Description
Boise Cascade (the “Company” or “Boise”) represents a compelling long opportunity as a result of its recently announced acquisition OfficeMax (“OMX”) in a deal worth approximately $1.5 billion (including debt assumed). As a result of the acquisition, Boise (NYSE: BCC; basic mkt cap: fully diluted mkt cap w/ ACES: $1,595mm) will be transformed from a conglomerate with a dual focus in contract office products and paper & forest products into a pure-play office products company. The forest products division is likely to be merged with a smaller player via a Reverse Morris Trust merger or sold piecemeal to several competitors. There are four key pieces to understanding the value creation at Boise: 1) the structure of the transactions to create the new office products company and to sell the forest products company, 2) the synergies that will result from the OMX acquisition, 3) the likely value of the forest products division, and 4) the trading value for the resulting office products business. I am confident that there is $35-40+ / share of value realizable within a year as a result of Boise’s restructuring with little downside to the current share price.
1) Structure of the Transactions
Boise will acquire OMX for $9.00 per share assuming that Boise’s stock trades between $25.77 and $21.09 prior to the close. At Boise stock prices above $25.77 or below $21.09, OMX shareholders will receive more that $9.00 per share (if above) or less than $9.00 per share (if below). 70% of the $9.00 per share will be paid in Boise stock and 30% will be paid in cash, although Boise has the option of changing these percentages. Once the merger is completed, Boise’s share count will be as follows:
Basic Shares Outstanding: 58.3mm
Shares from ACES: 5.4mm
Option Shares (treasury method): 0.1mm
Shares issued for OfficeMax acquisition: 31.9mm
Total Shares Outstanding: 95.7mm
Pro Forma Market Capitalization: $2,393mm
Importantly, the acquisition will be a taxable transaction for OMX shareholders. As a result, OMX will be able to make a 338 election immediately prior to completing its sale to Boise. OMX will therefore accelerate the recognition of its tax-loss carryforwards (over $500mm vs. approx. $350mm taxable gain) to offset the taxes that it would otherwise need to pay upon making a 338 election. This has two key benefits: 1) Boise will be able to write-up OMX to its acquisition price and then depreciate / amortize the full $1.5bn purchase price and 2) the Company will be able to complete a tax-free Reverse Morris Trust merger within the two years after closing the OMX acquisition (it would otherwise be unable to do so based on current tax law). In addition to allowing Boise to pursue a Reverse Morris Trust, the 338 election will allow Boise to tax-efficiently pursue the piecemeal sale of its forest products assets. Boise will be able to offset gains on the sale of its individual forest products assets with the incremental depreciation and amortization created by the 338 election.
For those of you without an extensive merger background, a Reverse Morris Trust is when a subsidiary company is merged into a smaller acquirer such that a change in control of the subsidiary occurs and such that the shareholders of the subsidiary now control over 50% of the acquirer. A good example of a recent Reverse Morris Trust merger was AT&T’s sale of its cable assets to Comcast. A Reverse Morris Trust merger is a tax-free transaction for the shareholders of the selling company (they will need to be issued stock directly in order to satisfy the change in control requirement).
The ability to have a Reverse Morris Trust is important when you consider the likely bidding scenario for Boise’s Forest Product assets. There are two likely acquirers: Domtar ($2.5bn mkt cap) and Weyerhaeuser ($12.4bn mkt cap). Domtar will be able to make its bid tax-free to both Boise and Boise’s shareholders as it has a smaller market cap than the likely value of the assets it will acquire. Weyerhaeuser, which trades at a significant multiple premium to Domtar, would normally be able to pay more than Domtar and still have an accretive acquisition. However, Weyerhaeuser will now be unable to offer the same tax advantages to Boise that Domtar will. This means that instead of bidding based on what its lower multiple competitor will be able to pay, Weyerhaeuser will need to bid based on the different after-tax proceeds available to Boise. Due to the ability of the lower multiple buyer to elect a Reverse Morris Trust merger (but not the higher multiple bidder), I expect a more vigorous auction for the paper assets than would otherwise occur.
Through the clever structuring of the OMX acquisition, Boise has made it possible to have a truly competitive auction for its forest products division.
2) Synergies from the OMX Acquisition
Boise’s acquisition of OMX is one of the few acquisitions where I truly believe that the synergies have upside. To summarize, the Company has laid out the following synergies: $60mm in purchasing, $40mm in logistics and administration, $30mm in marketing, and $30mm in paper. The Company believes that it will realize these synergies over the next two years.
