Ardagh (NYSE:ARD) IPO coming to market is an easy pass for an equity investor and if it actually gets public would be a great short. The Company has been looking for liquidity for years from public and private markets, and has failed for good reasons. This time looks no different. The Company is actually in worse shape than previous attempts with higher leverage and an even higher targeted valuation. Fair value for assets is closer to $8-$10/share vs. the $17-$20 potential IPO range. $8-$10/share still equates to a premium vs. historical for these assets and it's a higher multiple today simply because it has all time high leverage levels.
Ardagh is a low growth, capital intensive story operating in secular declining glass / can sector with greater than 6x+ Debt/EBITDA and the inability to generate returns on capital much higher than its own cost of capital. Priced at over 20% premium to peak historical values for glass / metal container companies (9.5x 2017 EBITDA) and a slight premium to current better growth profile, higher return on capital peers, ARD's IPO is an easy pass, and if completed, a great short opportunity.
HQ in Ireland, Ardagh is the 3rd largest provider of glass and metal containers for consumer packaged goods products globally. The Company is on the road for its $300 million IPO on the NYSE in the next two weeks. It has either then #1 or 2 share everywhere is operated, with over 50% of its EBITDA in Europe (16% GBP + 35% Euro Fx exposed).
Thesis For Ardagh Short
Significant risk to "high cash flow generation, reinvest at high returns" story, priced at levels that will that will cause multiple compression
1. Already experiencing negative revenue growth performance on best in class margins
- Dominance in metal and glass - significant contraction still ahead
- No exposure to plastics or any growth sectors in the packaging industry
- Operations heavily dispersed with "green" CEO
- Capital intensive business, with aging facilities, furnaces and equipment
2. No path for material, incremental M&A
- Industry already consolidated with company up against anti-trust in majority of developed markets
- Nothing of scale to buy unless willing to capex de novo build
3. Excessive leverage, and significant unfunded pension liabilities
- Unlevered equity returns are below 5%
- Levered equity returns are not much better than cost of capital
- Significant unfunded pension liability excluded from debt calculations including sizable German pension scheme. Risk of Merkel team (or new populist admin?) waking up to pension reform
4. Aggressive tax structure with significant risk to tax rate
- Double Irish blocker, which AAPL is currently being sued
5. Industry multiples at historic peaks (9-10x), with most leverage (>4x) in any period
- Company should trade at material discount to BLL/CCK/SLGN with better end markets and more potential growth
- More levered, more aggressive tax structure than peers
The Company's secular decline hinges on two critical factors:
First, Ardagh is now currently positioned with extremely high market share (>30%) in mature markets where there are no longer major transformative acquisitions to take place. It has maxed out its addressable M&A alternatives with the only remaining alternatives unable to gain regulatory approval.
- #1 producer metal cans by value in European seafood, paints, aerosol, nutrition
- #1 producer cans by value in NAmerica seafood
- #2 producer metal cans by value in Europe beverage + food can
- #3 producer bev can use by value in US/Brazil
Second, Ardagh is unable to reposition into growth products because it is too levered to acquire in growth areas and it would require too much capex on its existing facilities to convert to plastic. Its plastic peers like BERY have an insurmountable competitive advantage in plastic where annual capex spend is greater than 5% of sales/ Ardagh 's capex is below 5% of sales and in order to compete and transition their plans they would need to increase capex to 10% of sales / year. Thus Ardagh 's plant base and core product offering are not well-suited for the development of consumer demand o flexible, plastic products.
Additional Thesis Points
Ardagh is unable to reposition an push products through growth areas in order to generate future top line organic growth vs. expectations of low single digit growth. Conversions of glass / metal into plastic has been occurring for 30+ years but just in last 9 months there is evidence of material acceleration vs. previous long-term trends. These factors will have an impact on glass / metal can valuations. Several factors driving this recent acceleration in plastic share gains vs. glass / metal:
1. Metal can transitioning into non-round shapes which favors plastics
- WMT driving this because they want packages to be non-round to get more per square inch in shelves. Ardagh is currently #1 in tuna can market and that market is switching to plastic. Metal can providers prefer round cans because it is an area where they have cost advantages vs. plastic
- Europe 5+ years ahead of US in terms of transition to "non-round" plastic from more traditional round metal cans
- Negative environmental pressure associated with plastic recycling is not as important as the benefit of making non-round cans to better fit shelf space
2. Growth of specialty drink beverages that demand more customized cans lend themselves to plastic (all of the growth in CSDs occurring in specialty cans / bottles that will transition to plastic)
3. Consumer demanding fresh which is better with plastic than metal / glass
- Consumer staple products like corn, green beans etc. are not freshly cut in plastic packages
- Conversions of consumer to stand up pouches - more and more readily acceptable to branded retailers marketing purposes due to consumer usage preferences
4. Major changes coming out with microwave sterilization devices that benefit plastic vs. metal
- Enables 15 minute sterilization periods (can only be used on plastic) vs. 45 minute sterilization period currently required with old technology that is used by metal / glass. Provides vast productivity improvement to the line. New microwaves eliminate metal because they cannot go through microwaves. Glass can go through but metal lids and closures which are significant part of sales are also cut out.
- Many major players once they test the product determine they will not be moving back to metal once installed.
5. Further consolidation of top customers moves pricing power away from metal / glass
- Installed base of top 20 customers continue to consolidate, driving pricing pressure against suppliers as they are contracting
The Ardagh equity value is 1-1.5x EBITDA multiple turns higher than the existing 6x+ debt /EBITDA which equates to more like $8-$10/share for the equity value which is still a premium vs. historical multiples for these assets. And it is just a higher multiple today because leverage multiples are more than 2x greater than normal. A rising interest rate environment will erodes a material amount of the free cash flow from this business.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.