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September 13, 2023

Breakingviews: Smurfit $11 bln bid for dominance risks paper cut

by Breakingviews.

Rising to the top is rarely easy, nor cheap. That’s what Smurfit Kappa’s boss Anthony Smurfit learnt in his $11 billion swoop on U.S. rival WestRock, a deal that would create a global leader in paper and cardboard boxes used by the likes of Amazon.com and Unilever. The nearly 40% premium he’s offering risks overshadowing chunky cost cuts, and will shrink returns. Yet standing still in a softening packaging market is not an option.

Smurfit Kappa confirmed on Tuesday that it would combine with WestRock. Under the terms of the deal, the Irish box maker will offer one of its shares plus $5 in cash, equivalent in total to $43.51 per WestRock share, based on Smurfit Kappa’s closing price on Monday. That’s a 37% premium to the target’s share price last Wednesday, before the two parties first confirmed that they were discussing a combination.

The deal terms did not go down well with Smurfit Kappa investors on Tuesday. The company’s stock fell 10%, and has now lost 15% of its value since Thursday. There are reasons to worry. Smurfit Kappa says it will deliver pre-tax cost synergies in excess of $400 million. These are worth nearly $2.8 billion once taxed at 25%, capitalised, and after deducting a one-off charge of $235 million. The premium Smurfit is paying WestRock shareholders, however, is greater at around $3 billion, based on the target’s share price before the first reports of a deal. That means Smurfit is effectively paying a surplus to WestRock investors that exceeds the amount of extra value the deal will create.

Returns also look small. The deal values WestRock at roughly $20 billion, after including nearly $9 billion of net debt and the implied $11 billion equity value. Add the expected annual cost savings to WestRock’s forecast operating profit next year of $1.3 billion, using LSEG estimates, and tax the whole lot at 25%. The implied return to Smurfit is just $1.3 billion, or a measly 6% of the purchase price.

Still, a slowdown in internet deliveries after the Covid boom is already taking place. With the packaging market at risk of returning to the anemic annual pre-pandemic growth rate of around 2%, consolidation in the fragmented world of paper-box makers looks inevitable. U.S.-based International Paper, which had attempted to buy Smurfit Kappa in 2018, is probably still on the prowl. Joining forces will allow the two rivals to become the largest listed player in the sector by revenue, giving them more negotiating leverage with large e-commerce and consumer-goods customers.

Smurfit’s bid for global dominance makes strategic sense. But it’s not coming cheap.

Click here for an interactive version of the graphic.

Context News

Smurfit Kappa and WestRock on Sept. 12 announced a deal that would create the world’s largest listed packaging company, measured by revenue. If investors agree to the transaction, the Irish group would pay WestRock shareholders $5 in cash and one new share in Smurfit WestRock, a holding company that would be domiciled and headquartered in Dublin. Smurfit Kappa’s existing shareholders will ultimately own 50.4% of the combined group, while WestRock’s will have the other 49.6%. The companies plan to cut more than $400 million of costs per year as a result of the combination. Smurfit Kappa’s Ireland-listed shares fell 9.8% to 32.32 euros as of 0921 GMT on Sept. 12.

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