Boxed in? Smurfit fights to escape the clutches of US rival

Unwanted suitor International Paper expected to return with new offer

Tony Smurfit knew where he needed to go almost three years ago, when the board of Smurfit Kappa offered him the position of chief executive in Ireland's first multinational company.

Before committing, he visited the grave of his grandfather, Jefferson Smurfit, originally a tailor from Sunderland in northeast England, who acquired a small box-maker in Rathmines in south Dublin in 1938. The business would ultimately grow into Europe’s largest paper packaging group.

“I thanked him for giving me the opportunity to be in the position that I was able to work my way up the company,” Smurfit (54), said in a Today FM interview late last year. “The reason I love doing [the job] is that I’m honouring the memory of my grandfather and my father. I suppose it’s about legacy.”

Built over the course of the past eight decades through a series of carefully timed acquisitions in a highly cyclical industry, Smurfit Kappa is now subject to an overture of its own, as it emerged this week that US-based rival International Paper has pitched a €8.6 billion takeover proposal.


Buying smaller rivals

Smurfit Kappa’s board dismissed the proposal as “highly opportunistic” and one that undervalues the group, pledging to proceed with its own plan, unveiled last month, to invest €1.6 billion over the next four years expanding and buying smaller rivals.

However, its Memphis-based suitor is widely expected to come back again with an improved offer – leaving the last Smurfit in the group with an uphill battle to keep the family name over the door.

"We have taken the time to carefully consider the proposal and we decided to reject it," Smurfit Kappa chief financial officer Ken Bowles told The Irish Times on Tuesday. "The key message is that, when we look at the future prospects of Smurfit Kappa and the medium-term plan outlined a few weeks ago, that sets out the stall for the company for four to five years, and beyond. It's in shareholders' interest to remain independent."

Still, International Paper, which was first rumoured to be circling Smurfit Kappa three years’ ago , said later that day that it reserved the right to sweeten its rebuffed €36.46 cash-and-stock offer.

"The language in International Papers' statement suggests that this is the beginning of a process, rather than the end," said Gerard Moore, an analyst with Investec Ireland.

‘Other people’s mistakes’

First floated on the Irish stock exchange in 1964, the company doubled in size six years later when it bought the Hely group of packaging, radio, television and distribution companies, and took on the name Jefferson Smurfit Group (JSG).

It ventured into the US 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 accelerated the company’s acquisition drive. He proved particularly adept at acquiring assets in distress, most usually as a result of rivals overextending themselves building new plant at the wrong time in the cycle. It was a model of “buying other people’s mistakes”, the storied businessman would boast.

JSG exited the stock market in late 2002 when Chicago-based private equity firm Madison Dearborn took it over in a $3.5 billion deal, the equivalent of €3.7 billion at the time. It left Michael Smurfit with a stake of almost 7.5 per cent in the company and the position of chairman. Gary McGann, the former Aer Lingus boss, was appointed chief executive.

Smurfit’s holding was diluted further to 4.3 per cent in 2005 when the group merged with Dutch peer Kappa Packaging in a €6 billion deal. The combined group, Smurfit Kappa, as Europe’s leading cardboard box-maker, set about overhauling a hugely oversupplied market, before floating in March 2007 just after Dublin’s Iseq index reached an all-time high.

The group used much of the €1.5 billion proceeds from the initial public offering (IPO) to cut its debt mountain to €3.5 billion. However, it was soon forced to abandon its growth ambitions as the global financial crisis triggered a recession and investors ran away from heavily indebted companies.

Smurfit Kappa was forced to concentrate on lowering its debt burden to convince investors that it could survive – and has only been able to pivot again in the past few years towards a growth strategy.

Record earnings

Last month, the group unveiled record earnings before interest, tax, depreciation and amortisation (ebitda) of €1.24 billion as revenues rose 5 per cent to €8.56 billion and Tony Smurfit set out a series of ambitious financial targets to be achieved by the end of 2021. These include increasing its return on capital, setting a lower debt-burden target, relative to earnings, while investing €1.6 billion on opportunities in its own business and on deals.

The third-generation paper executive and his team, however, have been more preoccupied in recent weeks by the arrival on the scene of International Paper. One of the world’s largest paper groups with a market value of almost $23 billion (€18.6 billion), the US group made its first advance on February 14th – St Valentine’s Day. It delivered its proposal on February 23rd.

