Smurfit’s refusal to be boxed in by rivals pays off for investors

It's three years since cardboard box-maker Smurfit Kappa received a St Valentine's Day overture of the most unwelcome kind from US rival International Paper (IP).

And Tony Smurfit, chief executive of the group founded by his grandfather, has good reason to feel pleased with himself for defending the group against his Memphis-based rival's €9 billion cash-and-stock bid.

With Smurfit Kappa’s stock hitting record levels this week, and adding in dividends in recent years – including a surprise €193 million payout last autumn equating to a dividend that was spiked earlier in the year amid the Covid-19 shock – investors have made about a 25 per cent return above what they stood to make from IP’s ultimate offer. That doesn’t even take into account IP’s share price drop since it walked away in June 2018.

“There’s a very big misconception that we didn’t engage. We met with them, they presented a proposal that did not represent value to us and we told them that – publicly. And then they made another proposal, which was a minor increase and our [then] chairman, Liam O’Mahony, who played a blinder, took the call and told them, again, it didn’t meet any of our [expectations],” Smurfit says.

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“If they wanted to do something, they should have put another proposal on the table. We didn’t think they were even close enough to where we thought the future value of the company was.”

Smurfit refuses to say what price would have piqued his interest. But does he feel vindicated for refusing to allow IP have a look at the books, despite pressure from some shareholders?

“I don’t feel vindicated because of the share price. When you look at the share price, and you look at the dollar, and you look at [IP’s] share price, and the dividends that have been paid, we’re considerably above the last purported offer,” the 57-year-old says.

“But I think the more important thing is Smurfit Kappa’s 46,000 people, plus the community, plus all the charities, and plus our customers, who are generally really, really happy about the way it’s turned out.”

One analyst had privately compared the cultures of the two companies as “oil and water” at the time of the bid approach.

Sustainable packaging

Smurfit Kappa reported last week that its earnings declined 9 per cent to €1.51 billion last year as a result of a dip in box prices and the impact of Covid-19 lockdowns globally on cafes, bars and restaurants. However, the figure beat analysts’ expectations amid a strong surge in box volumes late last year.

If the company was already benefitting from the growth in recent years in online shopping and a gradual shift from plastic to more sustainable packaging, the pandemic has turbo-charged both trends.

“Ecommerce has been here for a long time but it’s accelerated because of Covid. I just see it as being a huge mega trend that’s going to continue to be a big driver of growth,” Smurfit says.

“But I think the whole issue of sustainability is just in its infancy. Boards themselves are going to come under more and more pressure to make sure that where XYZ company uses plastic and it can be replaced by a sustainable product such as paper, they should be doing so. That is a huge opportunity for a company like ours.”

Happily for Smurfit Kappa, the crisis has also fuelled the amount of investment money that is being devoted to environmental, social and governance (ESG) principles. The global value of assets where investment decisions are driven by ESG data breached $40 trillion (€33.3 trillion) last year, having almost doubled since 2016, according to the UN-backed Principles for Responsible Investment organisation.

“A brown box, if you put it in the right bin, will get reused seven, eight, or even nine times before it disintegrates. A box is basically fibre. Our obvious challenge is to make sure that our emissions from that box that we continue to reuse are less and less,” he says.

The Dublin-based manufacturer, which has an annual energy bill of close to €500 million, knows that it must pick up the pace on its own green journey, too. Having cut its CO2 emissions by a third between 2005 and 2019, the company announced late last year it plans to reach net zero emissions by 2050.

The story of Ireland's first real multinational dates back to Smurfit's grandfather, Jefferson Smurfit, originally a tailor from Sunderland in northeast England, acquiring a small box-maker in Rathmines in south Dublin in 1938.

The company floated on the Irish stock exchange in 1964 before doubling in size six years later through the purchase of the Hely group of packaging, radio, television and distribution companies. The then named Jefferson Smurfit Group (JSG) moved into the United States in 1974 with the purchase of an initial 40 per cent stake in Chicago-based paper and packaging company Time Industries.

Smurfit was succeeded on his death in 1977 by his eldest son Michael, who stepped up the company’s acquisition drive, focusing in particular on distressed assets that other companies had overstretched themselves developing at the wrong time in the economic cycle.

JSG exited the stock market in late 2002 when Chicago-based private equity firm Madison Dearborn took it over in a $3.5 billion (€2.8 billion) deal, before floating again in early 2007 as Smurfit Kappa – 15 months after completing a €6 billion tie-up with Dutch rival Kappa Packaging to create Europe's biggest cardboard box-maker.

The group, carrying high levels of borrowings from its time under private equity, was forced during the financial crisis to abandon using the initial public offering (IPO) to further grow the business and used much of the €1.5 billion raised to cut its net debt mountain. The company’s share price would slide more than 90 per cent from its flotation price in the space of two years to a little over €1, as equity investors questioned the viability of the business.

