Special delivery: How shifting fortunes brought US boxmaker WestRock to Smurfit Kappa

Mark Sutton, the chairman and chief executive of nine years at International Paper (IP), who led a failed attempt in 2018 to take over Irish cardboard boxmaker Smurfit Kappa, told investors on Wednesday last week that he has started the search for his successor after four decades with the business.

The day wasn’t over when he learned that the Irish corporate giant had parked up near his own front lawn.

Smurfit Kappa, which fought off a €9 billion unwanted bid from the US’s largest paper packaging group five years ago, confirmed that evening – on foot of a leak to the Wall Street Journal – that it was in tie-up talks with the Memphis-based IP’s nearest rival, WestRock, located some 650km to the east, in Atlanta.

The final deal, formally agreed this week, will create Smurfit WestRock, the world’s biggest packaging group with $34 billion (€31.7 billion) of annual revenues. It is essentially a takeover by Smurfit Kappa that will see the group headquartered in Dublin, but will result in its Irish stock market quotation being dropped as it moves its main listing from London to Wall Street.

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“We’ve both been long-term admirers of each other, so over the years we’ve always kept in touch on bits and pieces,” Smurfit Kappa chief financial officer Ken Bowles told The Irish Times. “We began talking in earnest at the start of this year on what a possible combination might look like.”

[ Smurfit Kappa shares slump as investors digest owning 50.4% of group after WestRock merger ]

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

The merger announcement on Tuesday highlighted how “culturally aligned” the two groups were, with Tony Smurfit, Smurfit Kappa’s third-generation chief executive and future CEO of the enlarged group, telling analysts his company’s focus on investing in innovation and its decentralised business model, where paper mill managers are encouraged to run their units like owner-operators, is similar to WestRock’s approach.

The corporate marriage, which will need approval of at least 75 per cent of Smurfit Kappa shareholders and over half of WestRock’s investors, as well as the nod from regulators, combines the largest cardboard group in Europe with the number two in the US

It contrasts sharply with the “cultural differences” Smurfit highlighted in 2018 that the group had with IP when he happily pointed out that an analyst had likened the pair to “oil and water”.

Bowles suggested that Sutton probably saw the opportunity to go after Smurfit Kappa in February 2018 when WestRock was preoccupied at the time with a deal, announced only weeks earlier, to buy Illinois-based KapStone Paper and Packaging for $3.5 billion.

“I think that’s part of the reason IP might have thought they had the space to move,” said Bowles. “WestRock was going through its own large M&A [mergers and acquisitions] integration.”

Share-based deal

A largely share-based deal, expected to be completed in the second quarter of next year, will see Smurfit Kappa shareholders end up with 50.4 per cent of the enlarged group. WestRock investors will also get a $1.28 billion cash payment as part of the $43.51-per-share transaction that values the US group at $11.2 billion.

The corporate marriage, which will need approval of at least 75 per cent of Smurfit Kappa shareholders and over half of WestRock’s investors, as well as the nod from regulators, combines the largest cardboard group in Europe with the number two in the US. It will also add a consumer packaging business to the Irish group’s make-up a time when brands are increasingly shifting from plastic to sustainable packaging.

The Smurfit family involvement in cardboard boxes goes back to 1938, when Tony’s grandfather, Jefferson Smurfit, originally a tailor from Sunderland in northeast England, bought a small, four-year-old box-maker in Rathmines in south Dublin.

For Smurfit’s father, Michael (87), who once famously quipped that “equity is blood” as he drove the group’s acquisitive international expansion between 1977 and 2007 – initially as CEO and latterly as chairman – to become Ireland’s first multinational, the latest merger further dilutes a personal stake that had already been watered down to about 2.5 per cent by the time he left the company. Tony Smurfit’s personal stake will be reduced a little over 0.25 per cent.

However, the transaction will keep the Smurfit name over a business where the current CEO is the last family member among what will become a group of about 100,000 employees.

And it will mark a return of that name to the major league of the US cardboard box industry, almost 50 years after it first set out to conquer that market.

The then-named Jefferson Smurfit Group (JSG) ventured into the world’s largest economy in 1974 with the purchase of an initial 40 per cent stake in Chicago-based paper and packaging company Time Industries. JSG joined forces a dozen years later with a Morgan Stanley-leveraged equity fund to buy Container Corporation of America from Mobil Oil, before merging the business in 1998 with Stone Corporation to form Smurfit-Stone, the US’s second-largest boxmaker.

The group spun out its 29 per cent stake in a heavily indebted Smurfit-Stone to shareholders in the wake of JSG’s own €3 billion debt-fuelled takeover in 2002 by Chicago private equity group Madison Dearborn.

Another crack

It would be another decade before the group – then named Smurfit Kappa, following its 2005 merger with the Dutch-based Kappa Packaging and subsequent initial public offering (IPO) in 2007 – would have another crack at the US with a deal to buy Orange County Group, which was focused on the southwest of the States, for $340 million.

While bolt-on deals followed, it had less than a 2 per cent share of the national market by the time Tony Smurfit and his counterpart at WestRock, David Sewell, began serious discussions in January on a tie-up.

Smurfit said he doesn’t see issues with competition authorities across the 42 countries in which combined group will have operations, other than Mexico, where both companies are active

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), according to Barclays analysts. WestRock has a 21 per cent slice of the more consolidated North American market. Both have interests in Latin America.

“The issue for us has always been scale in North America,” said Bowles. “This gives us scale there.”

