Resolute Forest Products (NYSE:RFP), which is based in Montreal, Quebec, is the largest producer in the world of newsprint, which is a commodity that has experienced and will continue to experience declining demand due to diminishing readership of newspapers. This creates a significant challenge for the company, and my solution for meeting this challenge is for Resolute to acquire publicly traded Tembec (OTCPK:TMBCF), which is also based in Montreal, in an M&A transaction and to sell their newsprint business by way of an IPO.
Resolute's management has in fact recently said that they would like to make an acquisition that would increase their exposure to lumber and pulp in order to reduce the importance of newsprint in their portfolio of businesses, and this is what they would be getting from an acquisition of Tembec, where lumber has recently been 24% of total sales and dissolving pulp (primarily high value specialty cellulose) has been 34%. However, I have no knowledge that they have specifically targeted Tembec as an acquisition, and there is no indication that they are contemplating a sale of the newsprint business.
A reluctance to sell the newsprint business may at least partly stem from a belief that there might be few or no strategic buyers of the business. This is why a sale by way of an IPO could be the best way to go. Also, there is one other publicly traded company that makes it possible to anticipate how Resolute's newsprint business might be valued as a stand-alone public company. That company is Norwegian based Norske Skog (OTCPK:NKSJF), where newsprint is 62% of recent total sales.
The following are key financials related to Resolute, Tembec, and Norske Skog. Even though Resolute is based in Canada, it reports in U.S. dollars, and I have converted Canadian dollars used by Tembec and Norwegian Kroner used by Norske Skog into U.S. dollars for the sake of comparison. Sales and earnings are for the 12 months ended in December 2013, and balance sheet figures are as of the end of December 2013. Dollar amounts except per share amounts are millions, and for Tembec sales and earnings have been adjusted downward to reflect the divestiture of a pulp mill that took place in May 2013.
|Resolute Forest Products|
|Stock price of $17.35|
|Corporate / other||-$19||-5%|
|Enterprise value / Adjusted EBITDA||5.1|
|Stock price of $2.13 (Can. $2.35)|
|Specialty cellulose pulp||$469||34%|
|Specialty cellulose pulp||$67||83%|
|Enterprise value / Adjusted EBITDA||7.8|
|Stock price of $.79 (NOK 4.73)|
|Corporate / other||-$5||-3%|
|Enterprise value / Adjusted EBITDA||8.5|
It is notable that based on financial results in 2013, Resolute's newsprint business is just a little bigger than all of Tembec. Consequently, the acquisition of Tembec would largely replace the sales and earnings foregone from the divestiture of the newsprint business. More importantly though is the fact that Resolute would have divested a business with a challenging earnings outlook and replaced it with some businesses that have good earnings prospects.
My estimate is that Tembec might be acquired for Can.$5.00 per share or about U.S.$4.54 per share. In U.S. dollars this would value the equity at $454 million and with $417 million in assumed net debt, the total acquisition value would be $871 million, which is an amount that Resolute can easily afford. If the acquisition value were reflected as an increase in long-term debt, Resolute would still have a manageable long-term debt to equity ratio of .52.
This acquisition price of Can.$5.00 per share is a 113% premium to a current stock price of Can.$2.35 (U.S.$2.13), which might seem excessive. In fact the stock price implies an acquisition value to 2013 adjusted EBITDA multiple of 11.4. However, using a discounted cash flow model I have calculated a fair value of about Can.$9.00 per share, and the all-time high price for the stock was Can.$6.40 per share in late March and early April 2011. (See my article entitled "Tembec - A Focus on Free Cash Flow and Valuation" by clicking here.)
I also estimate that Resolute's newsprint business might be sold for an enterprise value of U.S.$961 million, which is 8.5 times adjusted EBITDA for the 12 months ended in December 2013. This is the same valuation multiple implied by Norske Skog's current stock price.
An acquisition of Tembec for U.S.$871 million and the divestiture of the newsprint business for U.S.$961 million would result in net proceeds of U.S.$90 million, and based on financial results for 2013 there would be a net reduction in EBITDA of U.S.$32 million. However, because Resolute's newsprint business is likely to experience declining earnings in the coming years, while Tembec's businesses should generate increasing earnings, by my estimate within two years these two transactions should result in a net increase in EBITDA.
In modeling I have done on Tembec in Canadian dollars I estimate that adjusted EBITDA can rise by $97 million (U.S.$87 million) from $83 million in 2013 to $180 million in 2015 and stay at this higher level and higher for subsequent years. The components of this $97 million increase are as follows: $67 million from lumber, $36 million from dissolving pulp, and a decrease of $6 million from Tembec's other businesses. During this same time period Resolute's newsprint business is likely to experience a gradual decline in EBITDA.
In summary acquiring Tembec and divesting the newsprint business could result in net proceeds of U.S.$90 million and reduce EBITDA at Resolute by U.S.$32 million in the near term. However, by 2015 Tembec's businesses should be generating in excess of U.S.$55 million more EBITDA than Resolute's newsprint business.
Resolute's management should seriously consider this plan for changing the company's business portfolio and earnings outlook. It's a plan that can potentially make Resolute a better company and increase shareholder value.
Disclosure: I am long TMBCF. 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.
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