-Pacific made use of one such tax break to ride out the recession.
Whatever the approach, it seems to be working for the company’s bottom line. Georgia-Pacific’s debt rating has climbed from junk status to high investment grade. Annual net income averages just slightly more than $1 billion a year, according to Koch Industries, compared with $623 million before the acquisition.
Seeing value others missed
Like almost virtually everything with Koch Industries, the deal began in secret. Not even senior managers at Georgia- Pacific knew what was coming when a small delegation of Koch employees arrived in 2003 and started asking questions. Koch had amassed most of its influence in the energy business, owning oil refineries. But its sprawling business interests span agriculture, minerals, materials engineering and even cattle ranching.
One afternoon, Koch executives met with Georgia-Pacific executives on the 51st floor – reserved for Georgia-Pacific executives and their guests – of the company’s headquarters. Over lunch served on fine china, Wesley Jones, who oversaw Georgia Pacific’s wood-pulp mills, explained how they operated, where it bought timber and where it sold pulp, and the potential growth of Asian markets.
One of the visitors listening was James Hannan, who worked for Koch Industries and would be installed as Georgia- Pacific’s CEO in 2007. He wasn’t used to wearing a tie – Koch culture was much more informal.
Hannan and his team thought Georgia-Pacific’s pulp mills could push Koch into a new industry while allowing the company to build on what it did best. Pulping wood turned out to be not all that different from refining oil. At Koch’s oil refineries, crude oil was pumped in one end and then heated and processed in big towers, making gasoline and other products. At Georgia-Pacific’s pulp mills, truckloads of pine trees were fed into one end of the mill and cooked down into a fibrous goo and sprayed into churning machines that make long rolls of dense pulp material.
The Georgia-Pacific mills were attractive for another reason. Koch executives believed they were undervalued in a way a privately held company could exploit. The company had been on a decades-long spree buying a lot of businesses that didn’t fit neatly together – Georgia-Pacific made high-profit tissue paper and lower-profit wood pulp. The markets for tissue paper and plywood were so different that bank analysts had a hard time putting a single value on a company that was heavily involved in both. The pulp line was cyclical and dragged down the value of the consumer-products business.
Koch Industries wasn’t bothered by the boom-and-bust cycles of the wood-pulp business. Volatility was Koch’s bread and butter. Koch bought Georgia-Pacific’s pulp division in 2004 and renamed it Koch Cellulose. Koch put Jones in charge.
After Koch took the pulp mills private, Jones noticed an immediate change. The biggest, most obvious change was Koch’s willingness to reinvest its profits.
The art of killing dividends
Georgia-Pacific had been skimping on capital spending at its pulp mills for years, Jones said. That was partly because the company had to pay off the roughly $3.5 billion in debt it took on to buy Fort James, a tissue maker. The firm had about $8.7 billion in total debt in early 2005. Georgia-Pacific also paid out generous dividends to shareholders, a common practice that public companies employ to make their shares more enticing.
The company’s strategy was to run its mills as long as possible without shutting them down for repairs, Jones said. It delayed the purchase of new equipment that might have made the plants more profitable. The strategy worked for a while, Jones said, but by 2004 the equipment was starting to show serious wear and tear.
“We were trying to spend as little as possible,” Jones recalled. He said he was frustrated with the lack of investment. “There’s a lot of smaller stuff that we had to have fixed.”
Under Georgia-Pacific, Jones undertook a laborious, bureaucratic process to get new investments approved. He was girding himself for the same under Koch. He badly wanted to install a new set of more-efficient processing towers at Koch’s pulp mill in Brunswick, Ga. After the Koch purchase, he talked about it on the phone with a Koch executive in Wichita, saying they had cost $35 million to $40 million.
To Jones’s surprise, the investment was approved. On the phone. That was a first.
“I remember putting the phone down and thinking, ‘Damn,’ ” Jones said, shaking his head. “It was like a month or two after the acquisition. I was floored.”
Executives at Koch’s headquarters in Wichita were accustomed to such quick approvals. Charles Koch requires that 90 percent of the company’s profits are reinvested. He fought a legal battle for roughly 20 years against his younger brother Bill Koch, who along with other shareholders wanted to pull more cash out of the firm. Charles Koch refused.
To be sure, the relentless drive for profits has led to criticism of Koch’s business practices in the past. In 2000, the company paid what was then the largest civil fine ever – $30 million – for violating pollution laws after its pipelines sprung hundreds of leaks. Its oil refinery in Minnesota was fined for improperly dumping ammonia into local waterways. In such cases, Charles Koch has said, members of management had misinterpreted the company’s philosophy.
As it spent money on Georgia-Pacific’s pulp mills, Koch Industries liked the results.
“We were able to demonstrate relatively quickly that the improvement opportunities were there,” Jones said.
In late 2005, Koch Industries announced that it was buying all of Georgia-Pacific for $21 billion.
The timing of the deal could not have been worse.
Riding the crash
Koch took full custody of Georgia- Pacific just as the nation’s housing bubble burst. Georgia-Pacific made plywood, lumber and gypsum building panels used in everything from apartment buildings to new restaurants. The market collapsed.
