Description
Once again, disappointed arbs have created an incredible buying opportunity. I’m talking about Boise Cascade, which “disappointed” the street with an asset sale of substantially all of the assets of its remaining paper and forest product businesses to Madison Dearborn Partners for $3.725 billion. The new company will be renamed OfficeMax and will be almost a pure-play specialty retailer (there will be a few legacy forest product assets, which should be liquidated over time).
As some of you may remember, I wrote this stock up as a “value with a catalyst idea” nearly a year ago, at $25 claiming that there was 30% upside. The stock has performed almost exactly to expectations, but I now believe that the shares are at least as undervalued as they were then. I see 30+% upside after the return of capital (i.e. 30+% upside after you get the cash that the Company is returning) and clear catalysts over the next 6-12 months.
First, let’s review the transactions that Boise has undertaken:
1) Sold 79k acres of timberland for $84mm
2) Sold OSB mill for net proceeds of $90mm
3) Sold most of remaining paper & forest product assets for $3,725mm
Total Proceeds: $3,899mm
Remaining non-core assets:
1) Architectural Business: $90mm value (cost to build)
2) Higher & Better Use Land: $7mm value (former HBU land sales at around $1,000 - $1,500 per acre; 6,000 acres for sale)
Total Non-Core value: $97mm
Total Value of Forest Products: $3996mm
This is really quite a good outcome for the company and falls at the top-end of most analysts’ forecasts. It was, however, disappointing to the arbs who owned the company, mainly due to the relatively small amount of cash being returned to shareholders as a result of the lower than expected net proceeds to the Company, which break down as follows:
Pro Forma Net Debt:
Gross Proceeds from Madison Dearborn: $3,725
Reinvestment in Boise LLC Common Stock: (110)
Investment in Boise LLC Series A Stock: (65)
Investment in Timber Notes of Boise LLC: (165)
Expenses of Transaction: (250)
Pension Funding: (200)
Accounts Receivable Factoring Repayment: (200)
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Cash Available for Debt Repayment $2,735
Repayment of Preferred Stock (co estimate): (150)
Debt Retirement: (1,800)
Excess Cash currently at Company: 55
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Cash to Return to Shareholders: $ 840
Remaining Debt in Company: (330)
Remaining Cash in Company: 130
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Net Cash in Company after transaction: $ 640
As outlined above, after completing the transaction, I expect the Company to return $840mm to shareholders, or about $8.66 after the conversion of the ACES to common stock. This would make the pro-forma stock price $23.87 and the net debt in the company equal to $200mm.
In addition to the net cash at the Company after the transaction, they will continue to own several legacy forest product assets, a stake in the Boise LLC (the newco being formed by Madison Dearborn), and tax liabilities from the sale of the forestland. I estimate the net value of these assets to be about $272, which I break down as follows:
Architectural Products Business: $ 90
Higher & Better-Use Land: 7
Boise LLC Common Stock: 110
Series A Boise LLC Stock: 65
Boise LLC Timber Notes: 165
Residual Tax Liability from Timber Sale (PV) (165)*
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Total Value of Forest Product Assets 272
* Assuming that the Company leaves the notes outstanding for 15 years, the present value of the notes and interest should be approximately equal to the value of the tax liability. Longer time periods result in a value for the tax liability that is less than the value of the Timber notes while shorter notes result in the opposite.
Pro forma for the transaction, the return of capital, and the remaining forest product assets, the Enterprise Value of the Company will be as follows:
Current Price after capital return: $23.87
Shares Outstanding (after ACES conversion): 97
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Market Capitalization: $2,315
Plus net debt after return of capital: 200
Less value of forest products business: (272)
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Current Enterprise Value: $2,243
While I would normally look at the Enterprise Value relative to either this year’s EBITDA or trailing EBITDA, the ongoing integration between OfficeMax and Boise Office Products makes this year’s EBITDA irrelevant. Nevertheless, the Company is currently trading at a low 5.9x this year’s estimated EBITDA of $380mm. Next year’s EBITDA should be substantially higher, based on the following adjustments:
2004 Estimated EBITDA (company guidance): $ 380
One-time merger integration costs in 2004: 50
Incremental Synergies: 20
Organic Growth: 20**
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2005 Estimated EBITDA: $ 470
** This organic growth is equal to approximately 4.7% growth on the EBITDA base of 430mm in 2004 (380 of reported EBITDA plus 50 of one-time merger integration costs). This corresponds to same-store sales growth of about 1.5% given the operating leverage of the business.
The new company is therefore being valued at only 4.8x 2005E EBITDA, which is among the lowest valuations of all specialty retailers. Many analysts are comparing the business to Office Depot, which is being valued at 5.3x 2005E EBITDA. I believe that this is a faulty comparison and results in undervaluing Boise. Even if you believe that it is fair, your “fair value” for Boise would be $26.42 after the return of capital (11% upside).
Importantly, I believe that the expectations for Office Depot are unrealistic relative to those for the new OfficeMax. Office Depot is expected to increase EBITDA 11% next year despite lower fixed cost leverage than Boise and a worse track record of comparable sales. Office Depot has given poor guidance, is not currently executing against easy comps, and has a history of being too aggressive. The 11% EBITDA increase translates to about 5% same-store sales growth. To put this in context, 5% same-store sales growth should produce 13-15% EBITDA growth at Boise. Let’s see what Boise would look like with similar assumptions to those surrounding Office Depot:
Case 1: Similar EBITDA growth to Office Depot
2004 Estimated EBITDA (company guidance): $ 380
One-time merger integration costs in 2004: 50
Incremental Synergies: 20
Organic Growth: 47
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2005 Estimated EBITDA: $ 497
EV / EBITDA: 4.5x
Equivalent Value per Share at ODP Multiple: $27.90
Upside from price after return of capital: 17%
Case 2: Similar Comps to Office Depot
2004 Estimated EBITDA (company guidance): $ 380
One-time merger integration costs in 2004: 50
Incremental Synergies: 20
Organic Growth: 60
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2005 Estimated EBITDA: $ 510
EV / EBITDA: 4.4x
Equivalent Value per Share at ODP Multiple: $28.61
Upside from price after return of capital: 20%
So, we can see somewhere between about 10-20% upside based on where Office Depot is trading. Put another way, we can look at the implied valuation of Office Depot at the growth multiples we have assumed for Boise and what that valuation would translate to. By assuming 1.5% same store sales comps in 2005, Office Depot would be trading at 5.7x EBITDA. Likewise, 4.7% organic EBITDA growth would result in a multiple of 5.7x EBITDA for Office Depot. At 5.7x EBITDA, OfficeMax would be worth $28.36 per share, or 19% upside from current levels.
In addition to EBITDA multiples, we should also look at P/E multiples of the Company going forward and the DCF value. I have the following EPS estimates for the next 3 years:
2005 2006 2007
Previous Year EBITDA 380 470 530
Incremental Corporate Expense (10) 0 0
Reduced Pension Expense 10 0 0
Reduced Cost of Synergies 50 10 0
Additional Synergies 20 30 0
Organic Growth 20 20 25
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EBITDA 470 530 555
Depreciation & Amortization (160) (165) (170)
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EBIT 310 365 385
Interest Expense (10) (7) (2)
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Profit Before Tax 300 358 383
Taxes (105) (125) (134)
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Earnings 195 233 249
Earnings per Share $2.01 $2.40 $2.57
% Growth YOY 20% 7%
An alternative valuation of the company would put a multiple of between 12-16x 2005E EPS on the company and add in the value of the forest products business. Office Depot is currently trading at 12x 2005E EPS, but as I have laid out before, the organic growth estimates for ODP are much more aggressive than those for OfficeMax.
