The following article is part of The Motley Fool's "Stock Madness 2005," a contest based loosely on the annual NCAA College Basketball Tournament, a.k.a. March Madness. From March 17 to April 4, our writers and analysts will engage in head-to-head competition with each other, advocating and arguing on behalf of 64 stocks we've selected as among the most interesting to Foolish investors. You, dear readers, are the fans and referees -- you'll read these exciting duels and then vote for the stock you think is the better investment... and should therefore move on to the next round of play. The company that survives six "games" will be our tournament champion, and its writer our most valuable "coach."

But, please, make no mistake -- "Stock Madness 2005" is a GAME!

Our writers are doing this for fun. They are enjoying the spirit of competition and the art of debate. They are delighting in the search for positives in the companies they've drawn... and negatives in the companies they're pitted against. They are NOT necessarily recommending these stocks as the ones they believe in above all others. As ever, YOU must decide whether the stocks we're writing about -- winners and losers -- are deserving of your investment dollars.

Neenah Paper (NYSE:NP)
Alpharetta, Ga.
$34.20
52-week low-high: $21.00-41.50
$503 million market cap

By Nathan Parmelee

In Round Two of Stock Madness 2005, we bring you paper mills vs. oil refineries! The collective anticipation of the audience must be building to a massive crescendo. Actually, I kid. I'd like to offer kudos to our Foolish readers for picking out two companies that have excellent potential -- and just happen to reside in extremely dull industries.

But with our little Cinderella paper company, Motley Fool Hidden Gems recommendation Neenah Paper, still at the big dance, let's dig in. In the first round I mentioned that as an independent company Neenah now had more freedom to innovate and focus its resources as its management deemed fit. In the last month Neenah has shown that it will do just that -- by rolling out new products that consumers can purchase directly on the company website and by shutting down a portion of its oldest and most problematic pulp mill.

Closing its smallest pulp mill may not seem like a big deal, but it's these types of decisions that often get mired in bureaucracy when a company is just one division in a much larger enterprise. Instead Neenah will take a $7 million charge up front, and management then expects to see ongoing savings of $2 million to $4 million per year. It's great to see management already focusing on the pulp portion of the business; the pulp business is very cyclical because of its commodity nature. That said, pulp is a necessary input for the fine paper and technical paper divisions, which have excellent margins.

All of this is great, but here's the real reason why Neenah is a steal. When small companies like Neenah are spun off from much larger companies, such as Kimberly-Clark (NYSE:KMB), they rarely do well during their first few months as small caps in the public markets. This is because many of the owners of large companies are mutual funds -- and the funds either don't want to hold small caps or are explicitly directed not to hold small caps. All this selling creates an initially depressed stock price in the market and an opportunity to pick up a good company on the cheap for individuals like you and me.

Fool contributor Nathan Parmelee owns shares in Neenah Paper.

Valero (NYSE:VLO)
 San Antonio , Texas
$70.86
52-week low-high: $27.95-$77.15
 $17.7 billion market cap

By Bill Mann (TMF Otter)

Having dispatched of a utility in Round 1, I now get to take on another intense consumer of oil products, a paper company called Neenah.

You know who Neenah is? Yeah. Basically I'm up against Wisconsin-Milwaukee, a scrappy upstart that lacks a large following, has only been in the game a short time, and has done it with smart management. In terms of this contest, Neenah Paper has no advantages whatsoever. It's just glad to be here.

But just like the big dance, where the sweet stories of the opening rounds give way to the epic battles of the contenders in later rounds, such stories almost never have a Hoosiers ending. Jimmy Chitwood doesn't hit the shot.

Neenah's time for denouement has arrived. As a consumer of the very oil products Valero produces, it remains a business (and a very fine one) that is inherently going to lose out as long as its raw material costs are high. Ah, you say, but Neenah owns rights to harvest wood in millions of acres in Canada. Very true, but lumber isn't the only raw material that goes into pulp and paper, and, besides, we still have transportation issues. Since Neenah Paper is not the low-cost producer in what is at its roots a commodity business, these costs can be extremely meaningful.

Being the low-cost provider matters, especially in a business with excess capacity. In the refinery business, Valero has the best of both worlds -- it's the low cost producer, since its slate is heavily leveraged toward cheaper grades of crude oil, and the business has no excess capacity whatsoever. In fact, the refining business runs at nearly 100% of available capacity at all times, with little chance for more refineries being built due to regulatory constraints. It is a dirty business that no one wants in his back yard.

You can't have bigger barriers to entry than that. It's why I decided to pick Valero almost two years ago for Motley Fool Hidden Gems -- and then wait for the oil services business to tighten. It could do nothing else. Since there's no real avenue for additional capacity, the most reasonable route to reducing demand for Valero's products is a drop in oil consumption.

What is the probability of that happening in the near future?

Bill Mann does not own shares of either company mentioned in this article.

Rebuttals
Bill's right. The only threats to Valero at the moment do seem to be the decline of oil consumption or building of new refineries. While Bill doesn't seem to think that's likely, I say, "Why not?" As the prices for oil, which are largely determined by global demand (China and Asia), continue to rise, competing energy sources that are not currently cost-effective become ever more intriguing. And while the NIMBY cries and regulators have held off on refineries to date, if costs get high enough folks will begin to back down.

Neenah, on the other hand, is a company starting life anew with plenty of potential for unlocking value in land and in operations. I think it's an easy call and even if it's not, sometimes the real-life Jimmy Chitwood's make the big shot and pull off the upset -- N.P.

All right, here's a question: Why isn't Neenah Paper based in Neenah, Wis.?

Here's a more important question. Nathan Parmalee's thesis for Neenah involves the fact that companies that are spinoffs tend to underperform as a result of selling pressure from institutional owners who cannot justify holding smaller capitalization stocks. This tends to be true, but since Neenah Paper's spinoff was more than five months ago, can we not conclude that this selling pressure should have been relieved by now? Neenah Paper's a fine company, but I wouldn't put too much hope into added buoyancy in its shares based on the end of programmatic selling that has most likely long since ended. -- B.M.

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