“Honestly, in the company we never felt that we were going to break any covenants, albeit we came close,” says Smurfit, who was the group’s chief operations officer at the time, under CEO Gary McGann. “But our equity got crushed.”

Still, the company’s bonds only fell briefly to 75c on the dollar before quickly recovering to above 90c. “The bondholders always felt they were going to get paid.”

Spotted opportunity

Targeted bolt-on acquisitions and developing assets from scratch have been the preferred routes to growth in recent times. Group sales amounted to €8.5 billion last year.

Last November, Smurfit spotted an opportunity to raise €660 million through a share placing to allow the company accelerate its investment over the next three years as customers cry out for more sustainable packaging solutions and e-commerce continues to grow.

The fresh funds have also driven a 32 per cent drop in the group’s net debt, to €2.38 billion, cutting it to 1.6 times earnings before interest, tax, depreciation and amortisation (Ebitda) from 2.1 times. At its peak in 2006, the ratio was 5.5 times.

Smurfit Kappa's credit rating was raised to "investment grade" at Fitch, one of the world's three leading credit assessment agencies, as a result of the improved balance sheet and it has set a lower debt-ratio target to court other ratings firms.

“We were completely comfortable where we were, slightly below investment grade. But at the same time, I think the rating of our shares is below the long-term earnings potential of the company,” he said, adding that the main difference between Smurfit Kappa and Packaging Corporation of America, whose stock is trading on higher multiples of earnings than the wider sector, is the US company’s long-standing investment-grade rating among leading agencies.

“I think that they are a very, very good company. But I do think that we are much better than them. Why would the stock market attribute an earnings multiple to them considerably higher than us? So, I do believe that, in time, our multiple will expand very significantly and the investment grade piece is part of that.”

Smurfit, who had his sights set more on going full time into the horse racing industry in the early 1980s, joined the company in the middle of that decade on a graduate trainee programme. Industry watchers took note when he was handed the job of heading up the group’s French operation in 1996 with, as he puts it, his “moderate French”, before becoming deputy CEO and head of the European operations in quick succession towards the end of that decade. He was group chief operations officer between 2002 and 2015, before being appointed to the top job.

Was the Smurfit name a help or a hindrance as he climbed up the ranks?

“I was lucky. Things just opened at the right time. It wasn’t planned,” he says. “I had a couple of really good mentors. One was my uncle [Dermot]. And another was a very, very proper English man, who’s since passed away. He definitely would have been a Brexiteer.”

Smurfit, officially a Monaco resident, like his father, admits there was always "an expectation" that he would go into the business. And while he has retained a strong interest in the bloodstock industry, with his control of the family's Forenaghts Stud near Naas, Co Kildare, it has been difficult to match the highs of 1993, when his Vintage Crop chestnut gelding became the first overseas horse to win the prestigious Melbourne Cup in Australia.

“I think I’ve always been a good people manager, even when I was young,” he said. And an entrepreneur. As an 11-year-old schoolboy, he set up a lucrative tuck shop in school, with a sideline selling marbles when they were all the craze. “The checkered ones were always the high-value ones. I would have been turned in for the margins I used to make on those.”

Virtual plant visits

With more than 350 production sites across 35 countries in Europe and the Americas, Smurfit and his chief financial officer, Ken Bowles, have carried out more than 200 virtual plant visits since Covid-19 restrictions set in globally early last year.

“It’s definitely not the same as real visits. But it’s better than nothing,” says Smurfit, who contracted the virus last March, but had few symptoms at the time except for a loss of taste and smell.

As of late last week, 3,854 cases of Covid-19 and 33 related deaths have been reported across the company – mainly in the Americas. “In Mexico, which has been absolutely devastated by Covid and where the hospital system is very challenged, we’ve employed doctors with oxygen tanks and bought the medicines to treat anyone that gets it in the house [of employees],” he says.

On a conference call with analysts and investors on the day of the group's results last week, Smurfit made a point of saying the group "does not subscribe to the Milton Friedman school of economics", referring to the late American economist who espoused the idea of a free capital market system.

“We have broader societal and community-related responsibilities,” he says.

Smurfit, whose 0.5 per cent stake in the company is worth about €57 million, has recounted more than once how he visited the grave of his grandfather in May 2015 when he was named group CEO to thank him for setting up a company that would give him such opportunities.

He’s now contemplating the prospect of being the last family member to work for the business, with none of his four children showing any signs of joining.

“I’d love if they would, but thus far, they haven’t shown any interest. I had a cousin who came in two years ago [on the graduate programme] and he didn’t like it and left. I do know it’s a long, hard road.”