2005E EPS $2.01 $2.01 $2.01
P/E Multiple 12x 14x 16x
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Value per Share 24.12 28.14 32.16
Forest Products Value 2.80 2.80 2.80
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Total Value per Share 26.92 30.94 34.96
% Upside 13% 30% 46%
Let’s also look at an upside scenario based on EBITDA and same-store sales growth equal to that which is projected for Office Depot:
Case 1: Similar EBITDA growth to Office Depot
2005E EBITDA: 497
Depreciation & Amortization (160)
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EBIT 337
Interest Expense (10)
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Profit Before Tax 327
Taxes (114)
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Earnings 213
Earnings per Share $2.20
Current Price: $23.87
Forest Products Value: 2.80
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Value of Office Prod Business: 21.07
Current P/E Multiple 9.6x
Value at 12x EPS: 29.20
% Upside 22%
Value at 14x EPS: 33.60
% Upside 41%
Value at 16x EPS: 38.00
% Upside 59%
Case 2: Similar Comps to Office Depot
2005E EBITDA: 510
Depreciation & Amortization (160)
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EBIT 350
Interest Expense (10)
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Profit Before Tax 340
Taxes (119)
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Earnings 221
Earnings per Share $2.28
Current Price: $23.87
Forest Products Value: 2.80
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Value of Office Prod Business: 21.07
Current P/E Multiple 9.2x
Value at 12x EPS: 30.16
% Upside 26%
Value at 14x EPS: 34.72
% Upside 45%
Value at 16x EPS: 39.28
% Upside 65%
We can quickly cover a DCF of the business with this data table (assumes that 2005 EBITDA is $470mm. There is obviously upside if we use closer growth rates to those assumed by analysts for OPD).
Weighted Average Cost of Capital
7.5% 8.0% 8.5% 9.0% 9.5% 10.0%
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-1%| 31.28 29.58 28.05 26.68 25.45 24.32
Terminal 0%| 34.78 32.65 30.77 29.10 27.60 26.26
Growth 1%| 39.36 36.60 34.20 32.11 30.27 28.63
Rate 2%| 45.61 41.86 38.70 35.99 33.64 31.59
3%| 54.63 49.24 44.83 41.16 38.06 35.40
So, in order to believe that the Company is overvalued at $23.87 after the return of capital, you would need to believe either that the Company’s WACC is greater than 10% (unlikely) or that the Company’s terminal growth rate (after 2007) will be less than -1% (even more unlikely, in my view). In order to see 30% upside, you need only believe that the Company is worth $31.03 or more (seems pretty easy based on the above matrix).
Lastly, let’s cover the following four catalysts:
1) Closing of the MDP Transaction:
I expect that the company will close the sale to Madison Dearborn in 3-4 months, which will set the stage for a return of cash to shareholders (catalyst #2) and a transformation in the analyst and shareholder base (catalyst #3). The closing of the transaction will eliminate many of the current distractions. Shareholders should also be aware that the potential for an interloper to enter is still present and increases as the paper cycle strengthens. While we do not expect this and do not assign any value to it, there is a small possibility that this will occur.
2) Return of cash to shareholders:
The Company has announced its intention to return excess cash to shareholders of between $800mm and $1bn. I believe that the total return will be on the high side, but that the portion available to shareholders will be around $840mm ($8.66 per share). Most likely, this will be returned to shareholders through a Dutch Auction in order to eliminate the weak holders of the stock (as detailed below). This return should herald the transformation of the shareholder and analyst base that I outline in catalyst #2.
3) Transformation of the shareholder / analyst base:
As recently as several weeks ago, nearly a quarter of the shares were owned by hedge funds, mostly event driven funds. These funds have proven to be weak holders of the stock and have sold in droves over the past several days. I expect that the Company will rid itself of many of its weakest holders in the next 3-4 months and into the Dutch Auction that I anticipate. Likewise, the Company should gain new analyst coverage from a sell-side community who understands the new OfficeMax better than the forest products analysts who previously covered it.
4) Continued Synergy Execution:
The Company has outlined $130mm of synergies that it expects to gain in the first 3 years of the deal, including $80mm this year. Through the end of Q2, the Company had realized $44mm of synergies and was on a run-rate for $108mm of synergies. While management has been cautious on guiding synergies upwards, they have admitted that there is “some upside” this year. The Company also appears to have completed only a small portion of its logistics synergies, so there could be upside on these synergies. At a minimum, the Company should execute on its original synergy plan and there is a chance for improvement from a total synergies perspective, a timing perspective, or both.
Catalyst
1. Closing of the sale of the forest products business
2. Return of cash to shareholders (27% of mkt cap)
3. Transition of shareholder / analyst base
4. Continued synergy execution