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Smurfit Kappa seeks to take advantage of packaging downturn to buy US rival

Market Beat: Timing of the deal to bring Smurfit together with WestRock reflects depressed valuations in the sector

Smurfit Kappa would pay WestRock investors for their shares “primarily” by way of stock in an enlarged group, to be known as Smurfit WestRock. Photograph: Smurfit Kappa

Residents of Tacoma, the Washington state city about 50km southwest of Seattle, would be forgiven for having mixed feelings about the closure in the coming weeks of a 94-year-old paper mill beside its port.

The winding up of the facility, which has the capacity to produce over 500,000 tonnes of paper used for cardboard boxes and other packaging products, comes with a cost of 400 jobs.

But the mill has also been long partly blamed locally for the “Aroma of Tacoma”, an odour that has been likened variously to rotten eggs or dog food – even if it has subsided in recent decades, especially since a nearby lead and copper smelter was shut down in the mid-1980s.

The Tacoma plant is the victim of the recent drop-off in demand for cardboard boxes, which reached unprecedented levels globally during the Covid pandemic when demand for physical stuff – from giant TVs to patio furniture – spiked amid lockdowns.

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it was clear from the details in the holding statement that the talks are well advanced. They had even got down to the brass tacks of annual cost savings that could be squeezed out of the merger, estimated at $400 million

All told, the owner of the mill, Atlanta-based WestRock, the second-largest paper packaging group in the US, has cut 1.9 million tonnes of capacity in recent times, focusing on getting rid of higher-cost facilities that are losing money from an earnings before interest, tax depreciation and amortisation (ebitda) perspective.

Shares in WestRock had lost more than a fifth of their value on Wall Street in the 12 months to last Wednesday. That was before the Wall Street Journal reported that evening that it was in tie-up talks with Smurfit Kappa, one of Ireland’s most storied companies.

The leak forced the Dublin-based group to issue a statement shortly after 3am on Thursday confirming the discussions on a potential $19 billion (€17.7 billion) marriage. But it was clear from the details in the holding statement that the talks are well advanced. They had even got down to the brass tacks of annual cost savings that could be squeezed out of the merger, estimated at $400 million. Still, it would require about $235 million of one-off restructuring costs to get there.

Cash payment

Smurfit Kappa, led by chief executive Tony Smurfit, the third generation to run the Irish group, would pay WestRock investors for their shares “primarily” by way of stock in an enlarged group, to be known as Smurfit WestRock. This suggests a partial cash payment is on the cards.

09/02/2021 - NEWS - Tony Smurfit, Smurfit Kappa Chief Executive photographed at the Smurfit Kappa World Headquarters in Clonskeagh. for Business Section Feature Interview Photograph: Alan Betson / The Irish Times

The timing of the deal seeks to take advantage of depressed valuations in the cyclical downturn, as the long-term growth stories surrounding ecommerce and sustainable packaging products remain intact.

Smurfit Kappa said a merged entity would move its main stock market listing from London to the New York Stock Exchange and abandon its Irish quotation. This would end a link with the Dublin market that stretches back to 1964

Some valuations are more depressed than others. Smurfit Kappa’s shares are currently trading at levels that give it an enterprise value – including equity and debt – of nearly seven times’ ebitda forecasts for next year, compared to a ratio of five times’ for WestRock, according to UBS analyst Andrew Jones. “Westrock appears much cheaper, implying Smurfit Kappa could benefit on valuation, though we would need more details to come to a strong conclusion,” he said.

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Sources say a deal is likely to be announced as early as next week. Investment bankers in Citigroup are advising Smurfit Kappa, while Evercore and Lazard are holding the hands of WestRock.

Smurfit Kappa said a merged entity would move its main stock market listing from London to the New York Stock Exchange and abandon its Irish quotation. This would end a link with the Dublin market that stretches back to 1964, save for a hiatus between 2002 (the company was then known as Jefferson Smurfit Group) and 2007 when the group fell under the ownership of US private equity giant Madison Dearborn and merged with Dutch peer Kappa Packaging.

While the €6 billion combination in 2005 with Kappa Packaging tied two heavily indebted, private-equity-owned businesses together – triggering concerns during the subsequent financial crisis about its ability to survive – Smurfit Kappa is in a much different place now.

The group’s net debt burden had fallen to a record low of 1.3 times’ ebitda at the end of last year – down from more than four times’ in 2009 and below its 1.5 to 2 times’ target range. (Its net debt stood at €3.12 billion, or 1.4 times ebitda at the end of June.)

“Smurfit Kappa Group is the only company – among European corrugated packaging peers – that has de-levered between 2015 and 2021,” said Barclays analyst Gaurav Jain in a report last month. “Stable free cash flow and leverage well below the management’s target range provides M&A [mergers and acquisitions] optionality and could lead to extra returns to shareholders over the next few years.”

Cost synergies

The state of Smurfit Kappa’s balance sheet has to be a major attraction to the board of WestRock at a time of higher interest rates. The US group’s $9.46 billion net debt equates to almost three times ebitda – partly explaining the US company’s lower market value compared to Smurfit Kappa, even though it has higher sales and earnings.

A combined group would have a ratio of 2.3 times earnings for the 12 months to June – before factoring in the benefits of cost synergies.

A deal would also bring the Irish company closer to some of its global customers. Smurfit Kappa has a market-leading 11.6 per cent share of the fragmented European market for containerboard (which is used to make cardboard boxes), while WestRock has a 21 per cent slice of the more consolidated North American market. This compares to the 30 per cent share controlled by International Paper, the Tennessee-based group that made an abortive attempt to buy Smurfit Kappa five years ago.

“We see a good cultural fit, with strong focus on innovation-driven expansion of sustainable packaging offering and a similar mindset of merits of organic capex (capital expenditure, or investment) with strong focus of value accretion,” said Credit Suisse analyst Lars Kjellberg.

However, investors in Smurfit Kappa seem to have taken a more cautious view as they await more details. Shares in the group have fallen about 7 per cent since news of the talks emerged.