Will Ardagh’s deleveraging be enough to calm market fears about its debt pile?

Financier Paul Coulson's voracious appetite for deals over the past two decades, building his Ardagh Group into an international glass and metal containers giant through €7.5 billion of acquisitions, has been surpassed only by one thing: his stomach for debt.

Now, at 67, the Dublin native, is rowing back on both – agreeing this week to hive off Ardagh’s food and speciality metal cans business into a joint venture, 57 per cent controlled by a Canadian teachers pension fund.

The $2.5 billion (€2.2 billion) cheque New York-listed Ardagh will receive will be used to chip away at the wider group’s $8.5 billion of borrowings, at a time with its high debt – together with issues in its US glass business – are weighing on its stock.

It may not be enough, according to JP Morgan analyst Tyler Langton, who downgraded his rating on Ardagh's shares to the equivalent of a sell on Thursday, as the company's historic deals-fuelled earnings expansion gives way to "low-single-digit" growth for the foreseeable future.

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“While the company should benefit from the improving volume growth profile of beverage cans, we still see risk from its North American Glass business, [and] higher leverage – even after the sale of a 57 per cent stake in its food and speciality business,” said Langton.

The food cans spin-off has prompted wildly-divergent speculation on whether this is just the beginning of an unpicking of the beast that Coulson has built – or preparing Ardagh’s balance sheet for another big surprise acquisition.

Irish Glass roots

Ardagh traces its roots back to the 1932 formation of the Irish Glass Bottle Company in Dublin and has been transformed since Coulson bought an initial stake in 1998 and became its chairman.

The early years of the metamorphosis were not without controversy. Some 375 workers at the bottle site in Ringsend in Dublin lost their jobs as Coulson closed the facility in 2002. The following year, the Cooler, as he has been known since his university days at Trinity College Dublin, split the business in two: Ardagh Glass, which was taken private, and South Wharf, which was set up to house its legacy asset, the leasehold on the 24-acre glass bottle site.

Following a dispute with Dublin Port, freeholder of the Ringsend site, a settlement was reached in 2006, whereby South Wharf – in which Coulson and his Yeoman International investment vehicle had a combined 27 per cent stake – took two-thirds of the proceeds from its €412 million sale later that year.

The buyers comprised a consortium involving developer Bernard McNamara, property financier Derek Quinlan and the Dublin Docklands Development Authority, a State agency. It was a deal that acquirers would regret when the economy crashed in late 2008.

The site was subsequently seized by receivers appointed by the National Asset Management Agency in 2012. The first application for the long-awaited redevelopment of the land, which has been earmarked for up to 3,500 homes, has only been lodged with the Dublin City Council in recent weeks.

Back at Ardagh, Coulson's first resort when it came to financing deals in the early years was Anglo Irish Bank, a lender more associated with the bankrolling of property developers, including the purchasers of the glass bottle site.

“It would have been utterly impossible to build this business without Anglo’s support in the early years,” Coulson told an Institute of Directors lunch three years’ ago in a rare public speech.

However, as the financier’s deals became more audacious, he would turn to global bond investors for finance from 2002. Ardagh quickly established itself, with a sub-investment, or junk, debt grade from leading credit ratings agencies, as the most active Irish user of the more expensive, or high-yield, end of the global debt markets. “The high-yield market is where we successfully made our home,” he said.

Ardagh diversified into metal packaging in 2010 with the €1.7 billion purchase of Dutch-based Impress Cooperative, before moving into the beverage can-making market six years' later when it bought $3.4 billion of assets from US packaging group Ball and UK rival Rexam as they offloaded 22 plants to appease competition authorities as part of their their own merger.

By the time Ardagh floated on the New York Stock Exchange in March 2017, it was producing metal and glass packaging across 109 facilities in 22 countries and generating sales of €7.7 billion. Annual sales are currently running at $9 billion, while the group employs more than 23,000 people.

Stock market listing

The initial public offering (IPO) – in which an 8 per cent stake in the business was sold to stock market investors for more than $350 million (€312 million) – was aimed at lowering the group’s then €7.2 billon of net borrowings and lowering its debt ratio to five times earnings before interest, tax, depreciation and amortisation (ebitda) from 5.4 times.

While the pitch to shareholders at the time of the flotation was that the company would continue to lower its debt burden, the net debt-to-ebitda ratio remained stubbornly high. Its net borrowings as of March stood at $8 billion – or 5.2 times earnings over 12 months.

In addition, Coulson has loaded two holding companies above the New York-listed operating business with $1.91 billion of high-cost debt. A significant portion of this was used to fund payments to the ultimate shareholders in the privately-held parent group – and to refinance borrowing taken on to finance prior cash returns. This debt, too, must ultimately be paid back with money generated by Ardagh Group selling bottles and aluminium cans.

