JSG deal: sparks widespread speculation.

Editor's Note: After this article was written, Jefferson Smurfit Group (JSG) received and recommended acceptance of the expected bid from Madison Dearborn Partners. The bid was valued at Euro 2.15 (US$ 2.06) per share, plus one Smurfit-Stone Container Co. share for every 16 JSG shares held. Published reports said a rival bid for the company was possible. For possible updates, go to www.tappi.org

In recent weeks, haggling over series of price increase announcements has dominated the day-to-day business of the European paper industry. But the real drama has been focused elsewhere--on the company located at Clonskeagh, Dublin 4, Ireland.

The confirmation that Madison Dearborn Partners Inc. (MDP), Chicago, Illinois, USA, is in talks with Ireland's Jefferson Smurfit Group (JSG) about a possible takeover has sent the paper industry into a frenzy of speculation. Not only that, but the subsequent news that the investment business of George Soros--Soros Private Equity Partners--was exploring the possibility of making a joint bid for JSG with MDP served to add a touch of financial glamour rarely seen in the forest products sector.

Of course, the realities of the situation are slightly more prosaic. As with most merger and acquisition deals in the paper sector, the story will ultimately come down to who is willing to pay most for Smurfit's assets. But even on that score, there is ample scope for debate at this stage of the game.

RAPID PACE

Jefferson Smurfit has grown from a small Dublin box plant into the world's largest packaging company in a matter of a few decades. Results for 2001 show that the company generated profits of Eur 168 million (US$157.6 million) on a turnover (sales) of Eur 4.51 billion (US$ 4.23 billion). Turnover in that year was up by more than 38% on the 1997 figure.

Over the years, the group has built a fearsome reputation as a highly acquisitive group with a knack for imposing financial discipline on an industry where such behavior had long been at a premium. Indeed, for many years it was a source of pride to the group's chairman, Michael Smurfit, that he had never bought a new paper machine despite the company's rapid growth.

Instead, Smurfit became a specialist at snapping up under-performing assets--often paper companies that were struggling financially due to adding too many new paper machines too quickly--and then imposing an operating rigor that made the assets sweat to produce profitable results.

So perhaps it should not be a surprise that the terms of the MDP bid include a proviso stating that current management remain in place. As such, the cooperation of Michael Smurfit and other key players, including CEO Gary McGann, will be a key part of any leveraged buyout by MDP.

What is ironic, though, is that several analysts have noted that many of the potential cost savings to be generated by a takeover are likely to come from some of the corporate expenditures currently being witnessed at the highest level in the company. In recent years, Smurfit's management has come in for severe shareholder criticism over executive pay and perks. Among the assets likely to be sold under a deal with MDP is an exclusive golf and country club outside Dublin.

CHECKING THE OPTIONS

A key item is the price that Madison Dearborn Partners would have to pay for JSG. MDP is one of the largest private equity investment firms in the U.S., managing at least four funds worth a total of US$ 7.5 billion. According the group, "MDP focuses on growth equity investments in the communications industry and management buyout transactions across a variety of industry sectors, including basic industries. MDP's objective is to invest in companies that have outstanding management teams and the potential for significant long-term equity appreciation."

Apparently, the company usually invests US$ 50 million to US$ 400 million in a single transaction, working with other financial groups to make up the total cost of the bid. in this case, Soros Private Equity Partners appears to be in the frame, but the glamour angle was not enough to interest some. As one Dublin-based analyst pointed out, "It would be a lot more interesting if Soros was coming in as another bidder, but that doesn't look like being the case."

MDP already has a number of interests in the paper sector via shareholdings in Bay State Paper, Buckeye Cellulose, Packaging Corporation of America and Riverwood. Initially, there was some speculation that JSG's 29.4% holding in Smurfit-Stone Container Corp. (SSCC) might be an element in MDP's attraction to a bid, but analysts appear to dismiss the idea. As one analyst noted, "There has been talk about this, but I really don't think Madison wants to own SSCC. outright. For one thing, they don't have fullboard control of companies like Packaging Corporation, and just look at the sheer scale of SSCC. Tying it all up together with their U.S. assets would be a hugely difficult task."

John Mattimoe, an analyst at Merrion Capital in Dublin, shared a similar opinion. "All the indications are that the deal is stacked up to get cash flows from the subsidiaries. If someone wanted to get into SSCC, there would be far easier ways of doing it."

If that is the case, then the options for MDP will include either a straight sell-off of the SSCC interest, or possibly a simple distribution to JSG's shareholders as part of the bid price. "Madison could look for a buyer or just distribute the shares in SSCC. Say, Eur 2-plus for Smurfit and some SSCC shares--that might be the form of the deal, but of course then that will make it a lot more complicated," noted one analyst.

PRICING THE DEAL

Such complexities could make valuing JSG a bit more difficult, but the price typically being touted for the company is just over seven times consolidated EBITDA (earnings before interest, tax, depreciation and amortization). Based on JSG's 2001 full-year results, a multiple of seven suggests a price of Eur 3.95 billion (US$ 3.70 billion). But some analysts say the range could be as broad as six times EBITDA to eight times.

