Paperworks - 9.5% Snr Notes due Aug 19 PAPWRK
April 26, 2017 - 10:53am EST by
todd1123
2017 2018
Price: 77.00 EPS 0 0
Shares Out. (in M): 0 P/E 0 0
Market Cap (in $M): 0 P/FCF 0 0
Net Debt (in $M): 325 EBIT 0 0
TEV ($): 325 TEV/EBIT 0 0

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  • Corporate debt

Description

Paperworks 9.5% Senior Notes due August 2019 is an attractive risk/reward that pays a ~12.5% current yield and ultimately has a ~40%+ all-in return profile over the next 12-months. Paperworks is a cycle-bet with a security that is top of capital structure, has an August 2019 maturity (hammer that likely results in a sale over the next 12-months), has more than adequate liquidity and appropriately compensates w/ ~12.5% CY as we wait for cycle normalization + significant recent evidence supporting 2H 2017E improvements makes timely. The business operates 1) with relatively stable and attractive end-market demand (folding cartons largely into grocery end-mkt), 2) is performing at cycle-bottom conditions (inputs went up $80 / ton over past 6-mths and output pricing went down by -$70/ton so squeezed on both sides), 3) competes against disciplined oligopolistic peers (WestRock, Graphic Packaging and Paperworks control >90% of the CRB supply) and 4) heightened evidence of improvements with the recent closure of Paperworks’ Phily mill resulting in industry operating rates >95% and pricing power ($50 / ton implemented in Feb / March and 2nd increase of $40 - $50 / ton working its way through the system) + significant optionality around OCC / input coming down as there was a 3-standard deviation move higher over the past 6-months.

 

At the current price of ~77, creating Paperworks from $0 - $235MM or ~4.7x mid-cycle EBITDA and ~5.7x EBITDA – capex (assumes $180 / ton of profitability versus GPK and WRK that generate $250 - $300/ton on their comparable business units). Moreover, there is a high likelihood of a sale of the business as Paperworks has 5 attractive converting plants (over the past 5-years, there has been a land grab to vertically integrate) and a strategic customer base (P&G is a marquee customer) and would likely be willing to pay up given significant synergies (historically, players such as Caraustar have successfully generated high single digit as % of sales synergies … applying that to Paperworks’ >$400MM of sales = $30 – $40MM of synergies). Ultimately, assuming a 101 take-out in 12-months, the all-in return profile is approximately 40% and the downside is limited as the security is top of the capital structure, has more than enough liquidity and creates the business for less than 4.75x mid-cycle EBITDA (versus comparables that trade >8.5x). Additionally, my mid-cycle estimate is relatively conservative as it assumes margins revert back to historical levels but a strong argument could be made for higher margins moving forward given current industry operating rates >95% versus historical in the low-90s.

 

Biz Snapshot: Paperworks is the 3rd largest recycled paperboard (CRB) operator controlling ~11% of the industry (~280k pro forma for recent closure of their Phily mill). The business has been owned by Sun Capital since 2008. Given recent actions around selling non-core business (sheeting operations sold in December 2016 for ~$68MM) and closing real estate (Phily mill closed last week and real estate sale likely results in >$20MM of net proceeds), Sun Capital appears to be tipping their hand on the ultimate goal of selling the existing 2 mills and 5 converting facilities ahead of the August 2019 maturity

 

Cap Structure: Straight-forward capital structure: $360MM of Snr Secured Notes trading in the ~77 context.

Factoring in cash and real estate, net debt is $325MM (face) and at ~77 price, creating the biz for ~$235MM

 

 

 

Mkt

 

 

Face

@ 77

Total Debt

 

367

277

Less: Cash

 

22

22

Less: Phily net sale

 

20

20

Creation value

 

325

235

 

 

 

 

Capacity

 

280,000

280,000

EBITDA / ton

 

180

180

EBITDA

 

$50

$50

 

 

 

 

Value / EBITDA

 

6.4x

4.7x

Current yield interim

 

12%

12%

Yield to 1-yr-take-out

 

 

39%

Yield to 2-yr-par

 

 

24%

 

 

 

 

Capex

 

7

7

EBITDA - Capex

 

$43

$43

TEV / EBITDA - Capex

 

7.5x

5.4x

 

Key characteristics of the biz: 1) relatively stable end-mkt demand, 2) rational oligopoly on supply and 3) very tight S/D dynamic currently with operating rates >95%

-        Demand: Folding cartons mostly for grocery end-mkt (cereals, snacks, beauty products, etc). End mkts have historically been stable with small growth but more recently small declines given shift in consumer preferences to healthier items. Overall should be very stable demand through the cycle  

