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A handy thing about the recurring nature of M&A speculation is that for all the most likely deals, there’s a readymade bank of analysis available for recycling. So it is with the possible purchase of DS Smith by Mondi, which has swung back around today:
The Board of DS Smith notes the recent media speculation and confirms that it has received a highly preliminary expression of interest from Mondi plc (“Mondi”) regarding a combination with DS Smith. The Board of DS Smith understands that Mondi is considering a possible offer for DS Smith although no proposal has been received at this stage.
There can be no certainty as to whether any proposal will be made or the terms of any such proposal. A further announcement will be made if and when appropriate.
A couple of things have changed since early 2021, when packaging maker Mondi was last seriously rumoured to be looking at its smaller peer. Mondi has exited Russia and last year warned on paper pricing; DS Smith hasn’t and didn’t. Both stocks are down over the past three years, by about 20 per cent for DS Smith and by 33 per cent for Mondi, as the price of cardboard slipped from ecommerce-fueled record highs.
Generally, though, the big picture stuff hasn’t changed. As we wrote at the time, a merger would create Europe’s largest containerboard maker by matching Mondi’s low-cost mills with DH Smith’s box factories. The combination would also take the stress off Mondi’s fine-paper business, which because of WFH hasn’t been doing great.
And even though it’s termed a “combination” in today’s statement, Mondi’s still quite a bit bigger than DS Smith and would be expected to use fresh equity to fund a transaction.
For a ready reckoner of what it all means, here’s Morgan Stanley (from 2021):
Advantages:
Mondi is net long containerboard while DS Smith is net short. So a tie up would neutralise that for the two companies.
A larger containerboard business – making it Europe’s largest – would have synergies
A larger containerboard business would effectively shrink the relative size of Mondi’s uncoated fine paper earnings share, potentially driving a re-rating.
DS Smith has, in our view, a more extensive new product development offering to Mondi.
Mondi trades on a 23% premium to DS Smith on a 12 month forward basis – though we argue that Mondi’s earnings is currently undermined by its uncoated fine paper business which we do expect to recover on a 2-3 year view.
DS Smith’s large corrugating business distributed across Europe is a good way to absorb Mondi’s paper in Easter Europe
Disadvantages:
Mondi has deliberately migrated its business from slower growing Western Europe to faster growing Eastern Europe. This served Mondi well in 2020 in particular. DS Smith is a far more Western Europe centric producer.
Mondi’s containerboard operations are more virgin based than DS Smith’s, an advantage we think is key long-term as barriers to entry are far higher than they are in recycled.
DS Smith sits somewhat higher on the cost curve than Mondi does.
Or if you prefer, here’s JPMorgan’s summary (from 2021):
At face value, these companies look a good fit given the complementary nature of their containerboard/box operations and geographic exposure. We would expect significant potential for synergies based on the combination of Mondi’s long low-cost containerboard position and DS Smith’s short position and large downstream footprint; over and above standard cost and revenue opportunities (head office, procurement, cross-selling etc). Clearly earnings and return accretion would ultimately depend on price but our preliminary calculations suggest good potential for such a deal at a reasonable price.
What counts as a reasonable price will have changed a bit, but is still likely to require equity. Here are some Jefferies numbers (from 2021):
Potential €9-11bn EV Acquisition Would Require >€2.5bn Equity Raise: Assuming 7.5x to 9.5x EV/EBITDA range implies €9-11bn EV, with a £2.1bn FY21E (30 Apr YE) net debt, pension deficit and £447m 1H21 debtor factoring and £1 = €1.16 FX rate. Assuming €9-11bn EV and our FY22E (30 April YE) DS Smith EBITDA of £937m (or €1,087m), it would imply Mondi being on >4x pro-forma 2022 net debt/EBITDA (FY21: 1.3x), which is above Mondi’s 3.5x debt covenant. Thus depending on the potential bid price, Mondi would need to potentially raise >€2.5bn of equity.
