Investing.com — Reports broke across the media yesterday that Brazilian-based pulp manufacturer Suzano Papel e Celulose (NYSE:SUZ) is entertaining a $15 billion offer to take over Tennessee-based International Paper (NYSE:IP) in the largest-ever deal for the sector.
While the company has neither confirmed nor denied its intentions, insider sources consulted exclusively by Investing.com say that IP’s Board will not only reject an eventual bid at the aforementioned price but also see little chance of the deal happening over the long run.
Suzano’s offer for IP, if accepted, would value its stock at $42 a share, representing a modest 6.5% premium above the current price. This offer, as per unidentified sources, is insufficient to sway the Board’s decision, especially considering the stock traded at $41 just two months ago.
After dipping on worse-than-expected earnings in late April, as well as on the report that insiders were selling a significant amount of shares, IP stock has bounced back significantly this month as the arrival of CEO Andrew Silvernail boosted sentiment back into the stock, propelling it to a 13% jump month-to-date.
Another issue standing in the way of a Suzano/IP deal is the latter’s agreed buyout of London-based DS Smith (OTC:DITHF) (LON:SMDS) for $10 billion, sealed in mid-April. If finalized, the deal would create a company substantially above Suzano’s financial reach, which is why the Brazilian company will allegedly propose the breakup of the agreement as one of the clauses of its IP bid.
However, the breakup clause celebrated in the April agreement implies a $221 million breakup fee, which would need to be paid up in cash by Suzano itself.
Deal Financially Out of Suzano’s Reach at This Point
Even in a best-scenario kind of deal, Suzano would be significantly constrained in terms of firepower to make the kind of deal that could sway IP’s Board.
The Brazilian company’s debt currently accounts for around 60% of total liabilities under a nearly 6.5% real rate environment in Brazil. This implies a 3X leverage to the current price, which would be raised to 5.3X if the company seals the deal at $42 a share, significantly rising as IP’s per-share premium moves northward.
These numbers put a very low ceiling on any bid price rises, as every dollar added to IP’s stock price would significantly constrain Suzano’s balance sheet. Usual premium prices for paid-for common shareholders at a takeover tend to vary between 15-25%, which, at current valuation, would bring IP’s price anywhere between $45-$49.
Analysts consulted by Investing.com say that the CEO’s new plan would be to push the stock to the high $50s or $60s, which would imply a north of $5 billion market share rise for IP, placing it way out of Suzano’s league.
In fact, worried by the company’s ballooning debt level in case the deal breaks, even at a $42/share price, Suzano stock plunged a hefty 12% when the news that the company is considering the merger broke across the media.
The next option for Suzano would be to include shares along with cash in the deal - given that the original bid is for an all-cash takeover.
However, that offer would also be significantly limited as the company’s indebted balance sheet and the high cyclicality of the pulp business would make such an offer highly unattractive to IP’s Board, particularly if it includes a high amount of shares.
Sell-side analysts at Jefferies agree that the deal would be highly unlikely given the current framework: “It’s hard for us to imagine IP would look to sell to Suzano unless the offer was significantly upsized from here, which Suzano does not appear to have the balance sheet,” says a report released right after the deal speculation news.
Sources consulted by Investing.com also believe that the IP/DS Smith current merger has a very high potential for both parties involved, which would be another dealbreaker for IP’s Board, which would be more inclined to consider moving on with the current potential.
Could the Deal Go Through Under a Different Framework?
Brazilian-based Itaú BBA sees potential in the deal despite the enormous hurdles standing in its way. According to the bank, “A potential deal with IP would be aligned with Suzano’s recent speech (details here and here), as the company has been vocal about considering M&A expansions in the paper business in North America and Europe as potential growth avenues.”
The bank also believes that “valuation post-deal appears appealing.” “An all-cash combination between Suzano and International Paper would result in a USD 7 -7.5 billion EBITDA giant, with an EV of roughly $44 billion (considering a $15 billion offering for IP’s equity),” it concluded.
Against this backdrop, analysts at Jefferies believe that the more likely outcome for the current speculation is opening up a “dialogue on IP selling its pulp business rather than the entire company” - given the former is the main focus of Suzano’s move.
The research company also hints at the possibility of the family that owns Suzano stepping in with a cash infusion that would potentially change the game.
However, as we await further news, such scenarios are still on the speculation real, and the likelihood of the current deal breaking appears slim to none.