International Paper Company (IP) Earnings Call Transcript & Summary

Good morning, and thank you for standing by. Welcome to today's webcast discussing the combination of International Paper and DS Smith. [Operator Instructions] It is now my pleasure to turn the call over to Mark Nellessen, Vice President, Investor Relations. Sir, the floor is yours.

Thank you, Greg. Welcome, and thank you for joining today's call to discuss our announcement that we have reached an agreement on the terms of a recommended offer to acquire DS Smith. In a moment, we will provide prepared remarks with a question-and-answer session to follow and we will reference certain slides during today's discussion. Investor presentation outlining the compelling rationale behind the combination has been posted to the Investor Relations section of our website. In addition, a replay of today's call will be available on our website beginning at 10:00 a.m. Central Time. Now turning to Slide 2. The purpose of this call is to discuss the acquisition announcement. Therefore, we do request that any questions be limited to those relating to this announcement. I would also like to remind everyone that statements of our expectations, plans, estimates and beliefs regarding future performance and events related to the combination constitute forward-looking statements. Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. Information regarding these risks and uncertainties is contained in the company's periodic filings with the Securities and Exchange Commission. Turning to Slide 3, we will begin our presentation. With me today are Mark Sutton, Chairman and CEO; Andy Silvernail, CEO Elect; and Tim Nicholls, Chief Financial Officer. With that, I'll turn the call over to Mark.

Thank you, Mark, and good morning and good afternoon to everyone, and thank you for joining us on short -- such short notice. I'll start my remarks on Slide 4. We are pleased to share with you that the Board of Directors of International Paper and DS Smith have reached an agreement to combine our 2 companies. We believe this is a highly complementary combination that will create significant value and a truly global leader in sustainable packaging solutions with enhanced opportunities for all stakeholders of International Paper and DS Smith. I'm pleased to have the next CEO of International Paper, Andy Silvernail on the call with me today to talk about the significant benefits of this combination. He has been working closely with us as a strategic adviser on this opportunity, and personally, I found his significant experience in value creation and his expertise in M&A to be a tremendous benefit during this process. We believe there are highly compelling strategic and financial benefits from this transaction. First, with this combination, International Paper will have winning positions in the attractive and growing regions of North America and Europe. This is aligned with our strategy to strengthen and profitably grow our packaging business across these regions, which represent the 2 largest profit pools globally for sustainable packaging. Given the combined capabilities and expertise, we will be better positioned to provide customers with an enhanced portfolio of products and solutions across a broader geographic reach. Second, as I mentioned earlier, we believe this combination will create significant shareholder value. We expect to achieve cash synergies of at least $514 million on a pretax basis. This transaction is also expected to be EPS accretive in year 1 and drive higher margins and financial returns. In addition, the combined company is projected to have a solid cash flow profile and a strong investment-grade balance sheet while maintaining our current credit rating and dividends. Finally, both companies have a lot of experience and a solid track record, successfully integrating acquisitions, including several in Europe. We also have shared cultures and similar values, and we plan to retain DS Smith's London headquarters as IP's new European headquarters. Turning to Slide 5. You see a summary of the agreed-upon terms of the combination. This is an all-share transaction and has an enterprise value of about USD 9.9 million after close. And after close, excuse me, DS Smith shareholders will own approximately 33.7% of the combined company, and IP shareholders will own approximately 66.3%. We'll also seek a secondary listing of our shares on the London Stock Exchange to accommodate shareholders. Andy will become CEO and the Director of the combined company, and IP will also benefit from the talent and expertise within DS Smith's management team. Miles Roberts, CEO of DS Smith has built a great company and he will serve as a valuable adviser through the integration process. Lastly, the transaction is expected to close by the fourth quarter of 2024, subject to shareholder approval. Now turning to Slide 6. Here, we show a snapshot of DS Smith's business and solid financial profile. The company is a leading provider of innovative, sustainable packaging solutions in more than 30 countries with a strong team, a broad set of capabilities and continued investment in its asset base and innovation. It plays a central role in the value chain across sectors, including consumer goods, industrials and e-commerce, through deep relationships with an attractive roster of customers. DS Smith is also a sustainability leader focused on driving the transition to the circular economy with ambitious targets in plastic replacement and reducing greenhouse gas emissions. Moving on to Slide 7. You can see that DS Smith's portfolio is concentrated on packaging. Combination will allow us to focus our core business on sustainable packaging in the attractive and growing North American and European regions. The combined company will be a truly global leader of sustainable packaging solutions with a pro forma packaging portfolio representing 90% of the combined company's revenue. We will bring together IP and DS Smith's leading packaging products in complementary geography. We believe this is a winning combination supported by strong sustainability trends serving as tailwinds for accelerated growth. As customer demand for sustainable packaging continues to grow, we will be well positioned to capture this increased market opportunity. And now I'll turn the call over to Andy Silvernail, who will take over on Slide 8. Andy?

Thank you, Mark. I'm looking forward to stepping into the role of CEO in a couple of weeks. I was excited to serve as an adviser on this transaction. I'm fortunate to be joining a strong company, which Mark and team have positioned well during his tenure. It's been great to work with the IP team as we reached agreement with DS Smith. I believe this transaction is a logical next step in IP strategy, building on the progress Mark and team have made. By streamlining the portfolio and strengthening the balance sheet, I believe International Paper is well positioned to invest for profitable growth. First, the company has strategic initiatives already underway across the portfolio, which I believe can create significant value. This includes the box go-to-market strategy in North America and the Global Cellulose Fiber optimization strategy. I'm committed to working with the teams across IP to execute these priorities going forward. In addition, I also believe a combination with DS Smith offers another catalyst to create significant value for shareholders. We'll create a winning position in Europe, the second-largest profit pool in packaging with long-term trends of growth. We will also benefit our packaging business in North America by improving box capabilities in the Eastern U.S. region, and increasing our integration rate to the most profitable channels to market. It will -- and it will leverage IP and DS Smith's combined market expertise and shared technologies to accelerate innovation and sustainability while driving commercial and operational excellence across the combined organization. I'm turning here to Slide 9. The combination will create a winning position in Europe by providing customers with a superior suite of products and solutions with greater geographic reach. Customers will also benefit from the market expertise and enhanced capabilities across both companies. The company also expects to capture significant synergies in Europe, particularly for cost optimization. I also believe there is considerable opportunity to leverage IP's manufacturing and technical expertise as well as accelerate innovation across the combined company. I'm now turning to Slide 10. Looking at North America. DS Smith offers an opportunity to enhance IP's packaging business in the Eastern U.S. and capabilities and customer offerings. In addition, there are opportunities to optimize the combined network of mills, box plants and supply chain across both geographies. This would allow the integration of approximately 500,000 to 600,000 tons of Containerboard from IP's North American mill system through DS Smith's European box channel. This would effectively increase the combined integration rate of approximately 90%. In addition to these benefits, the global scale offers significant synergy opportunities for procurement savings and overhead streamlining. I'm now on Slide 11. Together, the combined companies will have a stronger value proposition for global and regional customers with a more diverse portfolio of products and offerings. This combined market expertise and breadth of resources will accelerate product innovation and create significant value for customers. As we touched on already in this presentation, both companies have a strong commitment to developing innovative sustainability solutions. I believe there is a great opportunity to leverage DS Smith's capabilities in this area to accelerate growth across opportunities across IP's North American packaging business, and I'll talk more about this on Slide 12. Sorry, I'm back on Slide 12 now. Here, you can see DS Smith has been leading the way in innovation and sustainable solutions, something we're all very excited about. Together, we are growing with their customers by creating sustainable solutions as an alternative to plastic for a variety of consumer applications. I believe IP can leverage this capability across the North American packaging business to accelerate growth. This is another example of how the combined company can build on each other's expertise to create value for customers and for shareholders. With that, let me turn it over to our CFO, Tim Nicholls.

Thank you, Andy. Good morning, everyone. I'm on Slide 13, and I'd like to spend a few minutes discussing why we believe this opportunity is financially attractive. We believe the combined group can deliver at least $514 million of pretax cash synergies on an annual basis by the end of the fourth year following close. Included in this, we anticipate approximately $474 million of cost synergies per year, primarily driven from operational efficiencies, overhead reduction and procurement savings. As you can see on the slide, the balance comes from CapEx, procurement savings and commercial synergies. And I'd like to emphasize that all synergy targets have been developed based on a bottom-up approach with an action plan for each. . Turning to Slide 14. We expect that approximately 33% of the synergies would be achieved by the end of year 1, 66% by the end of year 2 and 95% by the end of year 3, all on a run rate basis following close. We anticipate total onetime cost of approximately $370 million to achieve these synergies with no significant dissynergies expected. All of this is underpinned by IP and DS Smith's strong track record of successfully acquiring and integrating businesses, which reinforces our confidence in achieving these targets. In addition to our own review, the synergies were independently validated and sensitized as part of a quantified financial benefit statement as required under Rule 28.1(a) of the U.K. Takeover Code. The independent accountants report by Deloitte LLP can be found on our website. Turning to Slide 15. We expect the combination of IP and DS Smith to deliver margin expansion and higher financial returns on the business. The combination is also expected to be EPS accretive in year 1 and the deal ROIC is expected to exceed our weighted average cost of capital by the end of year 3. We also expect to maintain a strong balance sheet and a solid cash flow profile. We believe this will support IP's current credit rating, cash returns to share owners, including share repurchases and maintaining our current dividend while providing added flexibility to invest in projects with attractive returns. The chart helps illustrate the impact on key financial metrics from the target synergies by compiling 2023 data for the 2 companies. More details to come later this summer as we prepare our proxy statement. And with that, I'll turn it back over to Mark.

Thank you, Tim, and thank you, Andy. I'm going to turn to Slide 16. Today, we have covered several elements that are critical to the successful integration of the 2 businesses. Some of those are obviously tangible like synergy targets and headquarters locations. Some are softer, but equally important like the cultural fit of the 2 organizations and teams. And on that point, I believe the cultures of these 2 companies are very complementary. We have long admired DS Smith and our work to make this transaction come to fruition has reinforced my respect for the talent of their team. I have to say this process has made me even more confident that the combination not only makes strategic sense, but will be seamless. Our 2 businesses share purpose-driven cultures with a relentless focus on sustainability, profitable growth and finding innovative solutions to meet customer needs. We have strong corporate values that are closely aligned from fostering safe and inclusive working environments to an unwavering commitment to ethics. Both teams have also been through large-scale integrations before and are highly engaged and drive in environments that give them an increased opportunity to grow and develop, all of which gives me a high degree of confidence in our ability to deliver the synergies and create significant value. I move to Slide 17 now, and I won't go through all the details on this slide, but this is another good example of how our cultures are aligned. We have a shared commitment to sustainability, which includes our focus on 4 key areas: healthy and abundant forest in nature, renewable solutions and circularity, sustainable operations and thriving people and communities. As a combined company, we believe we will be even better positioned to achieve our sustainability initiatives over the long term. Before moving to Q&A and wrapping up with Slide 18, let me reiterate how energized we are about this opportunity to create a truly global leader in sustainable packaging solutions with winning positions in North America and in Europe. I want to underscore that this combination would not have been possible without the efforts of our talented team at IP, their hard work has put us in a position to pursue this exciting strategic combination. I also want to express my gratitude to the DS Smith team for their collaboration and reaching our agreement. We look forward to bringing together our 2 experienced talented workforces driven by a shared commitment to customer service, innovation, sustainability and collaboration. We are confident that bringing together IP and DS Smith will drive significant value and future opportunities for our employees, our customers and our shareholders. With that, operator, please open the lines for our Q&A session.

[Operator Instructions] Your first question comes from the line of Philip Ng from Jefferies.

Exciting news today. I'm not an expert on the U.K. takeover rule, but Mark, to be helpful -- Mark and team would be helpful. Is this effectively the last and final offer? This is effectively done deal this point? Or can the other bidder step in? And is there a breakup fee that you guys have set up for this transaction at this point?

So all the details of the offer are in the 2.7 announcement fill, but what this is called under the U.K. rules is a firm offer and typically, under the U.K. rules, there isn't any firm offer protection, deal protection. So if you look at the 2.7 announcement, which I know you haven't had time to do yet, it kind of covers those types of terms. But this is an offer. The important thing about this offer is it meets the test of the firm offer, and it's been recommended by both Boards of Directors to shareholders.

Okay. But Mondi and there could still come in and offer something higher and DS Smith has the ability to reassess that? Or once again, I'm not familiar with how this all work market.

Yes. Part of the rules, just what would require me not to speculate or comment on that.

Okay. Fair enough. And then from a CapEx intensity of the business and how you guys plan on deploying capital with the combination, I believe DS Smith is going through a CapEx cycle themselves. You guys obviously have a healthy dividend. So kind of help us think through how you plan on deploying capital, whether it's potentially consolidating Europe more. Are you going to be focused more internally? Just help us kind of think through how you want to prioritize capital deployment in the next few years.

Phil, it's Tim. So I think the first thing to start with is there's really no change to our capital allocation framework. And we've had that publicly out there for a number of years now in terms of how we think about where and how to deploy cash. If you look at our practice, we typically say that we're around depreciation. You can also look at it on a percentage of sales basis. And it ebbs and flows based on specific project opportunities, but we feel good about the amount of cash generation from the project that balance sheet stays strong, dividend -- current dividend is maintained, additional cash returns to share owners and then for attractive projects, we will be investing at a similar rate as we have in the past.

I think, Phil, the other thing I'll add to Tim's comments is we mentioned DS Smith in some type of a capital cycle. And I'll just remind you that the large portion of our mill capital investments are behind us on the IP side, and we are focused very, very much on our converting operations in North America. And of course, the investment levels relative to what you spend in large integrated mills is just a different order of magnitude. And so most of the DS Smith asset base in Europe is box plants like we would have here, but also recycled -- mostly recycled mills. So we feel like there's a good complementary balance on the needs of both companies over the next few years from a capital investment standpoint. And we feel really, really good that our mill investment profile and program is largely completed other than normal maintenance.

But Tim, I guess, combined company will your capital intensity step up noticeably above the combined DNA or I want to understand once again, DS Smith is going through a capital investment cycle, perhaps it's not as intensive because it's on the box side, but is there a good way to think about CapEx as a combined company?

Yes. I mean, of the combined company, I think it'd still be around depreciation. And some years, it might be a little bit more, other years, it might be a little bit less, but I don't think there would be any significant change to how we're deploying capital for CapEx.

Your next question comes from the line of Mike Roxland from Truist Securities.

Mark, Andy, Tim, congrats on the transaction.

Thanks, Mike.

One quick question on regulatory issues. Is there anything that we should be concerned about given some asset concentration? I think there seems to be some overlap in Spain, France and Italy or even here on the east coast. So how are you thinking about any regulatory hurdles you may have to clear regarding asset concentration?

Yes. Great question. Thanks, Mike. We don't think there's anything significant. It appears to us and our advisers that it would be minimal, if anything. So no concerns there on our part.

Got you. And Tim, just to follow up quickly. I mean, do you think any divestitures may be required? I mean -- or how do you think about -- I mean it's obviously not significant, but probably maybe some converting assets that may have to be closed or sold in order to get over the hurdle?

Yes, we're not -- I mean, I'm not going to speculate on it. But like I said, we don't think that there's major regulatory issues. So nothing of significance.

Got it. Okay. Perfect. And then just 1 quick follow-up. In terms of the synergies. Is the 92% of cost synergies largely driven by the increasing integration of the 500,000 to 600,000 tonnes?

No, it's not. I mean that's a piece of it, and both from just reworking the supply chains and making sure that we're serving plans from the most logical freight logical mills, but there's overhead synergies that have been outlined, and there's also procurement savings that have been outlined. And then when you look at the mill footprint and the box plant footprints in terms of sharing best practices and making sure that we're optimizing those facilities that would be the balance of it.

Your next question comes from the line of Gaurav Jain from Barclays.

Congratulations on the transaction. So a couple of questions from me. So in terms of timing, if I understand correctly, the U.K. Takeover Code, until 7 days before DS Smith's EGM, anybody can come and come in with a higher offer? Is that the correct understanding of the timing?

Gaurav, I'm not sure about the 7 days comment, but as I mentioned on an earlier answer to a question. The U.K. Takeover Rules do not provide specific protection -- deal protection for a bidder. So the important thing is, again, if you look at the context of a 2.7 announcement, it qualifies under the term, firm offer, and this firm offer has been recommended to shareholders by the Boards of both companies. .

Sure. And the second question on DS Smith's working capital. So they have a very favorable payable days, almost like 200 days. And they've always said that they have some favorable terms from their suppliers, the paper mills. Now as you increase the integration rate, does it mean that there will be a working capital investment that needs to be done in the combined company?

Yes. I mean it's -- I think more to come on that. So one of the things that we'll do as part of our synergies is look at how we source and how we procure and we'll take all aspects of that in, in terms of not only price, but terms, so I think more to come on a future date. .

Your next question comes from the line of Charlie Muir-Sands.

The revenue synergies of a small number, which obviously quite good that it's so prudent. But can you talk about what's behind that? And is this about offering more product in existing overlap? Or do you think that there's an opportunity, let's say, more midterm, that there's a customer base out there that actually wants a transatlantic player that can offer a packaging solution on both sides of the Atlantic.

Great question, Charlie. This is Mark Sutton. I think the transatlantic customer still buys corrugated packaging regionally and locally. So your value proposition needs to be that you can deliver that service platform and the actual package that's needed locally. So where that's valuable to a customer, they value a global supplier, but this is a local and regional business. So some of those revenue synergies really have to do with some specific opportunities we've discovered early on in our work together that we can use some technology that DS Smith develop, for example, in Europe, and we can deploy that proactively to some of our customers in the U.S. That's where we really see the beginning. But longer term, we feel like we will have an offer for the transatlantic global multinational customers that value that. We will have an offer that brings the best of both types of packaging designs. And just recall and remember, the supply chains are quite different in North America and in Europe. So what ends up working for the same customer in Europe may be not effective in the North American supply chain or vice versa, but we have learned through some of our experience in IP's European business, for example, where we have a heavy Southern European focus in fresh food. Some of the technologies and business model and machinery model, we pioneered in Europe. We brought that back to the U.S., and it's really helped our position in the U.S. fresh fruit and vegetable business. So we see a lot of opportunities that are not captured right now in synergies. That's why the revenue synergies are small. But what's in there is specific items we saw that we could do and we think we can do right away. But it's -- the beauty of this business is, even though it's a transatlantic discussion, it's really about local execution. It's a distributed business that matters at the local level. The box plant is very close to the customer who's going to use the box. And it allows us to build a competitive advantage market by market by market in both Europe and the U.S.

That's very clear. And just my follow-up question. You obviously help me explain the level of increase in integration in the U.S. of 500,000 to 600,000 tonnes and the overall pro forma 90% position, just in Europe today, can you remind me what International Paper position is, I think maybe you're a net buyer of test liner?

We are in that buyer. We invested a few years ago in a conversion of a world-class newsprint mill in Spain, in Madrid, Spain. That helped us lower the amount of net buyer position that we had. So we have a very new world-class recycled Containerboard mill in Spain. But we are still a net buyer and I think part of what Tim was describing, Tim Nicholls, our CFO, on this whole integration. It's partly integrating capacity for virgin liner that we have in the U.S. to the DS Smith system, but it's also integrating within Europe in a more logical freight and logistics effective way. So DS Smith has, for example, kraftliner in Portugal, and there could be better ways to deploy that kraftliner versus what we're doing now with U.S. kraftliner going into our Southern Europe operations. So we've identified bottoms up, as Tim said, with the synergies, qualified by our auditors specific items that we know that we can execute because it's under the control of the 2 companies.

Your next question comes from the line of Brian Morgan from Morgan Stanley.

Just wondering on the break fees. I noticed in the release that IP is liable for break fees. It doesn't look like DS Smith as maybe, correct me on that if I'm wrong, I'm not expert, but don't break fee is normally bilateral.

Brian, it's a great question. Under the U.K. code, they're not bilateral. If you have any break fees, they're just one way. U.K. code is really designed to kind of aid in the sense of a process like this, the company that's being acquired. So this is normal in the U.K. code. And those numbers that are in the 2.7 announcement that you referenced are below what you would consider the norm in a transaction of this size. So we feel like they're very fair and if you read the -- what they apply to, it will be pretty clear. But this is common and customary and required by the U.K. code. .

Your next question comes from the line of Mike Weintraub from Seaport Research Partners.

Just want to clarify. So the integration of the 500,000 to 600,000 tons, is that simply shipping kraftliner from the U.S. to Europe to fulfill needs in the DS Smith system? Or are there other things going on in that number?