The letter provides excellent detail and well laid out thinking from a world class investor:
We are writing to express our disappointment at the merger terms you approved,and to announce our intention to vote against the Merger as it stands today. We believe that the acquisition by Rock-Tenn substantially undervalues the Company and we are acutely disappointed that the Board of Directors is willing to throw in the towel on the significant upside inherent in the Company’s assets.
To add insult to injury, it appears that the Company did not run a sale process, apparently in violation, or at least in ignorance, of your duties to shareholders to seek the best price available.
Finally, we cannot help but wonder whether Mr. Patrick Moore’s employment contract, which is set to expire on March 31st of 2011, played any part in pushing for this sale, given that he personally stands to earn a windfall in excess of $15 million as a result of the Merger.
One need look no further than the action of Rock-Tenn’s stock price following the announcement of the Merger. Typically, when an acquirer is deemed to have paid a “full and fair price” for a target, the acquirer’s shares trade down. It is telling to note that the price of Rock-Tenn common stock is UP 18% since the announcement, clear evidence that the market believes Rock-Tenn is getting a steal. This evidence is further buttressed by comments made by the CEO of Rock-Tenn in a conference call announcing the Merger (more on that below).
In short, we cannot help but conclude that the Board has forsaken its primary duty to maximize value for shareholders. We believe that, ultimately, Rock-Tenn would have been willing to pay significantly more for the strategic assets of the Company, and that there is still an opportunity for other buyers (perhaps with more potential synergies) to come forward with a valuation that is significantly higher than the implied Rock-Tenn deal price. Further, we believe that if the Board and management simply rolled up their sleeves and continued on the Company’s current course, Smurfit shareholders would be better off on a stand-alone basis than we would be if we were to accept the terms of the Rock-Tenn transaction.
A low transaction multiple is tough to swallow in any context, but it is a particularly bitter pill when it has resulted from a sale process that appears to be anything but robust. While we await the proxy statement to confirm this, Mr. Rubright’s comments on the Conference Call that “this transaction was exclusively negotiated on a one-on-one basis,” and that Rock-Tenn “[doesn’t] like to do transactions that are in a process,” lead us to believe that the Company and its advisers did not set up a competitive process for this asset.
In our experience, providing a would-be acquirer an exclusive opportunity to bid on your company, failing to conduct a market-check and ultimately signing a merger agreement without a “go-shop” provision and with a termination fee that borders on the high-end of reasonable is a likely indication that incentives of the Board are misaligned with those of the shareholders. One need look no further form misalignment than the interests of CEO and Director Patrick J. Moore.
After leading Smurfit into a bankruptcy that wiped out its prior shareholders, Mr. Moore was rewarded by being re-hired by the Board as Smurfit’s CEO for a period of 9 months, scheduled to terminate on March31, 2011. While moderate retirement packages for CEOs are commonplace, Mr. Moore appears to have hit the jackpot with his. In addition to receiving pension, health and other benefits, and becoming eligible for a “special incentive” bonus of $3.5 million upon retirement, he was granted a “change of control bonus” in his short-term employment agreement that would pay him a substantial sum if the Company received a “change of control” offer (such as for the Merger) before his retirement date and the transaction were to occur on or before September 30, 2011. Tellingly, he would receive nothing if, by that date, no change of control has occurred. Under this bonus provision, Mr. Moore stands to realize, by our account, a windfall payment of approximately $19 million (less any “special incentive” bonus he’s received) upon the closing of the Merger! Collectively, the Smurfit officers are getting $42 million. It is therefore not hard to imagine the incentives that pushed Mr. Moore, and possibly the Board, towards accepting this transaction with an eager buyer (especially at this price) without bothering to conduct a market check. Shareholders, however, do not receive the same special benefits, and we cannot help but wonder whether his looming retirement motivated Mr. Moore to push for a less-than-optimal result for his shareholders.
Smurfit Could Go It Alone and Shareholders Would be Better Off
It is no secret that Smurfit is an undermanaged, underperforming company with substantial upside opportunity and highly valuable assets. Obviously, Rock-Tenn believes this to be the case, as evidenced by Mr. Rubright’s comment on the Conference Call that “the opportunities for … investments in the Smurfit mill system are basically unlimited with very, very high paybacks.”
Unlimited opportunities for projects with “very, very high paybacks”? It sounds incredibly attractive to us. These opportunities do not require a strategic partner, and an independent Smurfit would have more than sufficient cash flow to fund them. All it would take is a Board seeking to maximize shareholder value and a management team properly incentivized for long-term appreciation and not a short-term exit.
Smurfit’s lack of a permanent management team and prior investment constraints prevented it from eliminating some rather glaring operational inefficiencies. Smurfit’s margins have long trailed its competitors despite having a mill system which Rock-Tenn and industry consultants believe to have at worst average structural costs.
Smurfit also maintains multiple corporate headquarters, further illustrating the significant level of “low hanging fruit” within the Company’s standalone cost structure. Mr. Rubright alluded to these opportunities when he stated that “perhaps the greatest value proposition in this transaction is bringing Rock-Tenn’s extremely customer focused approach to the market place; our discipline and execution; and our track record of continuous operational and administrative excellence.…”
Customer focus, discipline and execution, and continuous operational and administrative excellence are fundamental building blocks of any successful enterprise. A competent, motivated and properly incentivized management team would surely be capable of capitalizing on these opportunities and the great value they represent to Smurfit shareholders. So why does the Board believe that a merger with a competitor is the best way for Smurfit to realize its potential ?
Benefits to Rock-Tenn Should Have Led to Higher Consideration
Rock-Tenn’s asset base is 100% dependent on recycled inputs, meaning its earnings are highly vulnerable to increases in the cost of recycled fiber. Smurfit’s assets, on the other hand, are approximately 65% virgin fiber based, providing the Company with a long term structural advantage.
Asian recycled capacity, mostly located in China, represents approximately 31% of total global containerboard capacity. Continued economic growth in that region should increase global competition for recycled fiber inputs, which recently reached historically high price levels.
Rock-Tenn is disadvantaged relative to its domestic competitors which, like Smurfit, mainly operate virgin input assets. Mr. Rubright summarized the advantageous position of Smurfit’s assets when he stated that “the fact is United States virgin containerboard is a highly strategic global asset.”
Given Rock-Tenn’s structural disadvantage and appearance as a “forced buyer” of virgin input capacity, along with the meaningful synergies that Rock-Tenn surely expects to bring to the combined company, the Board should have demanded Rock-Tenn pay a meaningfully higher premium to the market price of the Common Stock than the paltry 27% agreed to in the Merger.
For all these reasons, we believe the Merger woefully shortchanges Smurfit shareholders.
Although we believe that Smurfit has the potential to thrive as a stand-alone company, we do not quarrel with the strategic rationale behind the Merger, and would support a sale of the Company, but believe that any business combination with Rock-Tenn or any other party must provide adequate consideration for the holders of Common Stock.
We note that the shareholder base appears to have turned over significantly since the announcement of the Merger, with over 100 million shares having changed hands already. Fortunately, the Merger was agreed to without any shareholder lockups or voting commitments, and therefore, given the wide dispersal of the Company’s common stock, the ultimate approval by shareholders is by no means assured.
We believe that there are other potential acquirers who may come forth, and we encourage any and all to do so.
We greatly regret that you, our representatives and fiduciaries, unwisely entered into a transaction without seeking competitive bids. As things stand now, we cannot support the Merger.
Here is a link to the full letter including the valuation work, it is a great read: