On March 26th, 2024, International Paper, a leading player in the North American paper and packaging industry, announced its £7.8bn acquisition of DS Smith. This move is part of a broader trend of consolidation in the industry, which follows periods of evolution before, during and after COVID-19. From doing all things paper-related to then streamlining business units towards packaging, paper and packaging companies are beginning to significantly increase their presence beyond their home regions for the first time, with the biggest American and European players spearheading the charge. In light of the world’s transition towards a sustainable future, paper and packaging companies fly under the radar as ones to watch.
International Paper – Company Overview
Founded in 1898, International Paper Company (IP) has been the leader in the paper and packaging business for years. The original company was created by the merger of 20 paper mills in northeastern USA, which after a series of acquisitions and organic growth became a giant in the paper and packaging business. During the 20th century, International Paper consolidated its presence in the market by acquiring Hammermill Paper Company in 1968, Federal Paper Board Company in 1995, and Champion International in 2000.
Coming into the century, International Paper was a giant in the industry offering a wide range of products. IP had 18 different business lines including paper, plastic, lumber, and natural gas production. In fact, up until 2006, IP was the second-largest landowner in the United States only behind the Federal Government. However, offering such a wide range of products made its operations inefficient, achieving a Return on Investment of only 3% while taking in a lot of debt.
The new business plan consisted of lowering the manufacturing cost, increasing the sales volume, and streamlining the organisation. To achieve the latter, management decided to divest from most of its business lines and focus on the basics. During this time IP went through a complete turnaround, selling its lumber mills, mineral rights, and most importantly its forestland to focus on two key operations: industrial packaging and uncoated paper. While selling 6.8 million acres of its forestland to conservation groups, financial buyers, and strategic buyers for a value of $6.1bn, IP included clauses in sales contracts varying from 10 to 30 years of supply of pulp and paper mills to continue its operations.
In the past 15 years, International Paper has focused on continuing to consolidate its presence in the market while expanding vertically along the value chain and securing its supply chain. Today, IP owns 20 containerboard mills, 200 converting facilities, and 18 recycling plants- having key operations in the US, Latin America, Morocco, France, Italy, Canada, and Spain. International Paper’s recycling plants are not seen as a revenue source but rather an expense, as it is core for securing a stable and reliable supply of recycled materials to produce packaging and uncoated paper. Today, it is estimated that two out of every three Amazon cardboard boxes are produced by IP.
DS Smith – Company Overview
Established in London by the Smith family in the 1940s, DS Smith (DSS) grew in the box-making industry through a mixture of internal investment and acquisitions, being listed on the London Stock Exchange in 1950. In a similar way as International Paper on the other side of the pond, DS Smith acquired companies of the likes of St Regis, Kaysersberg, SCA Packaging, and Europac to become one of the biggest players in the European market.
In 2017 DS Smith crossed the Atlantic for the first time in its history, acquiring Interstate Resources. This signified its first entry into the corrugated packaging business in the United States, with the east-coast-based company possessing twelve packaging sites and two paper mills.
DS Smith’s core operations focus on packaging solutions, paper products, and recycling services. In terms of packaging solutions, the company offers industrial packaging, e-commerce packaging, and retail packaging. Its business has a huge focus on sustainability and takes part in the fight against climate change and plastic pollution. Its paper products, consisting of containerboard products made from 100% recycled or sustainably sourced materials, include white liners, brown liners, medium grades, kraft liners, coated papers, and dual-use grades. DS Smith also offers a wide range of services, most notably supply chain services focused on improving quality, cutting lead times, and making sure customers have a reliable supply of products.
Paper Industry
With a valuation close to $12bn, International Paper is an important actor in the paper industry. However, investors are concerned over the company’s visible stagnation over the last few years. Valued at $61.81 a share in June 2021, it now sits at $34.76 a share in April 2023. Taking a closer look at its financials, its revenue has hovered around the $20bn mark for the last decade, in 2023 it saw an 11% decrease in its revenue and a decrease of its EPS from 4.41 to 0.83. The source of this slump according to International Paper? - weaker volumes caused by the higher rates set by the American and European central banks to fight inflation which have seriously impacted global demand. Consumers have narrowed their spending to non- discretionary goods such as food and rent, additionally International Paper’s customers have been thinning down their inventories to reduce costs, both effects have led analysts to project a year-over-year of decline of 3.5% in volumes for the Industrial Packaging segment in the first quarter of 2024.
