Who Knew Paper Could Be So Sexy?

| About: Boise Inc. (BZ)

There has been some interesting action of late in the paper business. And things are only getting hotter. Hedge fund, Starboard Value, has an activist campaign going on at Wausau Paper, owning 15% of the company, and looking for cost cutting. And now, fellow hedge fund, Carlson Capital, has gone activist at Boise (NYSE:BZ).

Boise is a manufacturer of packaging and paper products, including corrugated containers and sheets, containerboard, protective packaging products, imaging papers for the office and home, printing and converting papers, label and release papers, newsprint and market pulp.

Boise already has a standing offer from Packaging Corporation of America (NYSE:PKG) to buy the company for $12.55. However, the stock has been trading above that mark since the announcement. Suggesting that Mr. Market believes a higher offer will come in, which is exactly what Carlson is pushing for.

Prior to the buyout announcement, Carlson was one of the company's largest shareholders, but the fund recently boosted its stake to help shareholders fight for a higher for a "fairer" price. Carlson now owns 6.7% of the company

In essence, Carlson believes the deal significantly undervalues BZ. Carlson values BZ at $14 to $17, which is 12% to 36% higher.

Carlson feels the most value could be unlocked via a separation of the paper and packaging segments. As noted by Carlson, "the offer doesn't take into account the overall improvement we're seeing in operations for BZ's packaging and paper segments."

The real beauty is that even if Carlson can only get the buyout price up to $13, that's still an annualized 12.5% return, assuming the deal closes before year-end. What's more is that it's highly unlikely that PKG backs out of the deal. With the financing already in place, and potential benefits, it's definitely in PKG's best interest to see the deal through. Even PKG's shares were up 8% over the last month due to the acquisition of the news.

That's because PKG is getting a hell of a deal. It's paying 0.5x sales for BZ, while PKG actually trades at 1.9x. The buyout is at a 7.5x EV/EBITDA, where the median EV/EBITDA multiple is 8.7x for the four comparable takeovers of $500 million or more over the past five years.

The deal will boost PKG's containerboard capacity by an impressive 42% and give PKG a much needed presence in the Pacific Northwest. So they definitely want the deal to get done, question is, at what price? Another 40 cents on the BZ buyout would only be an extra $40 million for PKG, which has $370 million in cash on the balance sheet.

And Clint Carlson (Carlson Capital founder) is no stranger to M&A arbitrage. Clint cut his teeth on event-driven investments while he was head of risk arbitrage at Bass Brothers' investment arm. Before that Carlson was a co-manager for Maxxam Group's risk arbitrage fund. Clint started Carlson Capital in 1993 and his fund focuses on risk arbitrage and event-driven arbitrage.

We would be buyers of the stock given Carlson Capital's involvement, and we like the under-followed, under-rated, paper business. You also have Paulson & Co. and LSV Asset Management owning meaningful stakes, each with over 5.5 million shares to their names. We see the worst case as being that you invest in BZ for three months and a higher deal doesn't materialize. And if you're afraid of the absolute worst case where PKG backs out and the stock price tumbles (although, according to Carlson, remaining as a standalone public company could be one of the best ways to unlock the true value), BZ shareholders should buy some protection with covered calls (an income oriented strategy).

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BZ over 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.