Jefferson Smurfit sets its sights on a new future: with a successful leveraged buyout behind him, Tony Smurfit talks about his new role and the future of the company.

Now that the dust has settled and "the deal" has been done, the Jefferson Smurfit Group (JSG) is back to the day-to-day business of doing business without the stress and distraction of dealing with one of the largest leveraged buy-outs the industry has witnessed.

A new board of directors is in place and the Ireland-based JSG is now in private hands following a EUR 3.7 billion deal that saw the U.S. investment firm, Madison Dearborn Partners (MDP), take control of the packaging giant. Under the deal, shareholders received EUR 2.15/share in cash, plus one share of common stock of Smurfit Stone Container Corp. (SSCC) for every 16 JSG shares held.

Industry watchers are now keen to find out if the strategic direction of the new company is set to change in any way. The answer, according to the group's new president and chief operating officer, Tony Smurfit, is yes and no. Yes, because the group's short-term focus will be on paying down the debt raised to finance the deal. But no, since JSG is not about to suddenly change the successful strategy that has seen the company grow from a small box plant in Dublin to a multinational packaging giant over the course of a few decades.

"Typically, Smurfit has grown through acquisitions, but we will he taking a pause on that for the time being," said Smurfit. "We've just had a very successful bond issue in a very difficult market and our mission now over the next few years will be to pay down some of that debt. Of course, we will still continue to look at smaller acquisitions it the opportunities arise, but deals on the scale of Nettingsdorfer or Munskjo that we've done in the past will take aback seat, probably for the next three to tour years. Once we've done that, we'll see what happens."

SPINNING OUT

As Smurfit concedes, the MDP deal represented a rather convenient way out of a situation that had been bothering JSG shareholders in recent years. The Irish company's 32% stake in SSCC was widely considered a strategically important holding, but the highly geared (leveraged) balance sheet of the U.S. firm meant that SSCC created a drag on JSG's share price. As a result, JSG traded at a discount to several of its rivals in the sector, much to the annoyance of some shareholders.

"One of the main drivers for the deal was the Smurfit Stone stake. We had $1.2-$1.5 billion of assets sitting on the balance sheet and it wasn't paying a dividend so it wasn't generating a return for the group. The Madison deal turned out to be the best strategic option for the group, but that is bearing in mind that we couldn't do anything that might harm the interests of the Smurfit Stone shareholders in any way. This was simply the best solution to a very difficult problem," Smurfit said.

"As it is, Smurfit Stone has now been successfully spun off and is one of the most widely traded paper stocks in the U.S., which means in the world as well. There's no doubt in my mind that Smurfit Stone will go on to be a powerhouse in the United States."

Of course, since Tony Smurfit is a director of SSCC, he would say that. But anecdotal evidence suggests that there is broad agreement among analysts that both companies benefit from operating as separate entities.

"At the end of the day, they're happy, the shareholders of JSG are happy and the owners of Madison Dearborn are happy that they have got a great company. All in all, there weren't any complaints simply because it was a great deal all round. It was an effective way of releasing value to all of our stakeholders," Smurfit explained.

"Timing was also a factor. You have to remember that the equity markets were falling over the summer when the deal was going through, so getting cash for the shareholders in that period played an important part, as cash does in almost any deal," stated Smurfit.

NEW LOOK

As it is, the deal actually provides a slight boost for the Smurfit family in terms of the percentage ownership of JSG. As Smurfit pointed out, "The family controlled slightly more than 7% of the company before on a fully diluted basis, but in Newco [the post-public JSG] that is up to about 8%. We're also, I think, still the biggest individual investor in Smurfit Stone Container, at about 2.5-3.0%."

The tact that MDP stated up front that its friendly bid was conditional on the incumbent management staying in control always suggested that radical alteration to the group's strategy was unlikely. But it is clear that the company will have to steer a steady course over the next few years to ensure that debt levels stay under control.

On recent evidence, the market appears to be showing confidence in the company's ability to do just that. Over the mid-year months, increasingly nervous investors have watched a host of blue chips drop into the "fallen angel" category as previously secure corporate bonds have been dragged down to junk status. Indeed, record default levels have left many people extremely wary of corporate bond issues. Yet against this background, MDP successfully launched one of the biggest ever bonds offered by a European borrower to fund the JSG purchase.

