Abitibi & Bowater: Even More Rewards To Come

Includes: ABY-OLD, BOW
by: Vincent Di Carmine

At the end of our post of two weeks ago regarding Abitibi Consolidated Inc. (ABY-OLD) we said that mergers and acquisitions and other resource conversion activities (like the spin-off of under evaluated assets) were the main possible catalyst for a material share price increase of Abitibi's depressed stock price, but we were not expecting good news to materialize so quickly.

Today Abitibi announced that it agreed to merge with Greenville- (S. Carolina) based Bowater Inc. (BOW).

Bowater is the largest newsprint and mechanical paper producer in United States. It also produces pulp, speciality paper, timber products and other timber-related products in mills located in United States, Canada and South Korea. The company also owns 835,0000 acres of timberland in United States and Canada.

The deal is subject to regulatory and shareholders approval and is expected to close in the third quarter 2007. We will wait for some highlights on antitrust approval since both companies hold a meaningful share of the North American newspaper market.

The merger can be considered as a merger of equals. The Executive Chairman and CEO offices will be shared by the present Abitibi and Bowater CEOs respectively. The 14 members Board of Directors of the new company to be named AbitibiBowater will consist of 7 directors from each company.

Each common share of Abitibi will be exchanged for 0.06261 common share of AbitibiBowater and each share of Bowater will be exchanged for an 0.52 share of the combined firm. At Friday's closing quote, the new company would be 48% owned by former Abitibi shareholders and 52% owned by former Bowater shareholders. Sales of AbitibiBowater should fetch $7.9 billion and the enterprise value should exceed $8 billion.

Management expects to achieve an annualized $250 million of cost cutting above the cost savings in place in both companies.

The deal should be highly rewarding for the shareholders of both companies. We expect cost saving initiatives, better pricing power and asset use should materially improve cash flows and allow the new company to reduce debt and invest profitably in value added paper mills.

We do not exclude further spin-offs, refinancing or other asset conversions of certain Abitibi or Bowater assets to bring to light the market value of their hydro power or timberland assets. Abitibi management already showed the way last Friday with their announced sale of their Ontario-based hydro power facilities to a majority owned joint-venture financed with non-recourse debt.

Before the announcement of the merger agreement this morning Abitibi shareholders were already comforted by a Barron's column published this week-end. The Seeking Alpha excerpt of the article quotes from John Schneider, advisor to the Touchstone Large Cap Value Fund (The fund was started in March 2006, you can read a short bio of John Schneider here). He has some good points:

1) The Canadian Dollar is weakening against the U.S. Dollar. (USD gained 5 cents from the highs), each cent gain is worth C$ 0.08/share in earnings and more in free cash flow, the stock was quoting on Friday at C$3.11 in Toronto.

2) Worldwide newsprint demand is increasing despite the secular decline in North America. Magazine paper volumes are catching up and should exceed newsprint volumes in 2010.

3) Sentiment is gloomy around the stock. The stock is the worst performer of the Toronto Stock index for the last 20 years and we would guess that a number of investors have been disappointed so far.

Before getting the merger news, Schneider said he was expecting a $0.50/share profit in "a few years". Applying a 10 times multiple to these earnings the stock was expected to double in the meantime.

Barron's was focusing on the earnings side of the story that may mature in a few years. But the other side, the "assets conversion" story, has already started to reward Abitibi shareholders. Abitibi was up 25% this morning at $3.34.

ABY 1-yr. chart:

ABY Investment

Related Articles: Abitibi's Better Than It Looks on Paper - Barron's; Abitibi: Ugly Paper Duckling Can Become a Swan; Abitibi Consolidated: A Peter Lynch Play?; Trees and Paper: The Rodney Dangerfield of Commodity Stocks

Disclosure: At the time of posting the author was long Abitibi Consolidated.

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