Sappi Limited (SPI.F) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Special Investor Call to discuss the transaction between Sappi and UPM. [Operator Instructions] Please be advised today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, Steve Binnie, CEO. Please go ahead.

Good day, everybody. Thanks for joining. As always, we've got a presentation that I'm going to be talking through, and I will be calling out the page numbers as we move through. And I'm going to start on Page 3 of the presentation. We're here today to talk about our Proposed Joint Venture Transaction between Sappi and UPM. And it's a Proposed Joint Venture, as I said. We have signed a nonbinding letter of intent to combine our European Graphic Paper businesses. Both companies would own 50% of this Proposed Joint Venture. It will be non-listed. And it would -- if you combine the assets, Sappi has 4 mills, UPM 8 mills. It will combine them into a complementary portfolio, which would be operated as an independent company. And we believe that it has significant opportunities to optimize these assets into the combined businesses. We estimate that it will achieve at least EUR 100 million of synergies through savings and fixed and variable costs, and I'll talk about that in a little bit more as we move through. Turning to Slide 4. We always talk about our Thrive Strategy. This proposed transaction represents a significant step forward in achieving that strategy. It will unlock significant value for our shareholders for Sappi. It will lower debt and increase profits. Specifically on the profit dimension, we will account for this joint venture through an equity accounted income line in our income statement, and that share is estimated to exceed the EBITDA of the stand-alone European Graphic Paper business that we currently include in our results. Directly, it will reduce our exposure to graphic paper markets, which we've talked about for some time. Overall, it will reduce -- post the transaction, we will reduce to -- about 20% of our overall volumes will be in graphic paper. And the reason we say that is that it's a stand-alone entity with no recourse back to Sappi. So we have less direct exposure. We will retain our investments in our European Packaging and Specialty businesses. That will remain an important part of Sappi. Our focus there will continue to be to improve profitability. The cash proceeds from the transaction will be allocated to reducing debt. And over time, we anticipate dividends, which will also further reduce debt as we move forward. Turning to Slide 5, which is the rationale for the creation of the joint venture itself. It's fair to say that the European Graphic Paper has been in structural decline for many years, mainly as a result of the digital substitution. There is excess capacity as the demand has declined. There has been capacity coming out, but not enough. Overall, you can see that since 2007, the graphic paper demand is now 60% less. On top of all of that, we've got the overcapacity that I mentioned, but we've had rising costs. And more specifically there, since the Ukraine war, we've seen energy prices, wood prices rising. And more recently, in the current year, all the issues around the tariffs, the trade tensions, that further disrupted trade flows and that's a joint impact. Firstly, it's meant there's less opportunities for European exporters in the U.S. And also, it's meant that we've seen more imports coming into Europe than previously. These were imports that would have gone into the U.S., but because of tariffs have now been redirected. So that just added to the pressure. At the same time, as all of this, the carbon legislation in Europe is more onerous. It costs more. So it adds to the challenges. Turning to Slide 6. The proposed joint venture represents a fundamental and necessary step towards securing the long-term viability and resilience of the European graphic paper industry and ensuring supply -- security of supply for the customer. The business that we're going to be creating will be more stable, more resilient and adaptable to the dynamics in the environment. We will be able to look at the asset portfolio, optimize that portfolio, allocate production to the most cost-efficient site. As you know, over the years, both ourselves and UPM have been dramatically reducing the number of paper machines that we have. And that's reduced our flexibility as we move forward. So this creates more flexibility. We'll be able to improve the product mix on the machines. No 2 machines are exactly the same. And by having a wider portfolio, we can optimize that mix improve efficiencies, which ultimately will reduce costs. On the supply chain side, we have more locations. It enables us to be closer to customers in many instances, so lowering our supply chain costs. And ultimately, the overall business will be more efficient and optimized. The cost savings that we have talked about, we estimate to be at least EUR 100 million, and that's a combination of the variable costs through the efficiencies that I talked about. We do believe that we can direct the production to the lowest cost machines that will boost profitability. On the SG&A side, there are duplicate structures in place. We can streamline that. And then on the fixed costs themselves specifically, by taking out and optimizing and rationalizing capacity, there are substantial opportunities. Dividends to the shareholders will -- are anticipated. Obviously, in the initial year, we will be working through the synergy opportunities, setting up the joint venture. So in the first