Smurfit Kappa: Potential Merger

Here at the Lab, we are back to comment on Smurfit Kappa (OTCPK:SMFKY, OTCPK:SMFTF). Why? Last week, the company announced that it is in active discussion with WestRock (WRK). Our internal team covers both companies, and we have good coverage in the paper & packaging industry. Before going to our forward-thinking analysis, it is essential to report the potential combination:

According to Smurfit Kappa's announcement:

1. The new combined company would be domiciled and incorporated in Ireland, with the global headquarters in its capital (Dublin). While WestRock will continue to be headquartered in Atlanta to run North and South American operations. Therefore, no changes here;
2. On the stock exchange, the potential combination would be effected through an Irish scheme, with Smurfit Kappa merging with WestRock. According to the news, WestRock shareholders would receive shares of the combined group. In addition, Smurfit shares would be de-listed from Euronext Dublin. Therefore, if the deal goes on, Smurfit WestRock's ordinary shares would be listed on the New York Stock Exchange;
3. Going to the financials, the potential combination is expected to have top-line sales and EBITDA of $34 and $5.5 billion, respectively;
4. Smurfit Kappa believes that to achieve-tax run-rate cost synergies of approximately $400 million; however, we should also factor a negative one-off cash costs of about $235 million in the first year;
5. The potential combination might create a global leader in the "Go-To" packaging market.

Here are our main highlights.

• The potential merger might combine two highly complementary industrial platform portfolios with a global reach across 42 countries. As a reminder, Smurfit Kappa focused its activities on the European containerboard/ corrugated packaging, and the EU represents 77% of group sales in 2022, while the Americas are at 23% (mainly in the South American region). Currently, Smurfit is the EU's largest corrugated packaging company, with approximately a 12% market share penetration. On the other hand, WestRock revenue lines are split between corrugated packaging (65%) and consumer packaging (35%), with 90% of sales generated in North America;
• Both companies have innovative products and complementary portfolios with biodegradable packaging solutions;
• While Smurfit Kappa management sees significant synergies, looking at the press release details, no detail has been disclosed. Given the fact that we cross-coverage both companies, there is some geographical overlap in the South American region but little elsewhere. Therefore, here at the Lab, we would require more detail on where the two companies will derive additional savings. This also makes the potential combination more likely;
• For the above points, we see no regulatory risk on the Antitrust authority;
• Smurfit is trading at a premium compared to the sector and WestRock. This valuation is due to a solid M&A execution, a disciplined capital allocation, a DPS story growth;
• Valuation details have not been disclosed but will be crucial to our view on the deal. Currently, Smurfit Kappa trades at 6x EBITDA while Westrock is at 5x. Therefore, Westrock valuation is much cheaper. This might imply a potential benefit to SKG's future valuation, though we would need more details to come to a strong conclusion.
• In addition, any merger combination would be conditional on shareholders' approval.

Conclusion

Since our initiation of coverage called "Resilient Margin, A Strong Buy Now," we are up by 12.41% in stock price appreciation; however, post Q2 results, and after the announcement, the company share price declined by 7.07%.

The company highlighted a cost synergies expectation of $400 million, suggesting that the merger is well advanced to calculate this number. As reported, "any such combination would result in Westrock shareholders receiving consideration consisting primarily of the shares of the Combined group," suggesting to our analysis that the transaction would likely be structured as a share swap. But no financial terms have been disclosed yet. While the American company is a more significant entity than Smurfit Kappa in terms of Enterprise Value and EBITDA, it is Smurfit Kappa that is acquiring WestRock.

Here at the Lab, we initiated Smurfit Kappa with a buy given 1) a compelling valuation, 2) solid results, 3) an M&A track record, and 4) FCF evolution with a growing and reliable DPS. Creating value in a cyclical industry takes work and time. However, the company has a balance sheet capacity to acquire assets in a down-cycle scenario. While M&A seems easy, execution is the risk. Here at the Lab, this transaction may create significant value for Smurfit Kappa shareholders, given its past track record. However, before commenting, we should understand the share swap financials term. We positively see this announcement but are not pricing in any development. Therefore, we confirmed our previous valuation at €45 per share, based on a 7x EV/EBITDA multiple.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.