However, according to reports, International Paper is 49% undervalued as analysts point at its strong debt coverage and how earnings are expected to grow faster than the American market (23% to 14%), so what is keeping back investors from placing their money in the paper industry giant? Other than the high inflationary environment, the industry has slowed down after the end of the pandemic. Covid-19 brought an unpredictable shipping surge making these years extremely profitable for the paper packaging industry. Now that this spike in online purchases has gone down, the packaging industry has entered a consolidation phase and is readjusting its capacity and expectations to the post-pandemic environment.
International Paper’s stagnancy also stems from a lack of innovation and development. Compared to its rival WestRock, it owns several less recycling plants, and this has a direct impact on its cost of production. International Paper’s production is composed of 65% virgin wood and 35% recycled wood, while its competitor is at 60% virgin and 40% recycled. While recycled plants are run at a loss, they enable firms to greatly reduce overall production costs, this explains part of WestRock catch-up and how its market value now stands over International Paper’s at $12.2bn. Additionally, WestRock has been able to navigate new opportunities better, during Covid, it introduced a new food packaging box with better isolation to limit the spread of the virus. For its e-commerce customers, it has offered new box size scanner machines able to fit more items in the package with no wasted space. While International Paper was struggling to expand internationally, WestRock doubled down on domestic expansion in the United States which, paired with this innovative mindset, now makes them the most valuable firm by market cap in the paper industry.
Figure 1: Stock Price Comparison
Additionally, due to the Russo-Ukrainian war, International Paper has been obliged to sell its 50% stake in Ilim Group, a Russian firm which exported 2.05 million tons of pulp and paper products to China in 2023 for a value of $1.2bn. Being partners since 2007, this was a serious blow to the firm and, while no financial information has been disclosed, given the geopolitical tension and pressure from the US government we would be inclined to think the selling price was far below the fair value of its stake. While the failure in Russia can’t be attributed to mismanagement from the firm, International Paper hasn’t been extremely successful in its other international ventures, notably Brazil. With hopes of becoming the South American leader in paper and packaging, the firm had established several corrugated board plants in the country, but despite their efforts they were not competitive on the Brazilian packaging market and were not helped by the turbulent economic crisis in the country. Mr. Sutton, chairman of International Paper, declared that the packaging business in Brazil had made no profits over the last few years, in 2018 they reported a $122mn loss on those assets. These cases highlight the firm’s difficulties expanding its operations internationally.
For the upcoming decades, one key acronym will be at the center of International Paper’s operations, ESG. Indeed, in the fight against climate change, trees are an essential asset through their capacity to absorb carbon dioxide, as such regulators are honing down on the abusive exploitation of forests by the paper industry, which uses between 33-40% of all industrial wood traded globally. Forests in the United States are heavily regulated, over the last 100 years there has been no decrease in overall forest land in the US and annual growth of forests is at its highest point in years. Additionally, firms have no incentive to not replant trees as they would be foolishly destroying the material used to produce their goods. The issue lies in the lack of regulation in other countries, notably those with large enough forests such that wood collecting firms do not see the need to replant given the important reserve, with no replanting costs, they can provide competitors of International Paper with cheaper virgin wood. Since the latter supplies itself mainly with more expensive wood from the United States, it could be driven out from international markets from these competitors offering smaller prices. To face this issue, International Paper has responded proactively by investing in Brazil, home to 12% of the world’s forests, now owning 314,000 acres of Brazilian woodland and enabling them to supply themselves with cheaper virgin wood for production.