year, likely to be relatively small. But in time, as we realize the benefits, those will be -- will represent a further opportunity for the shareholders to realize dividends. The initial structure is targeting a net debt ratio to EBITDA of 2.5x. From a customer perspective, in Europe, this will help secure supply for the industry. It will ensure stable superior service, and as I said earlier, provide geographic and delivery flexibility. Importantly, both Sappi and UPM are committed to their CO2 reduction programs. We've made great progress on both sides, and that same philosophy will be embedded in the new joint venture. On Slide 7, and this is turning now to Sappi itself. The Proposed joint venture, we believe, is the best opportunity to maximize value extraction from our European Graphic Paper business. We've looked at many options over the years and we believe that consolidation, rationalization of the industry makes a lot of sense, and it creates better balance. It will improve operating rates in the industry and ultimately boost profitability for the shareholders. It secures the future of our European Graphic Paper business. And as I said earlier, the earnings that we will account for via the equity accounted income will be greater than the current EBITDA. It is aligned with our strategy to reducing graphic paper. It's very important to point out that the business is stand-alone. There is no recourse back to the shareholders. It will be self-financing. We are creating a sustainable growing profitability business moving forward. The structures that we're putting in place will provide divestment flexibility for the shareholders as we move forward. Ultimately, it will reduce debt via the initial cash consideration that we will receive and then through the dividends over time. Slide 8 has a financial summary of the transaction. I don't intend -- there's a lot of numbers on the page. I don't intend going into all of them. But just to highlight the key aspects. Overall, the enterprise value is estimated at EUR 1.4 billion. That excludes the synergies that we talked about. Through the 2 shareholders, there will be pension and other liabilities -- it's mainly pensions that will be put into the joint venture. And as I said, initially, the structure will be targeting a net debt of 2.5x. That's pre-synergies. We have had discussions with our key bank partners and we have been given letters of comfort for them. We've got to finalize the funding, but we have a high degree of confidence that we can execute at these levels. Specifically to Sappi, it's 4 mills. Our value is EUR 320 million, it's 5x our EBITDA for the period ending September '25. We're putting in some pension liabilities of EUR 53 million. So overall, as you add that all together, it will be a 50-50 Joint Venture. Moving to Slide 9. Some of the key aspects of the transaction. It is classified as a Category 1 in terms of the JSE rules, so it will require approval by shareholders via ordinary resolution. A circular will be distributed in due course. We're working on that. The final agreement are in the process of being negotiated. That's ongoing, and we expect that those agreements will be signed in the first half of 2026. The cash that we receive will be used to reduce debt. And then the transaction is subject to the fulfillment of a number of conditions precedent, as you would expect, in a transaction like this. And we do have a slide on that. That's the next slide. Slide 10. Firstly, the approval of the transaction by shareholders. Then the financing. As I said to you earlier, we do have letters of comfort in place from our key banks and now in the process of finalizing that in time for signing the final agreements. The transaction has to be approved by the various competition and regulatory authorities, and that's probably the most longest condition or what we expect to be the longest condition. We estimate around the year. We have had initial dialogue. We did take advice from our advisers on this process. We have to go through it, but we think we've got a strong case to present to the competition and regulatory authorities in Europe. It does need approval by the Reserve Bank in South Africa and then obviously, other notifications approvals in any other impacted countries. Turning to Slide 11. So in summary, this transaction is the most beneficial solution for our European Graphic Paper business. It will unlock value, increase earnings, reduce debt and importantly, give us an exit path. Our direct exposure to the graphic paper market will reduce and allows us to focus on our growing segments of Pulp Packaging Specialty Papers. The North American Graphic Paper business remains integral to our strategy. That market is in balance. We make good margins. and is supported by a strong and diversified regional portfolio, an important part of the business. On our last results call, we talked about a number of rationalization initiatives that we have undertaken in Europe to boost profitability and reduce costs, those will continue. Business will continue. We are focused on improving profitability. We talked about $60 million and those plans are still in place. And similarly, our Back to Basics, which we talked about on the last results announcement: focus on operational efficiencies, reducing costs, strengthening the balance sheet, and as I keep saying, our #1 priority from a strategic perspective is to reduce debt. This transaction will help with that and will accelerate the debt reduction. So operator, I've gone through the slides. I'm now going to put it back to you for questions.