MDP's financing vehicle raised an impressive EUR 905 million (US$ 950.26 million) via a 10-year Euro denominated bond and a second US$ denominated bond. The first tranche raised EUR 350 million priced to yield 10.125%, and the second was for US$545 million yielding 9.625%. The bond sale was the largest offering of speculative-grade debt in Europe this year; Standard & Poor's rated the bonds a B and Moody's gave the debt an equivalent B2.

As Smurfit pointed out, though, the company's financial history provided a solid foundation for the debt offering in addition to MDP's financial contacts. "In the United States, for example, we've got a good record. Smurfit Stone paid down something like US$ 1 billion worth of debt, we've taken the tough decisions to close down machines to offset overcapacity in the market, and we're capable of generating lots of cashflow and profits. This is good quality debt. That's really why SSCC is one of the most highly regarded high yield bonds in the market. Overall, our approach to debt has been to the market's liking over many years."

NEW LOOK

Under the new regime, 39-year-old Tony Smurfit progresses from his previous role as CEO of Smurfit Europe to become president and chief operating officer of the Jefferson Smurfit Group worldwide, where he will work closely with Gary McCann in the CEO position and, of course, the chairman, Michael Smurfit.

Despite the additional responsibility, Tony Smurfit is unfazed by the prospect of any closer scrutiny of his performance. As he noted, as CEO of Smurfit Europe he was already responsible for running a division that represented the majority of JSG's directly controlled operations.

"I don't think there will be any more attention paid to me now than there was before, but it does add more diverse geographic responsibilities. The Latin American operations are very well managed already, but hopefully I can help them in some ways as well."

Closer to home, Smurfit's most immediate challenge lies in pushing through and maintaining the corrugated price increases announced across Europe in the third quarter of 2002. Customers were told the rise had to go through as wastepaper prices had soared over the course of the year, but by mid-October with recovered paper prices dropping fast the situation had altered significantly.

Nevertheless, Smurfit believes that the prices will hold. As he pointed out, customers do not want to have to deal with prices going up and down every week, but more importantly, he believes that the extra volatility seen in the recovered paper markets will generate another cycle that will push wastepaper higher.

"In the world markets, a big issue is the amount of capacity coming on stream in the Far East and the effect that will have on wastepaper prices in the United States and Europe, which is very much an unknown factor," Smurfit explained. "The last two years have been difficult for corrugated production in the United States. But if you take even just two things--a recovery in the U.S. economy and increasing demand in China--then I think you'll continue to a lot more volatility in prices. We'll see where wastepaper goes in February, but in my opinion it will still be up."

CAPACITY COMING

Even if that turns out to be the case, customers are likely to point to the extra capacity coming on stream from the new Papierfabrik Palm machine in Germany. The 11 m wide, 600,000 metric ton/yr testliner and corrugating (fluting) machine started up in October and represents a massive step up in capacity for the region. Smurfit feels, though, that the new unit can be accommodated without softening the market to a massive degree.

"If you look at the statistics, Europe is in need of an extra 300,000-500,000 (metric) tons every year historically so there is a need for new capacity," he said. "It depends what [Palm] does of course, but if the company introduces the capacity rationally then there should be very little effect on the market. If you look at the extra capacity added by Saica or Prowell in the past few years, that's been absorbed, so we see no reason why this new capacity should not be absorbed just as easily."

Arguably, a more significant factor for JSG's business is the state of the global economy and, as Smurfit freely admits, no one can claim to have any real insight into where that is heading at this juncture. In the fourth quarter of this year, conflicting economic indicators appeared to be the norm and bond and stock markets around the world reflected that uncertainty.

Whatever happens, Smurfit is in no doubt about what his job will be for the medium term. "Our basic business is very stable. It's about producing a corrugated box that helps our customers reduce their cost base and develop new packaging ideas," he said. "That's really our strength."

COST FOCUS

That focus on cost and price has always been at the heart of the Jefferson Smurfit identity. For the bulk of the company's history, the key strategy has revolved around conserving cash with a view to future acquisitions. Perhaps unfairly, that has led to accusations that the group invests too little in its asset base. But Smurfit is adamant that JSG's approach is the right one.

"Capital is a scarce commodity that should only go to those that are going to use it most effectively," Smurfit stated. "Each investment is judged on its own merits, outside of the health and safety and environmental investments. I try to give everyone what they want in terms of capital and I don't think you'll hear anyone in the company say that they lack capital for investment. But capital should he hard to get, so everyone knows they have to make their case to get it.

"At the end of the day, the customer doesn't care if the product came off a 20-year old Bobst or a brand new machine as long as they get a good price and good quality."