Deal Structure and Rationale
On March 26th, 2024, International Paper announced it had reached an agreement to buy UK-listed DS Smith in an all-share £7.8bn deal. The definite agreement was reached on April 16th, 2024. With an offer per share price of 3.62 pounds, IP will issue 0.1285 shares for each DS Smith share, for a total of 179,948,967 new shares. This implies that DS Smith will own 33.3% of the combined group, while IP will own the remaining 66.7%, for a total consideration to DS Smith’s shareholders of £5.06bn.
The valuation of £7.8bn comes at an EV/Revenue multiple of 1.0x, EV/EBITDA multiple of 6.5x, and EV/EBIT multiple of 10.0x. The sell-side advisors to DS Smith were Goldman Sachs, Citigroup, and J.P. Morgan. Merrill Lynch International acted as the financial advisor to International Paper.
In terms of rationale, although the paper and packaging industry is characterized by strong M&A and consolidation trends, firms in this space tend to specialize rather than vertically integrate along the value chain. International Paper’s acquisition of DS Smith, however, is a clear outlier as it aims to merge two of the largest players in the paper and packaging industries. The rationale behind the deal consists of strategic and financial considerations, which led to both companies recommending the all-stock deal to their shareholders.
The two companies are not only focusing on different segments of the value chain but also on different geographies. The merger would unite the North American and English company creating a global leader in sustainable packaging and could attract a larger customer base in both regions. For IP this is a particularly attractive aspect, as due to strong European sustainability legislation on packaging materials, the acquisition would allow them to tap into a large market for sustainable packaging solutions. The two businesses’ complementary nature means the combination would increase vertical integration and improve profitability. Through integrating IP’s North American network of mills and DS Smith’s European network of box plants and mills the combined integration rate would increase to around 90%, meaning the vast majority of raw materials for the company’s packaging solutions would be produced in-house. The combination also enhances the value propositions of International Paper through a larger product portfolio, larger exposure to new segments like fast moving consumer goods and e-commerce through packaging, and the potential to cross-sell products to existing customers.
The deal is also attractive, as the experienced teams and alike company cultures ensure a low-friction integration of the two companies. Both firms' leaderships have extensive experience of conducting large scale acquisitions, and part of the leadership of DS Smith would stay on as advisors to the combined entity to ensure a smooth integration process.
The financial value created for shareholders is due to cost, CAPEX and revenue synergies. By the end of the fourth year after the acquisition, these synergies are expected to reach $514mn in pre-tax savings, mostly due to cost synergies. Of the $474mn dollars that cost savings represent, around half are attributed to operational synergies due to integrated mill and box plants and access to a more global supply chain. These operational synergies include increased operational efficiencies in plants through sharing of know-how and technological expertise, as well as freight optimization. Other cost-saving items include larger bargaining power in operational procurement due to a larger scale and decreased overhead through eliminating duplicate work in the two organizations. The combined entity is projected to cut as many as 400 FTEs of its combined workforce, mainly in the high-cost senior management rank. The remaining 8% of total synergies is attributed to a larger scale in CAPEX procurement through larger size and revenue synergies from increased cross-selling opportunities.
The Future of the Paper Industry
Players in the paper and packaging industry had been looking to consolidate for a while, reflected by IP’s failed attempts to acquire Smurfit Kappa (due to shareholder disagreement and missing financing) (2018), Mondi’s interest in DS Smith (2021), exclusive comments to the FT by IP detailing their focus on snapping up smaller U.S./European players (2021), and commentary by RBC on an acquisition of DS Smith by IP (2021). With WestRock and Smurfit Kappa announcing their merger in September 2023, followed by IP’s announced acquisition of DS Smith in April 2024 (outbidding UK-based paper packaging manufacturer Mondi), sector consolidation among leading players is finally beginning to kick off. Below are the market share pie charts before the post-COVID sector consolidation took place.
Figure 2: source BNP Paribas
The top 6 cardboard makers accounted for 80% and 45% of total sales in the U.S. and Europe respectively. The CEO of Smurfit attributed Europe’s fragmentation to the large remaining number of big family companies who believe in “dynastic situations”.
