KapStone - Despite An Excellent Deal, There Is Little Upside In This Paper Manufacturer

| About: KapStone Paper (KS)

Shares of KapStone Paper and Packaging (NYSE:KS) spiked upwards in Monday's trading session following the announcement of the acquisition of Longview Fibre Paper and Packaging.

After shares have more than doubled over the past year, and shareholders have fully priced in the benefits from the announced deal with Longview, there is not much upside potential left.

The Deal

KapStone announced that is has signed an agreement under which it will acquire Longview Fibre Paper. KapStone will pay $1.025 billion in cash to Longview's previous owner, Brookfield Capital Partners II, a private equity fund managed by Brookfield Asset Management (NYSE:BAM).

Longview is manufacturing high quality containerboards as well as lightweight high performance multiwall paper and specialty Kraft papers. The deal increases the exposure to the highly desirable containerboard segment and boosts the performance of the multiwall paper industry, a segment growing at 4% per year.

Chairman and CEO Roger W. Stone commented on the rationale behind the deal, "Acquiring Longview is an outstanding opportunity for numerous reasons. The acquisition immediately adds value for our shareholders by increasing earnings and generating very strong free cash flow."

For the year of 2012, Longview generated annual sales of $831 million on which it reported $118 million in EBITDA. First quarter revenues for 2013 came in at $217 million on which the firm reported $42 million in EBITDA.

The $1.025 billion deal values Longview at roughly 1.2 times annual revenues and 8.7 times annual EBITDA. This even excludes $10 million in anticipated synergies in the first 18 months following the closure of the deal.

The deal is expected to close this summer and is subject to normal closing conditions.


KapStone ended its first quarter of its fiscal 2013 with $7.6 million in cash and equivalents. The company operates with $347.2 million in short and long term debt, for a sizable net debt position. While KapStone has committed financing in place, the net debt position following completion of the deal will increase significantly.

KapStone generated annual revenues of $1.22 billion for 2012, up 34% on the year. Net income roughly halved to $62.5 million, coming in at $1.31 per share.

Factoring in a 18% jump following the news of the acquisition, the market values KapStone at almost $1.7 billion. This values the business at 1.4 times annual revenues and 27 times annual earnings.

KapStone currently does not pay a regular dividend.

Some Historical Perspective

After trading at very distressed levels in 2009 shares have seen an impressive rebound. Trading at high single digits in 2010, shares have steadily risen to highs of $35 at the moment, following year to date returns of 60%.

The reason for the solid returns are growth, or better said, profitable growth in a historically difficult sector to operate in. Between 2009 and 2012, KapStone almost doubled its annual revenues to $1.22 billion. At the same time net income fell by almost a quarter to $62.5 million.

Investment Thesis

The deal with Longview is transformational for KapStone as it significantly boosts the company's operations. The deal will boost annual revenues by around 70%. The multiples seem fair at 1.2 times annual revenues, a roughly 15% discount to KapStone's own valuation. The EBITDA multiple at 8.7 times is in line with KapStone's 9.3 times own valuation. These multiples exclude the $10 million in annual synergies which will make the deal a bit more attractive.

Longview, which has been purchased by Brookfield back in 2007 has turned itself into a profitable enterprise. Following these improvements, Brookfield has been looking to sell the business over the past year. KapStone itself has been growing rapidly after its acquisition of International Paper's Kraft business back in 2007.

Upon completion of the deal, KapStone will be valued around $1.7 billion, while operating with almost $1.4 billion in total debt. Combined, both firms generate $2.05 billion in revenues and roughly $300 million in adjusted EBITDA, excluding the estimated synergies.

It is easy to understand why KapStone's investors like the deal. The company is buying a profitable and growing business at a 5-15% discount compared to its own valuation, excluding $10 million in annual synergies. Monday's trading action reflects upon this as KapStone's market capitalization has increased by roughly $250 million following the announcement of the deal.

After shares have more than doubled over the past year, and KapStone's shareholders have fully reflected the expected synergies, there is little room to the upside left at these levels.

I have to remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.