-        Supply: Rational oligopoly w/ 3 players controlling ~90% of the industry

-        Resulting utilization = pxing power: Papwrks closed >5% of capacity earlier this yr putting industry op rates >95 percent, level where pxing power. Industry has already implemented a $50 / ton increase and is in the process of pushing for a $40 - $50 / ton 2nd increase

 

Why the opportunity: in 2016, S/D was imbalanced and the industry lost pricing power resulting in -$70/ton declines. Additionally, inputs (mainly OCC) temporarily spiked higher (3-standard deviation event peaking in March 2017 at $175 / ton) squeezing margins. The market has over-reacted to this temporary margin squeeze and is applying a punitive multiple to trough earnings power

 

Divergence: Paperworks closed capacity making S/D tight and industry has already established a $50 / ton increase and is focused on a 2nd $50 / ton increase … in the meantime, input costs are in the early stages of coming down. This ultimately will drive margins toward mid-cycle levels (if not higher) in the 2H of 2017E and creating Paperworks for an attractive sub-6x EBITDA-capex multiple on relatively conservative estimate of mid-cycle

 

Valuation: Paperboard companies have historically transacted at 8x plus EBITDA multiples (WRK and GPK both trade >8.5x 17E EBITDA). To be fully covered through the 9.5% Senior Note, need to believe in mid-cycle EBITDA of $50MM and ~6.5x EBITDA multiple. Additionally, given Paperworks’ owner (Sun Capital) has been involved in the business for some time + the biz faces a 2019 maturity, there is a heightened chance of a sale of the business over the next 12-months. Re: M&A, there should be significant synergy value given scale benefits around procurement, freight, and mill / converting facility integration + >$40MM of SG&A at Paperworks = likely argue for at least $30mm of synergies so a strategic could theoretically pay >$400MM and get a 15 - 20% cash-on-cash return (>$70MM of post-synergized profits / $400MM)

 

Base / Upside / Downside:  See recovery analysis below. On the downside, difficult to see a scenario in which the recovery value is not >80% and collecting 9.5% coupon per annum in the interim. More likely scenario is that this is par paper given 1) cycle recovery on standalone basis or 2) strategic buy-out

 

 

STANDALONE SCENARIO

 

M&A SCENARIO

 

 

 

 

 

 

 

 

 

Low

Mid

High

 

Low

Mid

High

 

 

 

 

 

 

 

 

Tons

280

280

280

 

280

280

280

EBITDA / ton

145

180

215

 

145

180

215

Mid-cycle EBITDA

$41

$50

$60

 

$41

$50

$60

% margin assumed

10.6%

12.6%

14.4%

 

10.6%

12.6%

14.4%

 

 

 

 

 

 

 

 

Synergies - % of sales

0%

0%

0%

 

7.5%

7.5%

7.5%

Synergies implied

$0

$0

$0

 

$29

$30

$31

TOTAL EBITDA (w/ synergies)

$41

$50

$60

 

$69

$80

$91

 

 

 

 

 

 

 

 

PP assumed

$264

$328

$391

 

$382

$442

$503

Multiple (pre-synergies) (1)

6.50x

6.50x

6.50x

 

9.4x

8.8x

8.4x

Multiple (post-synergies)

6.5x

6.5x

6.5x

 

5.50x

5.50x

5.50x

 

 

 

 

 

 

 

 

Total value

$264

$328

$391

 

$382

$442

$503

 

 

 

 

 

 

 

 

NET debt factoring in real estate

325

325

325

 

325

325

325

Current "creation" value @ 77

235

235

235

 

235

235

235

 

 

 

 

 

 

 

 

% recovery implied

81%

101%

120%

 

117%

136%

155%

% yield (2-yrs assumed)

19%

19%

19%

 

19%

19%

19%

Total recovery (including coupon)

100%

120%

139%

 

136%

155%

174%

 

 

 

 

 

 

 

 

(1) Punitively assume 6.5x EBITDA (~7.5x EBITDA-capex) versus comps at >8x EBITDA

 

 

 

Risks:

 

Economic weakness – mitigant is that demand is mostly tied to grocery volumes which is steady

 

Execution risk – mgmt is closing Phily mill but mitigant is that this is relatively straight-forward procedure and customer specs should limit any risk of customer attrition

 

Input inflation stays higher for longer – difficult to forecast OCC, but mitigants are that 3-standard deviation move to $175 / ton as of March is unusual (statistics would argue for n-term normalization) and price increases (first CRB increase of $50/ton implemented and 2nd increase of $40 - $50/ton in process of being implemented) will offset cost inflation 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

