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According to a new report from Jefferies, a merger between Mondi and DS Smith could result in a European ‘industry leader’ for paper packaging solutions – yet conflicting desires between the companies’ shareholders may cause the agreement to fall below the ideal intrinsic value price target.

Mondi announced last week that it was considering an all-share bid to buy DS Smith. The merger could potentially yield a combined value higher than £10 billion, or €11,714,884,660 – but it is currently uncertain whether an offer will be made.

Bringing together the companies’ business operations is expected by Jefferies to create an ‘industry leader’ for paper packaging solutions in Europe – taking the top spot for bag conversion, niche sack and specialty kraft paper for bags, and both recycled and virgin containerboard in paper for boxes. It is also set to reach #1 or #2 for corrugated box packaging conversion.

DS Smith is currently ranked at #2 for box-making in Europe, with its footprint leaning towards Western Europe, particularly the UK, Spain, France, Benelux, and Italy. On the other hand, Mondi gears towards Central and Eastern Europe with eight plants in Turkey, six in Poland, three in Germany, and one each in Austria and the Czech Republic.

Jefferies asserts that the merger would be beneficial in strengthening the companies’ positions in their respective markets. Production costs for both box and paper for containerboard are anticipated to decrease across the group if the merger goes ahead. The route to market would be better secured, the report suggests, and the merger would apparently enable better utilization across the mill network, especially when the market is already oversupplied.

Mondi’s flexible packaging operations could also be introduced to DS Smith customers and unlock customer and cross-selling benefits medium term, the report suggests. On the other hand, DS Smith’s strengths are thought to lie in product designs and FMCG and retailer customer focus.

Mondi is set to benefit from the capability to drive volumes and cross-sell synergies for customers in the flexible packaging division, like mailer bags for e-commerce and leveraging DS Smith’s consumer goods and retailer relationships to replace plastics with paper where appropriate.

The report takes the stance that, in terms of structural growth, the merger will likely take a greater portion of plastic to paper. It is anticipated to benefit from structural growth trends in sustainable packaging, plastic-to-paper, and e-commerce, and take a greater portion of this growth versus industry.

This is attributed to its customer mix skewing towards larger FMCGs and retailers, which require a larger supplier to implement sustainability-minded packaging at scale and across geographies. Furthermore, it is necessary that Mondi and DS Smith collectively provide innovation and design offerings and are able to invest in machinery capabilities.

Similarly, the merger’s #1 spot in sack and specialty kraft paper for bags and primary packaging will apparently drive a shift in demand for plastic-to-paper alternatives.

Vertical integration, complementary offerings, and scale and efficiencies in supply chain and administration are expected to create ‘substantial’ synergies. Reportedly, DS Smith is ‘short’ 1.2mT of containerboard for paper and boxes, while Mondi is ‘long’ 1.4mT of mostly virgin containerboard.

Therefore, the report identifies ‘clear’ benefits for vertical integration to combine the companies’ containerboard mill system and box plant networks. Integrating mill systems for paper used in containerboard boxes and box plants could result in a combined footprint representing 2-5% of sales, equivalent to approximately €200 million to €400 million.

Jefferies continues that the pro-forma group would have a >6mT capacity for paper for containerboard boxes across the continent. This would be broadly integrated to produce a similar amount of containerboard in mT as it consumes in its box plants; specifically, it would be long 1.2mT for virgin containerboards and short 1mT of recycled containerboard.

This shortage is set to work to the companies’ advantage, as Jefferies predicts that the EU market for recycled containerboard may become oversupplied in the coming years. Capacity rationalization is expected to be a positive, with Mondi’s cost-advantaged mills in Europe set to generate returns and reap benefits from a steeper cost-curve environments; it is recommended that some of DS Smith’s higher-cost, smaller mills are disposed, rationalized, or run for cash.

Acquiring low-cost independent players at the bottom of the cycle is also expected to consolidate the market further and achieve further earnings accretive bolt on M&A (buy vs. build).

However, Jefferies believes that a merger should only be considered at an appropriate price. Where investor calls and meetings have reportedly focused on strategic rationale, potential synergies, and the appropriate valuation/price or share ration, Mondi shareholders are said to be concerned that the majority of the potential synergy upside could be given away to DS Smith shareholders.

On the other hand, DS Smith shareholders are apparently ensuring that the company is not acquired for anything below its perceived intrinsic value – a stance based on their belief that the shares could re-rate as conviction in light of resilient earnings delivery and increasingly higher returns through the cycle.

The report asserts that DS Smith standalone shares have consistently traded above £3.50 in the last 12 months, so any potential offer would need to exceed the £3.50 threshold to appeal to most DS Smith shareholders. Preliminary discussions have ranged from £3.60 to £4.40.

Even so, packaging shareholders are said to have identified an opportunity to benefit from additional synergy gains and a revaluation of the group in the long term. With DS Smith CEO Miles Roberts previously announcing his plans to retire no later than 30th November 2025, this outcome is expected to address concerns regarding his succession.

In the report’s base case of €300 million synergies, Mondi shareholders could see a >5% increase in earnings per share if they paid up to £4.30 to acquire DS Smith – yet perceived M&A risks and concerns that all synergies would go to DS Smith shareholders are reportedly preventing many Mondi shareholders from paying over £4. So far, talks have mostly fallen within the parameters of £3.50 and £3.80.

Generally, Jefferies believes that, unless synergies are higher than its €300 million base case, a price range between £3.60 and £3.80 will be the ‘sweet spot’ – potentially balancing the opposing demands of each company’s shareholders. DS Smith shareholders would still be expected to share the upside of the new entity, while Mondi shareholders would reap the benefits of strategic rationale plus >10% earnings per share accretion.

The news comes after a recent agreement in which Smurfit Kappa and WestRock will merge their businesses into a $20 billion company. It is set to be completed in the second quarter of 2024, subject to customary closing conditions, and both companies’ Boards of Directors are encouraging their shareholders to express their agreement to the combination.

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