Smurfit said he doesn’t see issues with competition authorities across the 42 countries in which combined group will have operations, other than Mexico, where both companies are active. He said Smurfit WestRock “will obviously work hard to overcome” any such concerns in Mexico.

WestRock, formed in 2015 through the merger of US paper and packaging groups RockTenn and MeadWestvaco, had harboured ambitions of making a play for Smurfit Kappa under its previous CEO, Steve Voorhees, before he stepped down in early 2021 due to ill health, according to well-placed sources.

Indeed, Voorhees was CFO of RockTenn when that company bought Smurfit Stone in 2011, shortly after the latter emerged from chapter 11 bankruptcy protection in Delaware.

However, the contrasting fortunes of Smurfit Kappa and WestRock in the past five years would ultimately play into the Irish group’s hands.

Larger market value

Smurfit Kappa may still be the smaller of the two by annual sales ($12.9 billion compared to $20.7 billion, in dollar terms) and earnings before interest tax, depreciation and amortisation, or Ebitda ($2.35 billion versus $3.23 billion), but the Irish company had a larger market value before news of the talks emerged.

This was partly explained by WestRock’s $9.46 billion net debt equating to almost three times Ebitda, at a time of heightened interest rates globally and when Smurfit Kappa’s leverage ratio stood at 1.4 times. But it was also down to the US group’s weaker profit margins – and the fallout from an uninspiring investor day presentation in May last year.

“It was really after the capital markets day that WestRock was seen by others in the industry as being ripe for a break-up or takeover,” according to a source familiar with the subsequent Smurfit Kappa talks.

However, the approach to set up a meeting in January to explore options was actually made by Sewell, who previously worked for paint maker Sherwin-Williams and General Electric, sources said.

At that stage, WestRock shares had lost half their value from a peak of more than $70 in early 2018, while Smurfit Kappa shares had increased by about a third – even factoring in a drop last year amid a fall in demand for cardboard boxes.

Investment bankers at Citigroup and PJT Partners have been acting as financial advisers to Smurfit Kappa, while Evercore and Lazard are working with WestRock. A spokesman for WestRock declined to comment the company’s previous interest in its Irish peer.

The deal also occurs against the background of a sharp drop-off in demand since the second half of last year for cardboard boxes, which reached unprecedented levels globally during the Covid pandemic when demand for physical goods – from giant TVs to patio furniture – spiked amid lockdowns.

While WestRock has this year moved to shut down two large, loss-making paper mills – in North Charleston, South Carolina and Tacoma, in Washington state – and is in the middle of a $1 billion cost-savings programme that’s set to continue to 2025, it is seen as behind its Irish suitor’s own “transformation journey” since Smurfit took over as CEO in 2015.

‘Consistent Ebidta margin’

“Within that time frame, we reduced our leverage multiple from 2.6 to 1.4 times today, delivered a consistent Ebidta margin in the 18-19 per cent range a ROTE 0in excess of our target of 17 per cent,” he said on Tuesday. ROTE refers to return on tangible equity, a key measure of profitability relative to shareholders’ equity in a business.

“We’ve more than doubled our earnings and, during the time frame, acquired 34 businesses, with a proven track record of effective integration and builders of long-term value.”

Smurfit Kappa expects to 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. One-off restructuring costs are estimated at $235 million.

Smurfit suggested to analysts that the WestRock side of the business’s Ebidta margins, currently running at about 15 per cent, “would gravitate” towards Smurfit Kappa’s level.

The deal values WestRock’s shares at a 36 per cent premium to where they were trading before the companies disclosed last week that they were in talks.

The real opportunity for WestRock shareholders is that they are getting a really experienced management team with a proven track record in the industry

—  Unnamed observer familiar with the merger negotiations

However, Bowles insisted that Smurfit Kappa was not overpaying, as it gives WestRock an enterprise value of about seven times consensus Ebidta forecasts for this year – which is in line with where Smurfit Kappa itself has recently been trading. He noted that many industry deals in the past couple of years had been at 10-12 times earnings.

The timing of this 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, according to industry observers.

“While any M&A is complex and execution is key, and acquiring assets in a cyclical business in a downcycle isn’t straightforward, we think this deal would likely create significant value for Smurfit shareholders,” said Barclays analyst Gaurav Jain.

Merger opportunities

Davy analyst Justin Jordan said he sees opportunities from the merger – including cross-selling of the two companies’ products and greater efficiency in investment – ultimately pushing merger synergies and cost savings over three years to $680 million to $1 billion. WestRock’s consumer packaging unit is matched by a successful bag-in-box business on the Smurfit Kappa side.

“The real opportunity for WestRock shareholders is that they are getting a really experienced management team with a proven track record in the industry in Tony and Ken,” said a person familiar to the recent negotiations.

Sewell and the company’s CFO, Alexander Pease, who joined the group almost two years ago, having previously worked for telecom networks company CommScope and salty snacks maker Snyder-Lance, plan to leave the enlarged group once the merger is completed, according to the WestRock spokesman.

Bank of America analyst George Staphos said that Smurfit Kappa was paying “fair value” for WestRock, after fielding questions from clients about the premium the Irish group is paying above its target’s recent stock price.

The groups’ complimentary geographic footprints, potential for the Smurfit Kappa to accelerate WestRock’s transformation, and the synergies goals mean that the tie-up makes sense strategically, he said.

But he cautioned that the Irish box maker needs to handle this with care. “Success of the deal is largely dependent on execution,” he said.