[Operator Instructions] And the first question is from Brian Morgan from Morgan Stanley.

Steve, thanks very much for the time. We've spoken to UPM already today. So just -- it's good to have a catch up with you here. On the antitrust considerations, you guys find pretty confident and be interested to just hear the rationale behind the confidence. It is 55-odd-percent of capacity in Europe. So just trying to understand how this can get through antitrust considerations?

Yes, indeed, it is around the 55% mark that you mentioned, but you've got to look at the whole picture. And this is an industry that hasn't declined. We are seeing increased imports coming in, in recent times. There is significant excess capacity, as you know, in the European environment. And as they assess the case, there will -- yes, they will look at market share, but they will also look at excess capacity that's out there. At the same time, in terms of the ability to unlock synergies to the benefits of the industry and to benefit customers, all of those will be important factors that they will take into account. It is a process, and it's a long process, it's a complex process. We have taken advice. We think we've got a strong case. But the investigation needs to be done by the authorities and they need to reach their conclusion. We've had the initial dialogues. They will appoint a task team to look at this. Our teams will be involved with that, working closely with them. We've got great advisers helping us, and we think we've got a strong case.

Okay. Cool. And then if I can just ask just on net debt-to-EBITDA out to this deal now. Obviously, you're deconsolidating EBITDA, but there's -- obviously, we don't see as much of a reduction in net debt. So net debt-to-EBITDA ratios will rise. How do you expect the banks to view that from a net debt to EBITDA for covenant purposes?

Yes, the way we -- and that's why we made that specific point about how we would account for it. The line item income from associates, we're going to bring into our EBITDA, and that's how we'll look at it with the banks, and how we report it to the market. So when you bring in 50% of the expected bottom line profits, which will be our share, that will be higher than what we currently include in EBITDA for the stand-alone business. So overall, it actually helps improve the ratios.

Okay. Cool. And then last question, if I may. So EUR 752 million payable by the JV to yourselves and UPM. Last 12 months EBITDA is about EUR 300 million. So that's at about 2.5x. In the scenario in 12 months' time where EBITDA may be lower if the market doesn't work out as well, we might be above 2.5x. So could you just help us think about how that will work in that scenario?

Yes. Look, we've done work on where we expect profits to be over the course of the next year. Both sides -- and you need to ask UPM specifically on their side. But as you know, we are undertaking initiatives in Europe to boost profitability. So we don't think that the -- certainly, the earnings from our side should be less than the numbers that we reported. The $60 million savings will be taken into account. So depending on when -- exactly when the transaction occurs, we are targeting -- we do think it will be around the 2.5x when the transaction commences.

We'll now move to the next question. This is from James Twyman from Prescient.

Congratulations on a very interesting and important deal for the company. Can I just ask, firstly, in terms of getting this EUR 100 million of synergies, presumably we're looking at a large-scale closures. Have you got any sort of idea about the cost of those closures? Because obviously, to get one side, you need the other? And secondly, are there any asset write-downs that you would expect as a result of this? It looks like there probably would be. And then thirdly, the EBITDA that you talked about of EUR 64 million, you report $64 million of EBITDA in your last results. So I'm just wondering if there's some different assets that are also included or whether it's a different time period? Those were my first questions.

I'll take your question on the first one. Glen, I'll let you talk about the any write-downs. In terms of the last question, maybe first on the EBITDA result. I think the number you were quoting was the overall European profitability?

Exactly, yes.

Yes. Just there was packaging numbers in there. So we've extracted -- we separated the business, and this is the portion specifically related to graphic paper. That's part of this transaction. I hope that makes sense.

Yes.

And the first question. Looks, James, you'll have to realize we're at a very early stage. We have had discussions. We're going through a process. We've identified the synergies. But in terms of specific mills at this stage, that's not something that we have finalized. We think overall, there is huge potential, but we're not at the stage yet to talk about specific mills. Glen, maybe you want to talk about the second question on would there be any write-downs if there were closures in the joint venture?

Yes, there will be write-downs. They will be limited to the value that we transfer into the joint venture, James. But we haven't been able to identify which capacity will be closed given that we're only at an LOI stage yet, and that will only be decided as and when the joint venture gets put together.

Yes. Maybe just to add to what Glen said. Just remember, when you do this transaction, you will be allocating the purchase price across your assets. And you'll be attributing more value to the assets that are anticipated to be held for longer. So that will help minimize any write-down.

Okay. Could I ask another one. In terms of the cash payments, UPM has got a much bigger cash payment than you have in order to make it a 50-50 joint venture. So I'm wondering why you didn't end up where you both take out a similar amount and you have a lower share. Why you've ended up doing it in that way because your effective debt, if you consolidate goes up quite significantly and UPMs goes down significantly. So there's a choice that happened somewhere where UPM has effectively lowered their exposure in this joint venture and you've increased it. Can you just talk around that?

Yes. I just want to clarify. Yes, the joint venture has debt, but that has non-recourse back to Sappi. Our exposure to the joint venture is limited to our equity investment. So that debt can never come back to Sappi. So that's the first important point. In terms of 50-50, we thought that it was important that we have 50-50. This is a partnership. It's going to be joint control. There are significant synergies. We are 2 strong players in the industry. This allows for rationalization and having a 50-50 share was deemed to be the best outcome as we negotiated the transaction. So yes, UPM gets a higher checkout at the beginning, but ultimately, as I say, the joint venture is stand-alone and our exposure is limited to our equity investment.

Okay. And is there a breakup cost to either side from this? I didn't see anything there, presumably not at this stage, but not at that stage yet?

No.

[Operator Instructions] No further questions coming through. So I'll hand back to Steve for any closing comments.

Thanks, operator. So thank you very much, everybody, for joining us. We think this is a very significant transaction. It's an exciting transaction, and we think it ticks lots of the boxes in order to unlock value for our shareholders. So thank you very much, much appreciated. And as we progress down the route, we'll give updates when they become available. So thank you very much.

Thank you. This concludes today's conference call. Thank you for participating, and you may now disconnect.