Third Point LLC, Royal Capital Management, L.L.C. and Monarch
Alternative Capital LP announced today that they had sent the
following letter to the Board of Directors of Smurfit-Stone
Container Corporation (NYSE: SSCC) announcing and explaining their
intention to vote against the proposed merger of Smurfit-Stone
Container with a subsidiary of Rock-Tenn Company:
VIA EMAIL
February 2, 2011 Mr. Ralph F. Hake, Chairman Mr.
Patrick J. Moore, Director and Chief Executive Officer Mr. Timothy
J. Bernlohr, Director Mr. Terrell K. Crews, Director Mr. Eugene I.
Davis, Director Mr. Michael E. Ducey, Director Mr. Jonathan F.
Foster, Director Mr. Ernst A. Häberli, Director Mr. Arthur W. Huge,
Director Mr. James J. O’Connor, Director Smurfit-Stone
Container Corporation 222 N. LaSalle Street Chicago, IL 60601
Attention: Ralph F. Hake, Chairman
Gentlemen:
Investment funds we manage are shareholders of Smurfit-Stone
Container Corporation (“Smurfit” or the “Company”), collectively
holding approximately 9% of the Company’s outstanding common stock
(the “Common Stock”). Our managed funds received more than 60% of
our shares in the Company’s bankruptcy reorganization, and owned
more than 96% of our current holdings before the Company announced
its agreement to be acquired by Rock-Tenn Company (“Rock-Tenn”) in
a cash-and-stock merger (the “Merger”). We are writing to express
our disappointment at the merger terms you approved, and to
announce our intention to vote against the Merger as it stands
today.
We believe that the acquisition by Rock-Tenn substantially
undervalues the Company and we are acutely disappointed that the
Board of Directors is willing to throw in the towel on the
significant upside inherent in the Company’s assets. To add insult
to injury, it appears that the Company did not run a sale process,
apparently in violation, or at least in ignorance, of your duties
to shareholders to seek the best price available. Finally, we
cannot help but wonder whether Mr. Patrick Moore’s employment
contract, which is set to expire on March 31st of 2011, played any
part in pushing for this sale, given that he personally stands to
earn a windfall in excess of $15 million as a result of the
Merger.
One need look no further than the action of Rock-Tenn’s stock
price following the announcement of the Merger. Typically, when an
acquirer is deemed to have paid a “full and fair price” for a
target, the acquirer’s shares trade down. It is telling to note
that the price of Rock-Tenn common stock is UP 18% since the announcement, clear
evidence that the market believes Rock-Tenn is getting a steal.
This evidence is further buttressed by comments made by the CEO of
Rock-Tenn in a conference call announcing the Merger (more on that
below).
In short, we cannot help but conclude that the Board has
forsaken its primary duty to maximize value for shareholders. We
believe that, ultimately, Rock-Tenn would have been willing to pay
significantly more for the strategic assets of the Company, and
that there is still an opportunity for other buyers (perhaps with
more potential synergies) to come forward with a valuation that is
significantly higher than the implied Rock-Tenn deal price.
Further, we believe that if the Board and management simply rolled
up their sleeves and continued on the Company’s current course,
Smurfit shareholders would be better off on a stand-alone basis
than we would be if we were to accept the terms of the Rock-Tenn
transaction.
The Proposed Transaction Represents a
Significant Discount to Precedent Valuations
$500 Million to $1.1
Billion Asset Ignored and Adjusted EBITDA Significantly
Discounted
Rock-Tenn’s press release announcing the transaction asserts
that $35.00 per share implies a Total Enterprise Value (“TEV”) to
Adjusted EBITDA multiple for Smurfit of 6.1x. In fact, we think the
multiple is closer to 5.1x for the following reasons.
- First, while Rock-Tenn chose to include
Smurfit’s full after-tax unfunded pension liability in its TEV
calculation, it neglected to include the value of Smurfit’s sizable
net operating loss (“NOL”) asset of $500 million. On a “tax
effected” basis, the NOL is worth ~$190 million or ~$1.88 per
Smurfit share. This figure doesn’t even include the possibility of
an additional $650 million in NOLs that may be realized if the IRS
permits Smurfit’s treatment of Black Liquor tax credits received in
2009. On a “tax effected” basis, the additional NOL from these tax
credits would conservatively be worth ~$250 million or ~$2.45 per
Smurfit share.