Credit ratings agency Standard & Poor’s (S&P) labelled the group’s financial policy last October as “aggressive”, as it lowered its outlook in Ardagh’s B+ credit grade to stable from positive. When all the net debt is combined, it amounts to about $10 billion, or about seven times earnings.

Shares in the publicly-quoted group, in which Coulson effectively owns a 33 per cent stake, lost almost half their value last year, with problems faced by the company compounded by general stock market malaise globally.

Ardagh issued two profit warnings in 2018, mainly due to problems in its US glass division as the mass beer market declined for a sixth straight year, and currency fluctuations eroded earnings. The company also had woes in its metal packaging unit in Europe, which was affected by a weak European food harvest as a prolonged heatwave last summer devastated crops across the continent.

Coulson has taken action in its North American glass division, closing two facilities and cutting product in a third over the past 16 months, with the loss of about 400 jobs. It has taken about 10 per cent of the company’s total glass capacity in the region.

Focus

While investor focus has mainly been on Ardagh’s US glass problems, followers of the company would also have noted issues in food and speciality metal packaging business, which have been camouflaged by the strength of the beverage cans operations bought three years’ ago.

Coulson told analysts on a call in April that while the volume of beverage cans sold by Ardagh in Europe rose by a “high single digit” percentage in the first three months of the year, the food and speciality cans business was only “modestly ahead” of a strong comparable period last year.

While beverage can volumes in North America and Brazil grew by about 4 per cent during first quarter, the food can business had actually dropped, he said.

This week's announcement that Ardagh is to spin off the food and speciality metal can business into a joint venture with US-based rival Exal Corporation, which is owned by the Ontario Teachers' Pension Plan Board, to form a new business called Trivium packaging, marks a step change from Coulson's previous acquisitive strategy.

Ardagh has said that its contributing business will make up $2.4 billion of Trivium’s $2.7 billion annual sales and $355 million of its $469 million of ebitda. It implies that this unit accounts for less than a quarter of Ardagh’s current earnings and is generating a 14.8 per cent ebitda margin, compared to a 16.2 per cent for the wider group last year.

Exal is much more adept at squeezing returns out of the business it is putting into the partnership, which mainly makes aerosol containers. This would appear to be delivering margins of the order of 38 per cent.

Ardagh will receive a $2.5 billion cash payment and a 43 per cent stake in Trivium under the terms of the deal.

S&P has indicated that it may upgrade its rating on Ardagh’s unsecured debt, as Coulson’s packaging group prepares to use the money it is receiving to buy back bonds. Ardagh sees its net debt declining to 4.7 times earnings as a result.

“We could lower the rating if Ardagh did not apply all of the disposal proceeds to debt repayment, or if its financial policy became more aggressive due to a large pure-debt-funded acquisition or dividend payment,” S&P said this week.

Speculation

There has been some speculation in recent days that Ardagh may be hiving off food and speciality cans to prepare its balance sheet for a more attractive large acquisition. However, sources familiar with the company’s thinking have poured cold water on this.

“Ardagh has a very large footprint with scale, so expect to see more organic projects and investments in existing facilities to support customers’ growth, rather than further large acquisitions,” said one source, adding that small “bolt-on deals” could not be ruled out.

The food cans spin-off is being characterised as a logical progression, aimed at delivering on Ardagh’s commitments to lower its debt burden after the 2016 IPO.

Mark Wilde, an analyst with BMO Capital in New York, expects further consolidation in the sector, after Ball pushed its tinplate food and aerosol assets into a joint venture with investment firm Platinum Equity.

“Among public packagers, Ardagh has one of the highest leverage ratios,” Wilde said, adding that he expects the group’s net-debt-to-ebitda ratio to fall to 4 times by the end of 2019.

Trivium, meanwhile, headed by Exal's chief executive Michael Mapes, has wasted no time hitting the debt markets itself, starting a round of talks with bond investors in London and the US this week to raise $2.75 billion to fund the cash payment to Ardagh, refinance some Exal loans and leave it with change to drive the new venture.

Trivium expects to scrape out about $40 million of cost and other synergies from the deal over the next few years, according to Ardagh. The combination is expected to be concluded in the final quarter of 2019, subject to regulatory approvals.

Tradable stock

Coulson, other company executives, and hundreds of small investors who remained on board since Ardagh Glass was taken private in 2003, still do not have shares that they can trade on the market. Two years after the IPO, they remain investors in the ultimate holding company above the listed business.

The company first flagged early last year that it was looking at ways to “materially” increase the amount of tradable stock by giving investors in the holding company direct shares in the publicly-quoted business.

However, Coulson said in April – as Ardagh shares languished below $14, or a 26 per cent discount to their IPO price – that it may be the back end of next year before the legacy shareholders get tradable stock.

Ardagh shares have since rallied to within 6.5 per cent of the price at which they floated. While Coulson has said that he has no plans to sell down his own stake (worth about €1.2 billion on paper) when long-standing shareholders eventually get their hands on direct shares in the listed company, others will be looking to cash out.