The board of Smurfit Kappa, chaired by Liam O'Mahony, issued a statement at 7am on Tuesday roundly rebuffing the pitch. It did so without warning International Paper, whose executives, led by chief executive Mark Sutton, were still asleep.

It took 11½ hours for the US group to come up with its response, in which it highlighted how its bid valued Smurfit Kappa at a 27 per cent premium to the FTSE 100-listed stock’s closing price on Monday, before investors had heard of the approach.

International Paper rejected its target’s comments that the bid was highly opportunistic and said an enlarged group “would constitute a premier global packaging company” and create an opportunity to realise “meaningful” cost savings.

“It is clear there is no love lost between these two management teams,” David O’Brien, an analyst with Goodbody Stockbrokers, wrote in a note to clients this week. “This story has more to run, and a third party entering the process cannot be ruled out.”

It was reported on Wednesday that Smurfit Kappa would entertain talks with International Paper if the US group came back with an offer above €40 per share. That would value the company at almost €9.5 billion.

Cost saving

However, Bank of America Merrill Lynch analyst Alexander Berglund has indicated that a successful bid may have to be as high as €10.6 billion, while UBS analyst Mark Fielding said an equity value of between €9 billion and €11 billion could be place on Smurfit Kappa, depending on the cost savings that International Paper can derive from combining both groups.

“Both businesses are integrated paper and packaging companies, although International Paper has a wider paper business and Smurfit is more focused on the packaging segment,” said Mr Fielding, noting that the US group generates 75 per cent of its sales in the Americas and most of the remainder in Europe and Russia, while Smurfit Kappa is the reverse. “We would see only limited potential issues from the competition authorities on any combination.”

The bid comes against the backdrop of a wave of deal-making across the industry as the global economy is now growing at its fastest and most broad-based pace since the beginning of the decade, according to the International Monetary Fund. Demand for paper-based packaging is also being driven by a boom in internet shopping and environmental concerns.

In January, US packaging company WestRock agreed to buy rival KapStone Paper and Packaging for about $3.5 billion, a year after snapping up Multi Packaging Solutions for $1.4 billion. South Africa's Mondi and DS Smith of the UK have also completed deals in the past six months.

“In addition, as part of globalisation, customers are often looking to consolidate their number of suppliers – and larger companies can invest more in innovation so there are clear advantages in scale,” said Investec’s Moore. “This process has already run its course in North America and now these producers are turning their attention to Europe and beyond.”

Top of the market

As Smurfit Kappa and its advisers at Citigroup and Davy circle the wagons to fend off the unwanted suitor, their biggest allies may be investors in International Paper, which, in turn is being advised by Deutsche Bank.

Shares in International Paper dropped almost 7 per cent over the course of two sessions on Wall Street after the bid was revealed. Perhaps more importantly, the value of its debt on the capital markets also declined. The company’s $1 billion of bonds, due in 2027, fell by 2.5 per cent in two days.

Mark Connelly, an analyst with Arkansas-based investment bank Stephens, concluded that the approach means "now it really must be the peak" for the industry, as International Paper has a "long and painful" history of doing deals at the top of the market.

Moody’s, one of the world’s top-three debt rating agencies, said the bid is “negative” for the US group’s creditworthiness, as it would push its debt up to 4.6 times ebitda from a ratio of 3.3 currently. By contrast, Smurfit Kappa’s ratio was 2.3 at the end of December – down from 4.2 in mid-2010.

Still, analysts believe that International Paper’s Sutton – having bided his time since he was first said to have Smurfit Kappa in his sights – will not back away easily.

“If there are any future offers, we’d have to take them back to the board and carefully evaluate them,” said Bowles. “We’d have a fiduciary duty to do so.”

It is unlikely, particularly given how the Irish company has reacted to the proposition, that Tony Smurfit would remain on board if Sutton succeeds, according to analysts.

Meanwhile, for a man who once famously quipped that “equity is blood”, Michael Smurfit (81) – who stepped down as chairman before the 2007 IPO and saw his stake diluted to 2.6 per cent by the deal – would see any remaining shares he may hold being mopped up under a trade takeover.

His son and fellow Monaco resident, Tony, who owns less than 0.5 per cent, would face the unwelcome prospect of having to deliver the news.

Joe Brennan

Joe Brennan

Joe Brennan is Markets Correspondent of The Irish Times