2H 2017 - 2018 performance (cycle bet); Possible sale of biz 

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    Description

    Paperworks 9.5% Senior Notes due August 2019 is an attractive risk/reward that pays a ~12.5% current yield and ultimately has a ~40%+ all-in return profile over the next 12-months. Paperworks is a cycle-bet with a security that is top of capital structure, has an August 2019 maturity (hammer that likely results in a sale over the next 12-months), has more than adequate liquidity and appropriately compensates w/ ~12.5% CY as we wait for cycle normalization + significant recent evidence supporting 2H 2017E improvements makes timely. The business operates 1) with relatively stable and attractive end-market demand (folding cartons largely into grocery end-mkt), 2) is performing at cycle-bottom conditions (inputs went up $80 / ton over past 6-mths and output pricing went down by -$70/ton so squeezed on both sides), 3) competes against disciplined oligopolistic peers (WestRock, Graphic Packaging and Paperworks control >90% of the CRB supply) and 4) heightened evidence of improvements with the recent closure of Paperworks’ Phily mill resulting in industry operating rates >95% and pricing power ($50 / ton implemented in Feb / March and 2nd increase of $40 - $50 / ton working its way through the system) + significant optionality around OCC / input coming down as there was a 3-standard deviation move higher over the past 6-months.

     

    At the current price of ~77, creating Paperworks from $0 - $235MM or ~4.7x mid-cycle EBITDA and ~5.7x EBITDA – capex (assumes $180 / ton of profitability versus GPK and WRK that generate $250 - $300/ton on their comparable business units). Moreover, there is a high likelihood of a sale of the business as Paperworks has 5 attractive converting plants (over the past 5-years, there has been a land grab to vertically integrate) and a strategic customer base (P&G is a marquee customer) and would likely be willing to pay up given significant synergies (historically, players such as Caraustar have successfully generated high single digit as % of sales synergies … applying that to Paperworks’ >$400MM of sales = $30 – $40MM of synergies). Ultimately, assuming a 101 take-out in 12-months, the all-in return profile is approximately 40% and the downside is limited as the security is top of the capital structure, has more than enough liquidity and creates the business for less than 4.75x mid-cycle EBITDA (versus comparables that trade >8.5x). Additionally, my mid-cycle estimate is relatively conservative as it assumes margins revert back to historical levels but a strong argument could be made for higher margins moving forward given current industry operating rates >95% versus historical in the low-90s.

     

    Biz Snapshot: Paperworks is the 3rd largest recycled paperboard (CRB) operator controlling ~11% of the industry (~280k pro forma for recent closure of their Phily mill). The business has been owned by Sun Capital since 2008. Given recent actions around selling non-core business (sheeting operations sold in December 2016 for ~$68MM) and closing real estate (Phily mill closed last week and real estate sale likely results in >$20MM of net proceeds), Sun Capital appears to be tipping their hand on the ultimate goal of selling the existing 2 mills and 5 converting facilities ahead of the August 2019 maturity

     

    Cap Structure: Straight-forward capital structure: $360MM of Snr Secured Notes trading in the ~77 context.

    Factoring in cash and real estate, net debt is $325MM (face) and at ~77 price, creating the biz for ~$235MM

     

     

     

    Mkt

     

     

    Face

    @ 77

    Total Debt

     

    367

    277

    Less: Cash

     

    22

    22

    Less: Phily net sale

     

    20

    20

    Creation value

     

    325

    235

     

     

     

     

    Capacity

     

    280,000

    280,000

    EBITDA / ton

     

    180

    180

    EBITDA

     

    $50

    $50

     

     

     

     

    Value / EBITDA

     

    6.4x

    4.7x

    Current yield interim

     

    12%

    12%

    Yield to 1-yr-take-out

     

     

    39%

    Yield to 2-yr-par

     

     

    24%

     

     

     

     

    Capex

     

    7

    7

    EBITDA - Capex

     

    $43

    $43

    TEV / EBITDA - Capex

     

    7.5x

    5.4x

     

    Key characteristics of the biz: 1) relatively stable end-mkt demand, 2) rational oligopoly on supply and 3) very tight S/D dynamic currently with operating rates >95%

    -        Demand: Folding cartons mostly for grocery end-mkt (cereals, snacks, beauty products, etc). End mkts have historically been stable with small growth but more recently small declines given shift in consumer preferences to healthier items. Overall should be very stable demand through the cycle  

    -        Supply: Rational oligopoly w/ 3 players controlling ~90% of the industry

    -        Resulting utilization = pxing power: Papwrks closed >5% of capacity earlier this yr putting industry op rates >95 percent, level where pxing power. Industry has already implemented a $50 / ton increase and is in the process of pushing for a $40 - $50 / ton 2nd increase