- Second, Rock-Tenn annualized Smurfit’s
fourth quarter 2010 Adjusted EBITDA of $205 million, resulting in a
“run-rate” figure of $820 million, even though Rock-Tenn CEO James
Rubright acknowledged on the January 24th conference call
announcing the Merger (the “Conference Call”) that this Adjusted
EBITDA figure was based on “the seasonally weakest December
quarter.” Annualizing Smurfit’s adjusted EBITDA for the six months
ended December 31, 2010 is far more appropriate, and Mr. Rubright
himself acknowledged that “if we had used trailing six month pro
formas … for Smurfit, particularly given the fact that those are
the post-bankruptcy operating results, it would have been higher”
than $820 million. Moreover, Smurfit has reported anticipated
SG&A savings of $50 million in 2011 from actions already taken.
As these savings are prospective, they obviously are not included
in the “run rate” for the fourth quarter of 2010. Thus, if we were
to annualize Smurfit’s trailing six month Adjusted EBITDA and add
the SG&A savings, we would arrive at a more appropriate
“run-rate” for 2011 Adjusted EBITDA of $938 million. It is unlikely
that the entire $110 per ton of containerboard price increases were
fully reflected in the earnings in the second half of 2010 due to
Smurfit's exposure to semi-annual and annual contracts.
International Paper and Temple-Inland announced on their third
quarter earnings calls that they had realized $95 and $93 per ton
of the price increases, respectively, at September 30, 2010. This
“run rate” figure also does not
include the significant benefit from a successful implementation of
the 2011 price increase already announced by one of Smurfit’s
competitors. Additionally, we are not alone in our views regarding
Smurfit’s earning potential. Goldman Sachs research analyst Richard
Skidmore published a report on January 9th, the most recent report
published by a major firm before the Merger, which estimated
Smurfit’s 2011 EBITDA at $938 million.
As illustrated below, Rock-Tenn’s announced valuation multiple
of 6.1x times drops to a paltry 5.1x with the adjustments described
above. We will not know until we see the proxy statement for this
transaction, but we wonder just what numbers Smurfit’s board was
looking at when it approved the Merger? This is the critical
question, because if Rock-Tenn had been willing to pay 6.1 times
the more appropriate Adjusted EBITDA of $938 million, and if an
appropriate value had been ascribed to the NOL, Smurfit’s
shareholders would receive nearly $44.00 per share of Common Stock
in the Merger.
EBITDA Illustrative
Rock-Tenn Adjusted Potential Valuation
Valuation Valuation Cash $ 449 $ 449 $ 449
Debt 1,194 1,194 1,194 After Tax Pension 700 700
700 Net Debt and Pension 1,445 1,445 1,445
NOLs -- (190 ) (190 ) Fully Diluted Shares (mm) 101
101 101
Price per Share $ 35.00 $
35.00 $ 43.98 Market
Capitalization 3,536 3,536 4,443
TEV $ 4,981 $ 4,791 $ 5,698 Smurfit Run Rate
Adjusted EBITDA $ 820 $ 938 $ 938
Implied TEV / Adjusted EBITDA 6.1x
5.1x 6.1x
Even Mr. Rubright has acknowledged that the Adjusted EBITDA used
to arrive at the 6.1x figure is questionable: “It’s not hard to
have annualized to a higher number than the one [Rock-Tenn] used.”
It may not be hard, but one can only wonder whether the Smurfit
Board did so when it approved the Merger. We await the proxy
statement to learn precisely what Adjusted EBITDA figure the Board
had in mind.
Historical Multiples are Significantly
Higher
Whether the multiple is 5.1x or 6.1x, precedent transactions in
this industry are significantly higher. In fact, Lazard Frères
& Co., the same company that gave a fairness opinion to the
Board for this transaction, testified in the Summer of 2010 during
Smurfit’s bankruptcy plan confirmation hearing that precedent containerboard transactions over the last
decade had a median TEV to EBITDA ratio of 7.7x! With
recent consolidation, one could argue that transactions in the
industry should command an even higher multiple. As illustrated
below, a multiple of 7.7x and the appropriate Adjusted EBITDA would
bring consideration to approximately $59 per share. Even if we used
Rock-Tenn’s intentionally understated Adjusted EBITDA of $820
million, a 7.7x multiple would bring consideration to approximately
$50 per share. Again, we look forward to reviewing the proxy
statement to determine how the Board and its advisers could
possibly have gotten comfortable with this anemic premium.