It should be noted that when Cinven/CVC bought the KNP BT assets to form Kappa in 1998, the multiple then was in the high sevens and more recently in 2000 SCA paid only slightly lower multiple of over Metsa Corrugated. According to another analyst, JSG's own recent takeover of Munksjo priced the assets at a similar rate. That implies that JSG could go for anything up to Eur 4.5 billion (US$ 4.22 billion), although a bid of Eur 4.20 per share looks likely to be at the upper limit of the possible range.

Smurfit shares traded at around Eur 2.60 to Eur 2.70 before the at approach was revealed, so Eur 4.20 a per share does look rich at a pre-announcement premium of 55% On the other hand, institutional investors are reported to have told the Irish Times newspaper that they of would not support a leveraged buyout at Eur 3.50 per share. Not only that, but JSG has been trading at a discount to its European peers on the basis of the "drag" that comes with the poor results from its holding in SSCC in the States.

JSG has been looking at ways of separating that business for some time now, so if MDP manages to offload SSCC in an effective manner, there should be some upside there. At any rate, the potential price range certainly looks fairly broad at this stage.

AUCTION HOUSE

According to Mattimoe, "A figure of Eur 3.50 per share has been talked about and our estimates suggest that a bid at this level, or perhaps a little higher, is possible. There's always a possibility that someone else will come in, but at this stage there doesn't seem to be any sign of it. If Madison comes in too low though, it runs the risk of tempting a third party."

The main problem for MDP is that, if it plays too conservative, the company could find itself in the middle of an auction. A broad range of potential suitors has already been suggested, including International Paper, SCA, and Mondi. One report even suggested that another private equity group could get involved. CVC and Cinven hold an interest in Kappa Packaging, for example, although one analyst discounted this on the basis that CVC/Cinven are more likely to be looking at their exit strategy by now, rather than taking on another huge asset.

When the MDP approach was revealed, Don Roberts at CIBC World Markets made a long list of reasons why IP might get involved, including:

* Scale, as IP is the only paper company in the Dow Jones 30 Index and wants to stay there

* The fact that extremely large U.S. corporations tend to trade on higher price/earnings multiples

* JSG would offer geographic diversification for IP.

Roberts cautioned that IP's merger and acquisition track record was mixed, wastepaper prices could climb, and synergy gains would be small since JSG is comparatively well managed. So it appears that there are plenty of reasons for and against getting involved.

Still, it may be difficult for trade buyers to get involved without overpaying, given the scale and potential complexity of JSG and MDP's friendly approach. A hostile takeover of what is widely considered to be a well-managed, large, international packaging player leaves little room for trade buyers to leverage huge synergies from the deal, although there could be an upside on price leadership issues.

Other considerations will include the response of the Smurfit family, which owns a significant number of the shares; the reaction from anti-trust authorities in certain markets; and the possibility of a rating downgrade that could trigger bond covenants. Whatever happens, it seems certain that all the players mentioned, and more, will be looking extremely closely at Madison's bid for JSG. Not only that, but everyone will be looking at the opportunities for doing something creative with SSCC to boot.

COMPLEX ISSUES

Under Ireland's takeover rules, MDP is discussing the bid with an independent board committee representing the Jefferson Smurfit Group. The committee is chaired by the group's senior independent director, Martin Rafferty, and includes former JSG president Howard Kilroy and former Irish government minister Ray McSharry. UBS Warburg and IBI Corporate Finance have been appointed as independent financial advisers, with William Fry Solicitors as the legal adviser. Deutsche Bank is reported to be advising MDP.

If the talks progress, the next phase will probably see MDP announce a formal bid before the end of June. Shortly after that that any potential bidders will show their hand--assuming that anyone else has the stomach to take on a complex deal of this magnitude.

What is not known is where this will leave the Smurfit family members, many of whom are still involved in JSG, day-to-day business as senior executives. Michael Smurfit had already announced his retirement from JSG. He could stay on in some role, but presumably he would bow out as planned. But even if the industry does lose one of its most colorful characters--as well as one of its best CEOs over the years-a deal that would involve Ireland's largest-ever leveraged buyout would also value Smurfit's stake in JSG at well over Eur 200 million (US$ 188 million).

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IN THIS ARTICLE YOU WILL LEARN:

* Why a U S.-based private equity group is making a bid to purchase Jefferson Smurfit Group.

* How JSG has grown into a high-performing company from its small beginnings decades ago.

* The legal issues that make pricing the deal more complicated.

ADDITIONAL RESOURCES:

* Jefferson Smurfit Group website: www.smurfit.ie

* Smurfit Stone website: www.smurfit-stone.com

* Website for Madison Dearborn Partners: www.mdcp.com

* To hear a 1999 interview with Michael Smurfit: http://www.onbusiness.ie/1999/1 123/moneymakers.html

About the author: Jim Kenny is contributing editor/Europe, for Solutions! magazine, and is based in Brussels, Belgium. He is the former vice president of editorial for Paperloop and today heads his own company, DSI. Contact him by phone at [phone], or by email at [e-mail]