The $60mm in purchasing synergies represents a 1% uplift in gross margins across the entire business. This will come from better buying in each company’s core products, complimentary non-core products, and better volume discounts. In the core product areas, Boise and OMX will be able to compare their prices for overlapping core products (i.e. pens, notebooks, etc.) and squeeze suppliers for the lower prices. In the non-core product areas, each firm will be able to dramatically increase its margins for products that sold well in one concept but not in the other. For instance, OMX buys technology products very well (49% of sales) whereas Boise does not (29% of sales). Boise will now be able to take advantage of OMX’s superior scale in purchasing technology. Lastly, the combined companies will be eligible for rebates that rival those given to Staples and Office Depot as they will be much closer in size and will purchase much more. Here are several examples of purchasing synergies:
-The Office Depot acquisition of Viking resulted in a GM increase at Viking of approx. 500bp
-In the Staples acquisition of Guilbert, Staples is aiming for a 400-500bp margin increase through better purchasing
Since OMX and Boise Office Solutions are of roughly equal size, the 1% overall Gross Margin uplift translates to about 2% at OMX. Based on my research of prior transactions and on the overlapping products, I think that there is upside to this estimate.
The $40mm savings in logistics and administration savings should result from the closure of OMX’s direct distribution centers (mostly internet & catalog sales). These centers have subpar scale and can be easily replaced by existing Boise centers as both have national reach. The $40mm should result from both firing workers and fewer facility operating expenses. Based on several conversations with knowledgeable logistics / operations types, these synergies should be achievable, but they won’t be the day-1 slam-dunk that the purchasing synergies are likely to be.
The $30mm in marketing synergies will come from branding costs and reduced marketing. I understand from several sources that the Company will take on the OfficeMax name at completion. I think that list management can give you $5-10mm of synergies, reduction in catalog production expenses and mailings another $5-10mm, website management $5mm, and SME cross-selling a final $5mm, but I am a bit hazy on the exact synergies here and haven’t gotten great clarity from anyone on this.
The $30mm of paper synergies should come from the direct distribution business. OMX sells about $350mm of paper every year (none from Boise). OMX will not try to replace all of the paper in its stores because that could cause serious structural problems for paper pricing due to the capacity utilization that would be lost at competitors as a result. Boise is likely to substitute its paper in the direct & internet sales channels, creating the $30mm of revenue synergies outlined.
Overall, these synergies seem pretty reasonable to me and have checked out. To be conservative, I have assumed $100mm of run-rate synergies at completion of the merger & integration (in about 1-year).
3) The Likely Value of the Forest Products Division
I think that the best way to look at the Forest Products division is on a sum of the parts basis. I think that I have been pretty conservative in the sum of the parts that follows:
Timber:
Northwest Pine Timber 815k acres at $610 / acre -- $497mm
Idaho Timber 195k acres at $800 / acre -- $156mm
Northwest Douglas Fir 300k acres at $2,000 / acre -- $600mm
Midwest Timber 308k acres at $460 / acre -- $142mm
Southern Timber 434k acres at $700 / acre –- $304mm
Total Timber: $1,699mm
Uncoated Freesheet (UCFS):
UCFS in Jackson, AL 520k tons at $1,200 / ton -- $624mm
UCFS Freesheet in Int’l Falls, MN 560k tons at $1,200 / ton -- $672mm
UCFS in St. Helen, OR 250k tons at $300 / ton -- $75mm
UCFS in Wallula, WA 240k tons at $300 / ton -- $72mm
Total UCFS: $1,443mm
Other Paper Assets:
Market Pulp 240k tons at $400 / ton -- $96mm
Newsprint at DeRidder, LA 440k tons at $500 / ton -- $220mm
Containerboard at DeRidder, LA 560k tons at $450 / ton -- $252mm
Containerboard at Wallula, WA 130k tons at $300 / ton -- $39mm
Total Other Paper Assets: $607mm
Building Products:
11 Plywood & Veneer Mills at $20mm each -- $220mm
1 Particleboard Mill at $5mm -- $5mm
1 OSB Plant at $25mm -- $25mm
7 Lumber Mills at $5mm each -- $35mm
3 Engineered Wood Products Plants at $50mm each -- $150mm
Total Building Products: $435mm
Other:
7 Corrugated Container Plants at $15mm each -- $105mm
1 New Wood Poylmer Plant at $93mm -- $93mm
Building Products Distribution Business (est EBITDA = $26mm) = $179mm
1 Brazilian Veneer Mill at $5mm -- $5mm
Total Other: $382mm
Total sum of parts value: $4,566mm
Notes: timber prices based on recent transactions in relevant geographic areas, $1,200 / ton UCFS based on recent multiples for attractive UCFS transactions (GP to Domtar and Bowater to Weyerhaeuser), DeRidder assets discounted 50% due to unique pairing, others based on discount to replacement value or other deal comps.
Alternatively, if you prefer to value the assets based on current trading multiples for the industry as a whole, their value is as follows:
Average industry EBITDA multiple of 6.8x:
$3,000mm (based on 2004E EBITDA of $440mm)
Weyerhaeuser EBITDA multiple of 8.6x:
$3,700mm (based on 2004E EBITDA of $440mm)
So, the total value of the forest products division is between $3.0bn and $4.6bn (a rather blunt knife)...