In a post-pandemic world with economies and valuations across the U.S. and Europe continuing to diverge in 2024, further M&A activity led by U.S. corporates can be expected. Commentary by the head of Smurfit Kappa supports this, saying that groups can achieve a higher valuation on Wall Street as he defended the decision to switch the company’s primary listing to New York as part of a merger with US rival WestRock. This has also been reflected in DS Smith’s preference for accepting IP’s bid over Mondi’s, despite offering a lower stake of control by c.13 percentage points while beating Mondi’s bid by c.10% (Mondi would give DSS a 46% stake while IP is giving 33%). Furthermore, a deal with Mondi would have created a European leader, complemented by the pair’s mismatch in containerboard production; DSS uses more of the raw material than it makes while the opposite is true for Mondi, DSS would contribute box factories while Mondi would contribute its low-cost mills. DSS buys a significant amount of raw material for its boxes while Mondi makes all of its own from virgin and recycled fibres. In sum, this results in less reliance on market prices and lower earnings volatility.
However, a DSS/Mondi deal would make the combined company too large for subsequent mergers or acquisitions, rendering a deal with an overseas company like IP more attractive if management believes inorganic growth holds greater precedence for success within today’s industry landscape. This may be the case, particularly when considering IP’s new CEO, Andrew Silvernail, who will join from an advisory role at KKR from May 1st. DSS may have also been less interested in retaining a larger stake of control, considering their long-standing CEO since 2010, Miles Roberts, announced his intention to retire by 2025.
Looking across EU countries and players for future developments and potential acquisition targets for the paper and packaging industry, there are a couple of matters to observe, namely (1) energy prices, (2) the transition from plastic to paper packaging, (3) players’ differing strategies in virgin/recycled fibres, end customer trends, and players’ facility typology.
In 2021, the CEO of DSS attributed rising UK energy prices to the downsizing of its paper and packaging industry over the past decade, while in Germany, the sector had doubled in size and is three to seven times larger than the UK’s thanks to lower energy prices and Berlin’s policies aimed at helping the industry with the additional costs associated with decarbonisation. DSS consequently put their money where their mouth is and expanded into Italy, Poland and Germany. With energy prices now higher than in 2021, though not as high as 2022, EU companies in the paper and packaging industry are more appealing targets relative to their UK peers. This is reflected by DSS’ activity in 2023, where the group cut costs by selling and shutting down old factories and recycling depots in the UK.
In a post-pandemic world with economies and valuations across the U.S. and Europe continuing to diverge in 2024, further M&A activity led by U.S. corporates can be expected. Commentary by the head of Smurfit Kappa supports this, saying that groups can achieve a higher valuation on Wall Street as he defended the decision to switch the company’s primary listing to New York as part of a merger with US rival WestRock. This has also been reflected in DS Smith’s preference for accepting IP’s bid over Mondi’s, despite offering a lower stake of control by c.13 percentage points while beating Mondi’s bid by c.10% (Mondi would give DSS a 46% stake while IP is giving 33%). Furthermore, a deal with Mondi would have created a European leader, complemented by the pair’s mismatch in containerboard production; DSS uses more of the raw material than it makes while the opposite is true for Mondi, DSS would contribute box factories while Mondi would contribute its low-cost mills. DSS buys a significant amount of raw material for its boxes while Mondi makes all of its own from virgin and recycled fibres. In sum, this results in less reliance on market prices and lower earnings volatility.
However, a DSS/Mondi deal would make the combined company too large for subsequent mergers or acquisitions, rendering a deal with an overseas company like IP more attractive if management believes inorganic growth holds greater precedence for success within today’s industry landscape. This may be the case, particularly when considering IP’s new CEO, Andrew Silvernail, who will join from an advisory role at KKR from May 1st. DSS may have also been less interested in retaining a larger stake of control, considering their long-standing CEO since 2010, Miles Roberts, announced his intention to retire by 2025.
Looking across EU countries and players for future developments and potential acquisition targets for the paper and packaging industry, there are a couple of matters to observe, namely (1) energy prices, (2) the transition from plastic to paper packaging, (3) players’ differing strategies in virgin/recycled fibres, end customer trends, and players’ facility typology.