Precedent Transaction Mult. Rock-Tenn
2H10A Adj. EBITDA Adj. EBITDA Cash $
449 $ 449 Debt 1,194 1,194 After Tax Pension 700
700 Net Debt and Pension 1,445 1,445 NOLs (190
) (190 ) Fully Diluted Shares (mm) 101 101
Price per
Share $ 50.07 $ 59.07
Market Capitalization 5,059 5,968 TEV $
6,314 $ 7,223 Smurfit Run Rate Adjusted EBITDA
$ 820 $ 938
Implied TEV / Adjusted
EBITDA 7.7x 7.7x
Questionable Sale
Process
A low transaction multiple is tough to swallow in any context,
but it is a particularly bitter pill when it has resulted from a
sale process that appears to be anything but robust. While we await
the proxy statement to confirm this, Mr. Rubright’s comments on the
Conference Call that “this transaction was exclusively negotiated
on a one-on-one basis,” and that Rock-Tenn “[doesn’t] like to do
transactions that are in a process,” lead us to believe that the
Company and its advisers did not set up a competitive process for
this asset. In our experience, providing a would-be acquirer an
exclusive opportunity to bid on your company, failing to conduct a
market-check and ultimately signing a merger agreement without a
“go-shop” provision and with a termination fee that borders on the
high-end of reasonable is a likely indication that incentives of
the Board are misaligned with those of the shareholders. One need
look no further for misalignment than the interests of CEO and
Director Patrick J. Moore.
After leading Smurfit into a bankruptcy that wiped out its prior
shareholders, Mr. Moore was rewarded by being re-hired by the Board
as Smurfit’s CEO for a period of 9 months, scheduled to terminate
on March 31, 2011. While moderate retirement packages for CEOs are
commonplace, Mr. Moore appears to have hit the jackpot with his. In
addition to receiving pension, health and other benefits, and
becoming eligible for a “special incentive” bonus of $3.5 million
upon retirement, he was granted a “change of control bonus” in his
short-term employment agreement that would pay him a substantial
sum if the Company received a “change of control” offer (such as
for the Merger) before his retirement date and the transaction were
to occur on or before September 30, 2011. Tellingly, he would
receive nothing if, by that date, no
change of control has occurred. Under this bonus provision, Mr.
Moore stands to realize, by our account, a windfall payment of
approximately $19 million (less any “special incentive” bonus he’s
received) upon the closing of the Merger! Collectively, the Smurfit
officers are getting $42 million. It is therefore not hard to
imagine the incentives that pushed Mr. Moore, and possibly the
Board, towards accepting this transaction with an eager buyer
(especially at this price) without bothering to conduct a market
check. Shareholders, however, do not receive the same special
benefits, and we cannot help but wonder whether his looming
retirement motivated Mr. Moore to push for a less-than-optimal
result for his shareholders.
Smurfit Could Go It Alone and
Shareholders Would be Better Off
It is no secret that Smurfit is an undermanaged, underperforming
company with substantial upside opportunity and highly valuable
assets. Obviously, Rock-Tenn believes this to be the case, as
evidenced by Mr. Rubright’s comment on the Conference Call that
“the opportunities for … investments in the Smurfit mill system are
basically unlimited with very, very high paybacks.” Unlimited
opportunities for projects with “very, very high paybacks”? It
sounds incredibly attractive to us. These opportunities do not
require a strategic partner, and an independent Smurfit would have
more than sufficient cash flow to fund them. All it would take is a
Board seeking to maximize shareholder value and a management team
properly incentivized for long-term appreciation and not a
short-term exit.
Smurfit’s lack of a permanent management team and prior
investment constraints prevented it from eliminating some rather
glaring operational inefficiencies. Smurfit’s margins have long
trailed its competitors despite having a mill system which
Rock-Tenn and industry consultants believe to have at worst average
structural costs. Smurfit also maintains multiple corporate
headquarters, further illustrating the significant level of “low
hanging fruit” within the Company’s standalone cost structure. Mr.
