BWY is a “busted IPO” of a cash generative business that trades at 50-70% of the sector average valuation. The company is a leading North American manufacturer of rigid metal and plastic containers, with number one market shares across almost 80% of its revenue.  After a “cold IPO” in June and earnings out of the gate that confused analysts, the stock is down over 30% from where it IPO’d and over 40% from the midpoint of the initial range.

 

The company organizes its business under two segments: Metal Containers and Plastic Containers.  Metal Containers consists of paint cans, aerosol cans, steel pails, oblong cans, and a variety of other specialty cans and ammunition boxes that customers use to package paint, household and personal care products, automotive aftermarket products, paint thinners, driveway and deck sealants.  Plastic Containers consists of injection-molded plastic pails, blow-molded tight-head containers, bottles, and drums that customers use to package petroleum products, pharmaceuticals, agricultural chemicals, other chemical applications, paint, ink, edible oils, high-tech coatings, high-solid coatings, roofing mastic and adhesives, and driveway sealants.

 

BWY operates in mature markets, and has modest growth characteristics of probably low/mid single digit organic top-line growth over the medium term with slightly higher EBITDA growth.  The businesses have medium to high ROIC with good cash-flow and leading industry positions.  Operating margins have been generally stable in Metal Containers, and are expanding in Plastic Containers as the company improves the scale of the segment and executes manufacturing efficiencies.  Steel and resin account for over 50% of costs and are historically passed through to customers with little exposure to BWY.  Capex is materially below D&A as there is significant amortization of intangibles that is non-economic and depreciation runs modestly above capex as fixed assets are generally depreciated over shorter periods than their economic lives.

 

The company has number one market shares on almost 80% of its revenues, and in many segments BWY is the market.  For example, 81% share in US paint cans, 75% share in specialty metal cans, 87% share in ammunition boxes, 67% in tight-head containers, and 85% share in plastic paint bottles.  The company is the low cost producer and most efficient manufacturer in most of its product lines, and the “China threat” is not relevant as there is relatively low labor content and shipping empty containers across the Pacific Ocean is not a viable business.  There is an opportunity for the company to roll out its “Metal playbook” of the past decade to Plastic Containers today and pick-off small producers in the U.S. to further consolidate the industry.  However, for now our sense is that the wide gap between BWY’s valuation and industry multiples has reduced management’s inclination to make acquisitions.  In the interim, the company is growing its Plastic Containers business faster than the market as it leverages its dominant positions in Metal to cross-sell to the same customers.

 

The current valuation of under 5.5x 2007 EBITDA is a significant discount to public packaging industry comps of ~8x.  Since BWY, as is typical for the sector, carries some financial leverage the discount on an equity basis is dramatic.  Excluding any working capital moves we believe BWY will generate after-tax FCF in excess of $1.50/shr in 2008 and in excess of $2/shr in 2009.   This 15-20% yield compares with mid/high single digit yields for most of the industry.  Comps generally have similar margins, slightly less leverage (2.7x median vs. 3.5x at BWY), and are  larger.  Some discount is appropriate given BWY’s newly public status and smaller size; however, the current gap seems overdone.  It is important to note that while public comps are larger, BWY is the 800lb gorilla in its particular industry segments.

 

This opportunity exists in part because:

·        BWY was a cold IPO.

§         The company was owned/controlled by Kelso & Co., and was one of the last investments in its VI fund that was raised in 1998.  Early this year, Kelso began looking at what to do next with the investment.  We understand that they looked at both a leveraged recap and selling the company, but based on a hospitable environment for public packaging companies and Kelso’s desire to retain an ongoing interest they decided to IPO the company.

§         The initial range was $16-18/shr, and our sense is that the company was led to believe that the high-end was likely.

§         The transaction ended up coming in a tough week for equity markets, where two other IPOs were cancelled and a third was significantly cut back.  BWY priced at $15/shr and Kelso reduced the number of shares it sold.

§         The stock immediately traded down, and went into “busted IPO purgatory”.

·        Analysts misunderstood fiscal 3Q (calendar 2Q) earnings

§         Historically the company has been on LIFO.  Management was advised that being a public company on LIFO is a nightmare because analysts/investors don’t understand it and it causes huge headaches.

§         The company told investors at the time of the IPO (and in the S-1) that it was converting to FIFO, probably during fiscal 3Q (calendar 2Q).  Sell-side forecasts were all done on a FIFO basis from what we can tell. 

§         The company reported solid earnings ahead of the street high on a FIFO basis, but had not yet converted away from LIFO.  The quarter was viewed as a “miss”.

§         Bottom line is that appropriately adjusting for the accounting, fiscal 3Q was a solid (better than expected) quarter, with very strong results in Plastic Containers offsetting softness in Metal Containers.  Fiscal 4Q commentary/guidance was a touch soft, but basically 2H07 is approximately in-line with where investor expectations should have been a couple months ago.

·        There is too much concern about housing. 

§         While housing is an important end market for the company, it should not be overstated.  For example, in metal paint cans, the company’s most impacted business segment, industry volumes are now expected to be down 4% this year.  This is milder than one might think because only 7% of industry volumes go into the volatile new single-family homes.  37% go into less volatile, albeit down, single-family repaint.  Multi-family repaint (31% of the market) is stable, and happens every time someone switches apartments.  Commercial activity accounts for the balance and is growing this year. 

§         While not perfectly comparable, the company’s largest customer Sherwin Williams (“SHW”) reflects this manageable exposure to housing.  The stock trades at over 8x EBITDA and the company is growing earnings this year and expected to grow in 2008 as well.

§         In many industries, a modest change in volumes can cause dramatic changes in pricing and earnings (homebuilding, steelmaking, autos, commodities, etc.).  However, this does not seem to be the case here.  With 81% share of the paint can market, BWY does not cut prices to “stimulate demand” in a down year.  Volumes go down, and margins are impacted because some efficiencies are lost, but pricing is largely unchanged.

 

Management has a significant economic interest in the company’s success through stock and option ownership.  We believe they are smart, shareholder oriented, and good executors.  The senior management group has an average of over 20 years experience in the packaging industry and has spent significant time under private equity ownership.

 

We believe the company should have mid-single digit EBITDA growth in 2008 and 2009, and significant FCF growth as the company benefits from de-levering.  Getting a median sector multiple on EBITDA puts the equity at ~$22/shr today.  While we think it is fair for a newly public company that is smaller than most comps to trade at a discount, we think getting 7-8x EBITDA (11-14x FCF) in two years is reasonable.  This would translate to a $25-30 stock.