In 2021, the CEO of DSS attributed rising UK energy prices to the downsizing of its paper and packaging industry over the past decade, while in Germany, the sector had doubled in size and is three to seven times larger than the UK’s thanks to lower energy prices and Berlin’s policies aimed at helping the industry with the additional costs associated with decarbonisation. DSS consequently put their money where their mouth is and expanded into Italy, Poland and Germany. With energy prices now higher than in 2021, though not as high as 2022, EU companies in the paper and packaging industry are more appealing targets relative to their UK peers. This is reflected by DSS’ activity in 2023, where the group cut costs by selling and shutting down old factories and recycling depots in the UK.
Figure 3: source BNP Paribas
The packaging sector is beginning to rebound since the withdrawal following the pandemic e-commerce boom, companies such as Smurfit Kappa are reporting a re- reversal in their top lines within their Q1 2024 trading updates. Analysts also expect the transition from plastic to paper packaging will further catalyse sector growth, with potentially up to 36% of the packaging market (i.e. the plastics portion) to replace and compete with. An example of a tailwind for the sector is in the UK, where multinational consumer brands and supermarkets look to eliminate unnecessary or problematic single-use packaging as early as 2025. Companies like DSS comment how they are entering contracts with consumer goods groups for six-year periods instead of the usual six to twelve months, to collaborate on developing new packaging. In light of this transition, plastic packaging manufacturing companies will be looking to divest or redirect their company strategy through inorganic means.
The compatibility between companies in M&A scenarios within the paper packaging sector depends on how a target and acquirer’s profiles interact across their use of paper fibres, the types of facilities they specialise in and their end customer focus. These factors in and of themselves are influenced by industry trends and demand. For example, since 2022, many companies have been shutting down or converting mills to serve the packaging industry which has benefited from the boom in e-commerce. Now that e-commerce has resided since a world under lockdown with COVID, there may be incentives for M&A to rebalance companies’ mills under operation. Such targets may consist of Mondi, whose supply chain is more upstream-based relative to DSS and consists of more low-cost mills. Another example is a company’s access to virgin vs. recycled fibres, which impacts costs. Again, Mondi has greater access to virgin fibres relative to DSS. Finally, companies may look to diversify their end-customer exposure to take advantage of a subsector upticks or avoid downticks (e.g. school/office paper supplies vs e-commerce supplies during COVID). Companies like WestRock have a greater share of pizza box and other food packaging, whereas companies like IP dominate the e-commerce space (particularly Amazon boxes).
The compatibility between companies in M&A scenarios within the paper packaging sector depends on how a target and acquirer’s profiles interact across their use of paper fibres, the types of facilities they specialise in and their end customer focus. These factors in and of themselves are influenced by industry trends and demand. For example, since 2022, many companies have been shutting down or converting mills to serve the packaging industry which has benefited from the boom in e-commerce. Now that e-commerce has resided since a world under lockdown with COVID, there may be incentives for M&A to rebalance companies’ mills under operation. Such targets may consist of Mondi, whose supply chain is more upstream-based relative to DSS and consists of more low-cost mills. Another example is a company’s access to virgin vs. recycled fibres, which impacts costs. Again, Mondi has greater access to virgin fibres relative to DSS. Finally, companies may look to diversify their end-customer exposure to take advantage of a subsector upticks or avoid downticks (e.g. school/office paper supplies vs e-commerce supplies during COVID). Companies like WestRock have a greater share of pizza box and other food packaging, whereas companies like IP dominate the e-commerce space (particularly Amazon boxes).
Conclusion
International Paper's acquisition of DS Smith marks a pivotal moment in the paper and packaging industry, reflecting a trend toward major consolidation as companies strive for greater scale and efficiency. This merger not only broadens International Paper's reach across key global markets but also positions the company to better meet the evolving demands of the industry’s clients. As the landscape continues to shift, this strategic move could set a precedent for future mergers and acquisitions within the sector, signaling a new era of global players.
Sources
- Financial Times
- The Wall Street Journal
- Yahoo Finance
- Modern MBA
- McKinsey
- Reuters
- DS Smith
- International Paper