When Georgia-Pacific hit a rough patch in 2009, it made use of a highly controversial tax credit for a pulping byproduct known as “black liquor,” the company acknowledged to The Washington Post. Critics said the creation of the tax credit in 2007 was a backdoor bailout for some wood companies in lean times.
“Of all the tax loopholes I’ve seen in the last three decades, none is more despicable than the totally unintended and unproductive black-liquor tax credit,” Marty Sullivan, a tax consultant and former staff economist with the Treasury Department, said in an email.
Karen Cole, a Georgia-Pacific spokeswoman, said: “We did not advocate for this tax credit, but ultimately we did participate in it – not doing so would have put us at a competitive disadvantage. We have consistently opposed all subsidies, mandates and programs that distort the market and will continue to do so, even when they benefit us.”
The market collapse was particularly bad news for Jose Casanova, a manager of Georgia-Pacific’s gypsum mill outside Savannah, Ga. Casanova said the market for his products tanked just as the plant opened a newly expanded production line. Sales were low for years afterward. But Casanova, who had worked for Georgia-Pacific since 2000, noticed something surprising. Koch didn’t pull back its capital spending.
Koch installed new safety fencing around the machines, hoping to cut down on lost-time accidents. The yellow metal barriers would discourage employees from manually dislodging jammed machines or trying to clean around conveyor belts while they were will running.
“We didn’t think it was possible – until we implemented it,” Casanova said. “Now we need to make sure the equipment is reliable. Then you don’t need to access the equipment and risk getting hurt.”
Koch’s experience with volatility created another practice that soon swept through Georgia-Pacific.
In the 1980s, Koch stopped routinely using annual budgets – those financial documents that for many public companies are akin to divinely inscribed stone tablets, dictating which financial targets would be hit in a given quarter. The power of budgets was logical for public companies – if sales or profits are below expectations, even for one quarter, it can hurt the stock price.
During the oil shocks of the 1970s and ’80s, Koch executives realized that budgets were all but worthless – it was all but impossible to predict how much Koch needed to pay for oil six months or a year down the road.
Instead, Koch uses “plans” for each year, sketching out revenue, costs and profits it anticipates, mainly used so executives can better plan acquisitions. Managers aren’t judged on how closely they adhere to the budget – just on whether they expand their business.
“The difference is that many companies go to painstaking detail on every line item in their budget in an effort to, I’ll say, predict the future,” Robertson said. “What we determined is that we weren’t very good at predicting the future. So why do we want to spend an inordinate amount of time trying to?”
A new culture
Koch’s other changes reshaped Georgia-Pacific’s corporate culture. Koch started almost immediately by moving senior executives out of the lavish offices on the 51st floor, where Hannan had received his first presentation on Georgia-Pacific’s pulp mills. Having a floor reserved for executives, where a necktie was required for admission, conveyed too much of a command-and- control mentality, Charles Koch later wrote.
Merging Koch Industries’ culture with Georgia-Pacific’s has not been without its challenges. The union was a complication for Koch, not known for any warmth toward organized labor. The company had unionized workers at some of its operations but nothing compared with the size and scope of Georgia-Pacific’s collective-bargaining units.
The Nation magazine published an article about other cultural tensions in 2011 with the headline “Big Brothers: Thought Control at Koch.” Employees were particularly troubled when Koch Industries shared literature that recommended voting for Republican Mitt Romney in the 2012 presidential election.
One union filed a labor complaint over Koch’s policy that restricted social-media posts for employees. Greg Pallesen, who represents Georgia-Pacific workers in the Association of Western Pulp and Papers Workers, told the news outlet In These Times that Koch’s policy was hypocritical and unfair to workers.
“They don’t allow their employees to have free speech,” he said. The National Labor Relations Board and Georgia- Pacific reached a settlement in which the company backed off the policy.
Still, the number of union workers at Georgia-Pacific has declined precipitously. When Koch took over, roughly 22,000 of 55,000 Georgia-Pacific employees were unionized. Today, that number has dropped steeply, to 11,800, the company said. A Koch official said that selling off its tissue business in Europe and closing some “noncompetitive facilities in the U.S.” contributed to that drop.
For its intense focus on company performance, Georgia-Pacific has not swept the paper market.
Its returns are probably average to above average when compared with competitors such as Kimberly-Clark or Procter & Gamble, said Chip Dillon, a stock analyst who has covered the forest-products industry for two decades. Both of those firms invest heavily in consumer products with higher profit margins and have strong market positions.
“I would say that Georgia-Pacific is respected. I wouldn’t say they’re feared. I think their competitors are equal to them in many senses,” Dillon said. “They’re not going to take over this business.”
Hannan said the best way to stay competitive is to stay uncomfortable. Even if the financial indicators for Georgia- Pacific are positive – with higher earnings, a lower debt rating and more acquisitions on the horizon – Hannan said the one emotion he tries to avoid is that of self-satisfaction.
“The thing you worry most about is that we’re going to feel that way,” Hannan said, “and then just get dragged down from behind and get our throats slit.”