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Smurfit’s move to box in WestRock looks sweeter as top rivals announce engagement

Capital expenditure at WestRock could increase from average $1 billion for the past eight years to $1.73 billion over each of the next three

Smurfit Kappa’s deal to buy US peer WestRock has increased by almost 11 per cent in value to €11.8 billion since it was announced last year. Photograph: Bloomberg

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Joe Brennan
Sat Apr 20 2024 - 06:00

The price of Smurfit Kappa’s largely stock-based deal to buy US peer WestRock has increased by almost 11 per cent to $12.6 billion (€11.8 billion) since it was announced last September, as packaging stocks have rebounded across the industry.

The cost of clearing the way for Smurfit Kappa boss Tony Smurfit and his trusted chief financial officer Ken Bowles to take executive control of a combined Smurfit WestRock? A further $45 million.

That’s the combined “golden parachute” compensation WestRock chief executive David Sewell and chief financial officer Alexander Pease stand to receive – between cash and the vesting of stock awards – as they exit the business following the expected completion of the deal in July, transaction filings with the US financial markets watchdog confirmed last week.

What has also gone up, the filings show, is the expected amount that will be needed to invested to turn around WestRock, a business with lower levels of profitability, relative to both sales and invested capital, than Smurfit Kappa.

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It’s estimated that capital expenditure on the WestRock side of the combined group will increase from an average of $1 billion for the past eight years to an average $1.73 billion over each of the next three years.

Cole Hathorn, an analyst with investment bank Jefferies in London, said in a report this week that this may be viewed as a negative by investors, as it suppresses the amount of free cash flow – the amount of money a company has left over after running and investment expenses – the group can generate.

[ Smurfit Kappa delay to chairman exit backed by shareholder adviser ]

Indeed, shares in Smurfit Kappa have eased back by as much as 5 per cent since the filing on April 11th (underperforming global equities, which have also dipped since then).

But on the positive front, the Smurfit side of an enlarged group is past a peak in capital expenditure, which is seen falling from €1.05 billion last year to an average €823 million over the subsequent three years.

More importantly, an inevitable slump in demand for cardboard boxes – following a spike in that for physical goods, from TVs to patio furniture, during pandemic lockdowns – seems to have played out.

The last month or so has seen the sector increase prices of certain containerboard products – which are used to make cardboard boxes and had slumped by more than 35 per cent from late 2022, according to analysts. The hope is that this will lead to increases in the price of boxes – the final product – within three to six months.

While WestRock moved last year to shut down two large, loss-making paper mills – in North Charleston, South Carolina and Tacoma, Washington state – and was already in the middle of a cost-savings programme before the deal was struck, it is behind its suitor’s own “transformation journey”, which has been under way since Tony Smurfit, grandson of the Irish group’s founder, Jefferson, took over as chief executive in 2015.

[ Smurfit Kappa signals WestRock deal will close in July as revenue falls in face of global slowdown ]

Smurfit Kappa’s earnings before interest, tax, depreciation and amortisation (Ebitda) margin widened to a peak of 19.1 per cent in the first half of last year from 14.4 per cent before Smurfit took charge. Profitability relative to every euro of capital invested in the business – a key figure for industrial companies – had risen from 15 per cent to 19 per cent over the same period (both performance ratios dipped as 2023 progressed due to the industrywide woes).

Justin Jordon, an analyst with Davy, said Smurfit Kappa can use lessons it’s learned over the past decade – including a greater focus on innovation and getting closer to customers, especially during the pandemic – to help turn around WestRock.

He noted that while cardboard box sales grew by an average of 1.5 per cent by volume over the last 20 years, Smurfit Kappa’s growth averaged 2-2.5 per cent over the past decade. “Smurfit Kappa’s outperformance relative to the packaging sector isn’t massive in any given year, but over the course of a decade, it is,” Jordan said.

Smurfit Kappa and WestRock said at the time the deal was unveiled that the tie-up would create the world’s largest box-maker, with combined sales of about $34 billion and Ebitda of $5.5 billion. Smurfit Kappa shareholders will own 50.4 per cent of the enlarged group.

Smurfit and Bowles have estimated they can scrape out more than $400 million of annual pretax cost synergies from the tie-up by the end of the first full year following completion.

Hathorn at Jefferies said despite higher-than-expected investment needed at WestRock, the deal (which remains subject to shareholder approval) is more compelling than when first struck. He reckons Smurfit WestRock could be churning out Ebitda of $6.25 billion by 2027, which would justify a share price of £52 (€61), up from about £35, currently (Smurfit Kappa plans to quit the Irish market once the deal goes through and move its main listing from London to New York).

[ Ardagh bonds drop as packaging giant eyes talks on debt ]

A move by International Paper (IP), the largest US paper packaging group that made an unwanted approach for Smurfit Kappa six years ago, to launch a formal bid this week for London-listed DS Smith, the second largest player in Europe, will help.

“Smurfit WestRock will get something of a free-rider benefit from DS Smith and its new owner closing some European mills, improving pricing power for European box-makers,” said Jordan. “Smurfit WestRock will be doing the same in North America, so it will lead to some more pricing power.”

UK packaging group Mondi, which had agreed in principle last month to buy DS Smith before IP gatecrashed the engagement party, announced on Friday it will not be making a fresh offer for its domestic peer.

Shares in DS Smith had been trading recently above IP’s £5.8 billion offer in anticipation Mondi would up its bid before a “put up or shut up” deadline next Tuesday. They slumped as much as 13 per cent during afternoon trading. Mondi jumped as much as 11.3 per cent out of relief it won’t get involved in a bidding war.

The IP deal gives DS Smith an enterprise value, which included net debt, of eight times estimated Ebitda for this year.

Even accounting for the increase in Smurfit Kappa’s shares in the seven months since it agreed to WestRock, the accord equates to less than seven times Ebitda, based on earnings forecasts in last week’s filing and its end-2023 net debt. And that ignores the turnaround potential analysts see in the US company.

“Smurfit Kappa would probably not be able to buy WestRock,” says Jordon, “on the same terms as agreed in September.”

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