NO CHANGE IN STRATEGY

Smurfit is well aware that some of the group's closest competitors are pushing hard to grab the higher value-added end of the market, but he does not see any great urgency to follow their lead or fund the massive investments required to go into the very high value niche segments.

"SCA has done a great ,job of strategy identification, for example, and they should be applauded for some of the things they've done. We're not as niche oriented as them, although we do have some broad niches, but we work hard at doing better in terms of productivity, efficiency and product optimization," he said. "We don't really measure ourselves against the competition. We concentrate on certain metrics. Return on capital employed, for example, is an area where I think we do well."

Smurfit's colleagues on the board representing MDP will certainly be pleased to hear that, but the short term focus on generating cashflow to fund debt reduction is likely to restrict the group to organic growth for the foreseeable future. However, Smurfit sees no reason to believe that the company will suffer unduly given the opportunities he sees to exploit growth in the markets JSG currently serves.

As he pointed out, "[The imminent EU] enlargement might help, but we're already in those markets through Duropack and we'll be making our growth in eastern Europe through them. We have a 40% share in the company and Duropack has a presence in the Czech Republic, Hungary, Slovenia, Slovakia etc. In fact, we're in a very good position in most European markets, with the exception of Belgium and Germany. But the last two markets are well served by Smurfit Stone and this position is currently being evaluated."

Further afield, Smurfit added that, despite recent economic problems in the region, Latin America also offers good growth prospects.

"Argentina had a very difficult year in 2002, of course, but we're number two there. Our operations in Colombia are excellent and we're easily the biggest there. We don't have a presence in Chile, but we're looking at that. We're the largest in Venezuela and number two in Mexico, although again we're looking at further opportunities there. So there is plenty of room for growth," he said.

One region where the company will not be extending its footprint is Asia. "In Asia we're small and any development of our Asian presence is on hold tot now," Smurfit said. "Asia is great if you find the right partner, but you have to find that partner first. It's obviously a very fast growing market, but there are also lots of companies competing for the business. There are other issues as well. For example, in some of these countries a change in a tax law can put you out of business. That's one of the reasons why we haven't looked at Russia until very recently. The credit risks arc just too great."

CHANGES AHEAD?

Looking further ahead, MDP as a venture capital group will undoubtedly seek a profitable exit from JSG at some point. Groups such as Madison Dearborn typically hold assets for 5-7 years and then exit through the public markets; but as Smurfit pointed out, that timeframe is a long way off and there is a lot that "still has to be decided." There is no knowing what will have happened to the markets by then--but one trend that seems clear is that there will be even more consolidation.

In the meantime, Tony Smurfit and the rest of the management team will be focusing on developing the group's core strengths and driving organic growth across the group. Their efforts, and the development of the global economy, will determine the eventual size and shape of the JSG of the future. But given the company's record to date, it would be a brave soul that bets against the group emerging as a key player in the box markets of the next decade.

ABOUT JEFFERSON SMURFIT GROUP AND MADISON DEARBORN PARTNERS

The Jefferson Smurfit Group grew from modest beginnings as a small box plant located in Dublin to become the world's largest packaging company in a matter of decades. Results for 2901 show that the company generated profits of EUR 168 million on a turnover (sales) of EUR 4.5 billion end turnover in that year was up by more than 38% on the 1997 figure.

Over the years, JSG has built up 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 pace of growth.

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

Partly as a result of that reputation, the terms of the Madison Dearborn Partners (MDP) bid for the company included a proviso that the current management remain in place after the acquisition Consequently, Chairman Michael Smurfit and players such as CEO Gary McGann will play a key role in the future of the company under MDP's control.

MDP is one of the largest private equity investment firms in the US managing at least four funds worth some US$ 7.5 billion in total. According the group, "MDP focuses on growth equity investments in the communications industry end management buyout transactions across a variety of industry sectors, including basic industries. MDP's objective is to invest in companies that have outstanding management team and the potential for significant long-term equity appreciation."

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.--Jim Kenny

IN THIS ARTICLE, YOU WILL LEARN:

* The strategic direction of JSG following the buyout by MDP

* The financial advantages of the buyout for JSG

* Prospects for JSG's key markets

* An analysis of JSG's future market prospects

ADDITIONAL RESOURCES:

* "The European packaging sector views an uncertain outlook," Solutions!, December 2002, p. 23

* JSG web site: www.smurfit.ie/

* Smurfit-Stone Container web site: www.smurfit-stone.com

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]