Packaging Corp - Great Deal With Boise But Valuation Is Too High

| About: Packaging Corporation (PKG)

Shares of Packaging Corp Of America (NYSE:PKG) jumped upwards on Monday's trading session. The producer of containerboard announced a large transaction which will increase annual revenues by some 80% and boost capacity its in the containerboard market.

While the deal is excellent, and I applaud management for negotiating this deal, the overall valuation has become too rich for me after shares have doubled over the past year.

The Deal

Packaging Corp announced that is has entered into a definitive agreement under which it will acquire Boise (BZ) for $12.55 per share in cash.

The deal values Boise at $1.995 billion, including the assumption of $714 million in debt.

As a result of the deal, Packaging Corp's containerboard capacity will increase by 42% to 3.7 million tons. The major rationale behind the deal is to boost capacity, create significant synergies and gain a foothold in the Pacific Northwest.

Chairman Paul Stecko commented on the rationale behind the deal, "The acquisition is an excellent fit, both geographically and strategically, with unique and substantial synergies. It provides the containerboard that PCA needs to support our strong corrugated products growth. The DeRidder containerboard mill is low cost, located in a very good wood basket and, after the D2 machine conversion, provides almost one million tons of primarily lightweight containerboard. "

Packaging Corp sees pre-tax synergies reaching $105 million per annum within three years of the deal closure. Synergies are driven by mill grade optimizations, and a reduction in transportation, as well as selling & general costs. The purchase price values the company at 12-months trailing EBITDA at $297 million. Factoring in expected synergies, the deal is valued at 5.0 times EBITDA as the deal is expected to be immediately accretive to earnings.

The deal is expected to close in the fourth quarter of the calendar year of 2013. The deal is subject to normal closing conditions, including regulatory approval. The board of directors of both companies have already approved the deal.


Packaging Corp ended the second quarter with $370.1 million in cash and equivalents. Total debt stood at $811.5 million, for a net debt position of around $441 million.

Revenues for the first six months of the year rose by 12.4% to $1.55 billion. Net earnings doubled to $125.1 million. Note that earnings growth was the result of special charges incurred last year, as operating earnings actually fell compared to the year before.

Factoring in gains of 7%, with shares exchanging hand at $58 per share, the market values Packaging Corp at $5.7 billion.

Packaging Corp pays a quarterly dividend of $0.40 per share, for an annual dividend yield of 2.8%.

Some Historical Perspective

After trading within a $10-$30 trading range for most of the past decade, shares of Packaging Corp have seen some good upside over the past year. They broke out towards the upside of the range, and promptly doubled to highs around $60 per share.

Between the calendar year of 2009 and 2012, Packaging Corp has grown its annual revenues by a cumulative 32% to $2.84 billion. Net earnings fell from $266 million in 2009 to $164 million over the past year. The company has repurchased a modest 5% of its shares outstanding over the same time period.

Investment Thesis

Shares of Boise rose by 26% to $12.55 per share, reflecting the offer price from Packaging Corp. The move boosted the market capitalization of the firm by some $250 million.

Add to that the $3.50 jump in Packaging's shares, the market capitalization of that firm has been boosted by some $350 million, valuing the combined entity a cool $600 million more than Friday. The market is obviously happy with the $105 million in projected annual synergies.

As such the enterprise value of Boise at $2.0 billion values the business at 0.8 times annual revenues. In comparison, Packaging Corp's $6.0 billion enterprise valuation, values the business at 2.0 times the $3.0 billion trailing annual revenues. Of course, Boise is much less profitable, generating merely $14 million in net income over the past year, compared to Packaging's $226 million in net earnings.

The newly combined entity will hold $2.5 billion in net debt, assuming no shares will be issued to finance the deal. The resulting equity valuation of $5.6 billion, values the new combination at 1.0 times annual revenues of $5.5 billion. Combined, net earnings run at $260 million at the moment. This could accrue to some $330 million factoring in expected synergies of $105 million at statutory tax rates. This would value the business at 17-18 times annual earnings.

While I applaud the stand-alone deal, as it will result in a 80% increase in revenues, is accretive to earnings, and will boost the overall operational strength of the company, I remain hesitant. On the back of the deal other names in the industry saw large jumps as well. Shares of KapStone Paper and Packaging (NYSE:KS) jumped up by some 8%.

Shares have doubled over the past year, operating in a cyclical industry as shares broke out of a long term resistance level. Add to that dividend hikes which resulted in attractive dividend yields, and a generally strong equity market, and investors bid up the shares towards $60 per share recently.

The deal is great, but the overall valuation is too high for my taste for a cyclical stock. I remain very cautious and stay on the sidelines at 17-18 times annual earnings, as the increase in leverage will prevent the company from repurchasing shares or hiking its dividend at an aggressive pace.

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.