Antitrust? Jefferies again (from 2021):
[Mondi + DS Smith] would create the European #1 containerboard & box producer with >€2.5bn pro-forma EBITDA. We would not expect major competition commission hurdles as pro-forma containerboard capacity would be 6.5mT (or 17% of European capacity) and on the box side Mondi’s 16 plants in CE European is where DS Smith is looking to grow its scale. SMDS is also short containerboard (particularly in kraftliner), where MNDI is long. We would expect footprint optimisation, head office and possibly some procurement synergies
However, given Mondi’s strategy of focusing on low cost mills, we would expect a rationalisation of some of SMDS’s recycled containerboard capacity with higher cost capacity likely sold/closed in time. We would also expect questions around the intentions for the N. America division. In our view Mondi is a good capital allocator and will not consolidate the market for consolidation’s sake. We would only expect Mondi to do a larger deal, if it is confident of delivering on any potential synergies and value accretive returns.
Or if you want the 2024 antitrust view, this just arrived from RBC:
We estimate SMDS has c8% Europe containerboard capacity (incl Turkey), while Mondi has c5% and combined they would be similar to #1 SKG at c12-13%. We would not expect substantial antitrust issues, but the market shares might be looked at on a country or more regional basis, where they would be higher. And we would expect a detailed review.
Recycled containerboard share estimate at c12%.
Virgin containerboard share estimate at c20%.
Box would likely be OK as Mondi is regional CE Europe + Turkey player and does not have box plants in W. Europe countries where SMDS has 20-30% share.
With EU containerboard (paper for box) market oversupplied and in need of capacity closures, we would expect capacity rationalisation as part of any potential merger, which would be a positive.
On synergies there’s a straightforward overlap in containerboard that’s about 3-5 per cent of combined sales, or approximately €250-400mn, with some potential for more. Back to JPMorgan (from 2021).
Our scenario with its assumptions and our estimates imply ~EUR230m of after-tax synergies would be required to keep the deal earnings neutral on FY+1 earnings. We would not see this as an ambitious synergy target noting SMDS was able to realise ~EUR70m synergies on a ~EUR1.9bn acquisition (Europac, whose LTM EBITDA at the time was EUR158m).
Other than the usual targets on the cost side of procurement, head office costs and portfolio rationalization, the combination should allow Mondi to capture additional conversion profits through DS Smith’s footprint; where it could shift paper sourcing to the new Group’s benefit – i.e. a combination could benefit beyond the sum of the parts, other than just from streamlining head office etc. In terms of revenue synergies, the enlarged group should benefit from product cross-selling (e.g. through Mondi’s plastics production and related products), product innovation (combining respective IP built up over the years) and the ability to pitch even greater global reach to prospective multinational customers. Overall we would expect the synergy potential to be significant.
Chances of counter-offers? Here’s RBC (from 2021):
With International Paper increasingly focusing on its corrugated packaging business, we think that the company could make another attempt to grow in the European market following the unsuccessful attempt to purchase Smurfit Kappa in 2018. In our view, DS Smith could be an attractive target given its large European footprint and growing presence in the North America. In addition, Europe is also the largest addressable market that we think International Paper would look to grow in after divesting its Brazilian packaging business earlier this year. [ . . . ]
While International Paper is already globally relevant, it lacks a large production presence outside of North America. Acquiring DS Smith could face anti-trust challenges in Europe, but we think the deal could get done with the sale of a few box plants. We believe that the combined company would be an even more important partner to multi-national CPG and e- commerce companies, driving above market growth.
In International Paper’s unsuccessful offer to acquire Smurfit Kappa Group plc, the company offered an initial 27.4% premium to their share price. While International Paper has historically traded at a premium to Smurfit Kappa on an EV/EBITDA multiple, that gap has recently closed following a rapid rise in Smurfit Kappa’s share price. We think that International Paper would prefer to acquire Smurfit when it is trading at a discount, which would allow for a more accretive transaction less dependent on synergies; however, we think that it is a transaction worth considering when the timing is right
We’ll read up on recent developments in kraftliner and update with fresh analysis as it arrives. In the meantime, though, that’s enough to get started.
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