     

    Why the opportunity: in 2016, S/D was imbalanced and the industry lost pricing power resulting in -$70/ton declines. Additionally, inputs (mainly OCC) temporarily spiked higher (3-standard deviation event peaking in March 2017 at $175 / ton) squeezing margins. The market has over-reacted to this temporary margin squeeze and is applying a punitive multiple to trough earnings power

     

    Divergence: Paperworks closed capacity making S/D tight and industry has already established a $50 / ton increase and is focused on a 2nd $50 / ton increase … in the meantime, input costs are in the early stages of coming down. This ultimately will drive margins toward mid-cycle levels (if not higher) in the 2H of 2017E and creating Paperworks for an attractive sub-6x EBITDA-capex multiple on relatively conservative estimate of mid-cycle

     

    Valuation: Paperboard companies have historically transacted at 8x plus EBITDA multiples (WRK and GPK both trade >8.5x 17E EBITDA). To be fully covered through the 9.5% Senior Note, need to believe in mid-cycle EBITDA of $50MM and ~6.5x EBITDA multiple. Additionally, given Paperworks’ owner (Sun Capital) has been involved in the business for some time + the biz faces a 2019 maturity, there is a heightened chance of a sale of the business over the next 12-months. Re: M&A, there should be significant synergy value given scale benefits around procurement, freight, and mill / converting facility integration + >$40MM of SG&A at Paperworks = likely argue for at least $30mm of synergies so a strategic could theoretically pay >$400MM and get a 15 - 20% cash-on-cash return (>$70MM of post-synergized profits / $400MM)

     

    Base / Upside / Downside:  See recovery analysis below. On the downside, difficult to see a scenario in which the recovery value is not >80% and collecting 9.5% coupon per annum in the interim. More likely scenario is that this is par paper given 1) cycle recovery on standalone basis or 2) strategic buy-out

     

     

    STANDALONE SCENARIO

     

    M&A SCENARIO

     

     

     

     

     

     

     

     

     

    Low

    Mid

    High

     

    Low

    Mid

    High

     

     

     

     

     

     

     

     

    Tons

    280

    280

    280

     

    280

    280

    280

    EBITDA / ton

    145

    180

    215

     

    145

    180

    215

    Mid-cycle EBITDA

    $41

    $50

    $60

     

    $41

    $50

    $60

    % margin assumed

    10.6%

    12.6%

    14.4%

     

    10.6%

    12.6%

    14.4%

     

     

     

     

     

     

     

     

    Synergies - % of sales

    0%

    0%

    0%

     

    7.5%

    7.5%

    7.5%

    Synergies implied

    $0

    $0

    $0

     

    $29

    $30

    $31

    TOTAL EBITDA (w/ synergies)

    $41

    $50

    $60

     

    $69

    $80

    $91

     

     

     

     

     

     

     

     

    PP assumed

    $264

    $328

    $391

     

    $382

    $442

    $503

    Multiple (pre-synergies) (1)

    6.50x

    6.50x

    6.50x

     

    9.4x

    8.8x

    8.4x

    Multiple (post-synergies)

    6.5x

    6.5x

    6.5x

     

    5.50x

    5.50x

    5.50x

     

     

     

     

     

     

     

     

    Total value

    $264

    $328

    $391

     

    $382

    $442

    $503

     

     

     

     

     

     

     

     

    NET debt factoring in real estate

    325

    325

    325

     

    325

    325

    325

    Current "creation" value @ 77

    235

    235

    235

     

    235

    235

    235

     

     

     

     

     

     

     

     

    % recovery implied

    81%

    101%

    120%

     

    117%

    136%

    155%

    % yield (2-yrs assumed)

    19%

    19%

    19%

     

    19%

    19%

    19%

    Total recovery (including coupon)

    100%

    120%

    139%

     

    136%

    155%

    174%

     

     

     

     

     

     

     

     

    (1) Punitively assume 6.5x EBITDA (~7.5x EBITDA-capex) versus comps at >8x EBITDA

     

     

     

    Risks:

     

    Economic weakness – mitigant is that demand is mostly tied to grocery volumes which is steady

     

    Execution risk – mgmt is closing Phily mill but mitigant is that this is relatively straight-forward procedure and customer specs should limit any risk of customer attrition

     

    Input inflation stays higher for longer – difficult to forecast OCC, but mitigants are that 3-standard deviation move to $175 / ton as of March is unusual (statistics would argue for n-term normalization) and price increases (first CRB increase of $50/ton implemented and 2nd increase of $40 - $50/ton in process of being implemented) will offset cost inflation 

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    2H 2017 - 2018 performance (cycle bet); Possible sale of biz 

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