Rubright alluded to these opportunities when he stated that
“perhaps the greatest value proposition in this transaction is
bringing Rock-Tenn’s extremely customer focused approach to the
market place; our discipline and execution; and our track record of
continuous operational and administrative excellence .…” Customer
focus, discipline and execution, and continuous operational and
administrative excellence are fundamental building blocks of any
successful enterprise. A competent, motivated and properly
incentivized management team would surely be capable of
capitalizing on these opportunities and the great value they
represent to Smurfit shareholders. So why does the Board believe
that a merger with a competitor is the best way for Smurfit to
realize its potential?
One of the more egregious examples of leaving money “on the
table” is Smurfit’s underfunded pension. While the “after tax”
amount of underfunding stood at $700 million as of December 31,
2010, this number likely overstates the Company’s actual cash
obligations. If, over the next two years, interest rates increase
by 100 basis points and Smurfit were to contribute the $445 million
currently projected, the plan would be nearly fully funded.
Furthermore, if one “tax effects” this $445 million contribution,
then the liability would be only $275 million, or a full $425
million less than the reported figure of $700 million. It is clear
that Rock-Tenn is fully aware of this potential savings, again as
evidenced by Mr. Rubright’s comments on the Conference Call after
an analyst asked him whether there could be a substantial reduction
in the pension obligation:
“You broke the code, okay? So
you’re right... If what you are suggesting happens, ... mandatory
funding responsibility will come down, and would we over-fund this
pension plan? The answer is no.”
Significant Benefits to Rock-Tenn
Should Have Led to Higher Consideration
Rock-Tenn’s asset base is 100% dependent on recycled inputs,
meaning its earnings are highly vulnerable to increases in the cost
of recycled fiber. Smurfit’s assets, on the other hand, are
approximately 65% virgin fiber based, providing the Company with a
long term structural advantage. Asian recycled capacity, mostly
located in China, represents approximately 31% of total global
containerboard capacity. Continued economic growth in that region
should increase global competition for recycled fiber inputs, which
recently reached historically high price levels. Rock-Tenn is
disadvantaged relative to its domestic competitors which, like
Smurfit, mainly operate virgin input assets. Mr. Rubright
summarized the advantageous position of Smurfit’s assets when he
stated that “the fact is United States virgin containerboard is a
highly strategic global asset.” Given Rock-Tenn’s structural
disadvantage and appearance as a “forced buyer” of virgin input
capacity, along with the meaningful synergies that Rock-Tenn surely
expects to bring to the combined company, the Board should have
demanded Rock-Tenn pay a meaningfully higher premium to the market
price of the Common Stock than the paltry 27% agreed to in the
Merger.
For all these reasons, we believe the Merger woefully
shortchanges Smurfit shareholders. Although we believe that Smurfit
has the potential to thrive as a stand-alone company, we do not
quarrel with the strategic rationale behind the Merger, and would
support a sale of the Company, but believe that any business
combination with Rock-Tenn or any other party must provide adequate
consideration for the holders of Common Stock. We note that the
shareholder base appears to have turned over significantly since
the announcement of the Merger, with over 100 million shares having
changed hands already. Fortunately, the Merger was agreed to
without any shareholder lockups or voting commitments, and
therefore, given the wide dispersal of the Company’s common stock,
the ultimate approval by shareholders is by no means assured. We
believe that there are other potential acquirers who may come
forth, and we encourage any and all to do so.
We greatly regret that you, our representatives and fiduciaries,
unwisely entered into a transaction without seeking competitive
bids. As things stand now, we cannot support the Merger.
Sincerely,
Third Point LLC
Royal Capital Management, L.L.C.
Monarch Alternative Capital LP
/s/ Josh Targoff
/s/ Yale Fergang
/s/ Andrew Herenstein
Josh Targoff
Yale Fergang
Andrew Herenstein
cc: David W. Bonanno
cc: Neal Shah
cc: Roger Schmitz
Third Point LLC
Royal Capital Management, L.L.C.
Monarch Alternative Capital LP 390 Park Avenue, 19th Floor
623 Fifth Avenue, 24th Floor
535 Madison Avenue New York, NY 10022
New York, NY 10022
New York, NY 10022
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