4) The trading value of the combined office products business:
Boise 2004E EBITDAR: $210mm
OMX 2004E EBITDAR: $506mm
Synergies: $100mm
Total EBITDAR: $816mm
Rent Expense: $367mm
EBITDA: $448mm
Staples EBITDA Multiple: 8.7x
Office Depot EBITDA Multiple: 6.8x
1 Multiple Pt. Disc. to Office Depot: 5.8x
Minimum Value (5.8x EBITDA): $2,600mm
Office Depot Multiple: $3,050mm
Staples Multiple: $3,900mm
The combined company is likely to be highly valued for its best in class same store sales growth and upside relative to either of its competitors. On the other hand, it will likely be penalized for its lower per square foot sales and its status as #3 in the industry. I would be surprised if it traded worse than Office Depot, a larger competitor that is not growing.
Total Value Upon Completion:
Upside Value:
+ $4,566mm for forest products (Breakup value)
+ $3,900mm for office products (Staples multiple)
- $1,949mm PF Net Debt
- $409mm Min. Interest, Pref Stock, Sold Receivables
- $817mm Pensions, Retirement Benefits, Deferred Taxes
$ 5,291mm Equity Value
$ 55.28 / share in piecemeal sale of forest products
+ $430mm PV10 of 338 election
$ 5,721mm in equity value
$ 59.78 / share in piecemeal sale of forest products
Middle Value:
+ $3,700mm for forest products (Weyerhaeuser Multiple)
+ $3,050mm for office products (Office Depot Multiple)
- $1,949mm PF Net Debt
- $409mm Min. Interest, Pref Stock, Sold Receivables
- $817mm Pensions, Retirement Benefits, Deferred Taxes
$ 3,575mm Equity Value
$ 37.35 / share in piecemeal sale of forest products
+ $430mm PV10 of 338 election
$ 4,005mm in equity value
$ 41.85 / share in piecemeal sale of forest products
Downside Value:
+ $3,000mm for forest products (Industry Avg. Multiple)
+ $2,600mm for office products (1x Mult Disc to Office Depot Multiple)
- $1,949mm PF Net Debt
- $409mm Min. Interest, Pref Stock, Sold Receivables
- $817mm Pensions, Retirement Benefits, Deferred Taxes
$ 2,425mm Equity Value
$ 25.34 / share in piecemeal sale of forest products
+ $430mm PV10 of 338 election
$ 2,855mm in equity value
$ 29.83 / share in piecemeal sale of forest products
NOTE: 338 Value (if Forest Products sold in Reverse Morris Trust) – PV10 based on 4-Year Average Life: $430mm ($4.49 / share)
Based on this analysis, I believe that you have very little downside to the current trading price and 50+% upside based on reasonable multiples for the forest products business and for the combined office products business with a haircut to the synergies. Note that there is upside to these estimates if the Company chooses to shift more of its compensation to cash from stock. Lastly, I believe that there are clear catalysts to lead to an increase in value here in addition to the stock being undervalued.
Background on the UCFS Auction & the Players:
Weyerhaeuser and Domtar are the second and third largest players in uncoated freesheet market with 19% and 15% market share respectively. Boise is the fourth largest player with 10% market share and IP is the largest with 26% market share. IP may be unable to compete due to anti-trust rules (this analysis is based on that conservative assumption). However, if IP is able to compete there is clear upside to my assumed value for the UCFS operations. If either Weyerhaeuser or Domtar wins the auction, they become a clear leader in the industry while the other is marginalized. This is especially true for Domtar – if Domtar loses the auction, it is a #3 player with market share of < 60% of the #2 player, while if it wins the auction it is neck and neck with the #1.
Background on Boise:
Boise is a conglomerate combining a contract office product business with a commodity paper and forest products business. Historically, Boise has traded poorly due to its lack of focus (commodity investors disliked the stable office products business while retail investors disliked the cyclical forest products business). In addition, Boise lacks scale in its core uncoated freesheet paper operations as it is the fourth largest player. In office products, Boise is the largest contract retailer with over $4 billion of sales but has been hurt in its efforts to expand to selling to SMEs due to its lack of retail locations for “top-up shopping” and its smaller scale than Staples and Office Depot. Boise was also hurt by its uncompetitive prices on technology due to its higher costs & lower volumes.
Background on OMX
OMX is the third largest retailer of office products (behind Office Depot and Staples) and has recently completed a restructuring based around its supply chain. Despite fixing these problems, OMX faced a difficult future due to its lack of a contract business. It was therefore unable to effectively sell to SMEs and large companies. By effectively targeting only the SOHO and individual purchasers, OMX achieved much lower sales volumes than either Office Depot or Staples.
Disclaimer: the author or his company may have a position in one or more of the company's mentioned in this
Catalyst
in order they are likely to occur:
1) Merger with OMX creates ability to refocus Boise on its office products division
2) Boise divests forest products via Reverse Morris Trust merger or in piecemeal sale
3) Synergies between the Boise and OMX businesses are quickly realized as purchasing is integrated and distribution centers are closed
4) Sales at the office products division should increase due to complimentary sales channels and ability to target SMEs