Smith (DS) (SMDS) Ordinary 10p

Potential bidder Mondi has confirmed it will not be making an offer for DS Smith. This follows an announcement earlier in the week that DS Smith had agreed to a proposed all-share combination with International Paper Company.

The shares fell 11.7% in early afternoon trading.

Company announcement (16th April 2024)

DS Smith and International Paper Company have agreed on deal terms that would combine the two groups. DS Smith investors would receive shares in the International Paper Company and own around 33.7% of the combined business.

The terms value DS Smith at £5.8bn, or 415p per share based on prices on 25 March. After a four-year integration period, the combination is expected to deliver annual pre-tax savings of at least £413mn.

The deal will require shareholder and regulatory approvals and is expected to be completed by the end of the year. In connection with the deal, International Paper Company is expected to issue a London listing of its shares.

Our view

Deal talk has been dominating the news recently, and with Mondi out of the race, DS Smith is looking to press on with US-based International Paper. Terms of the proposed combination look largely in line with recent expectations, but markets are a little unhappy that no improved offer came from Mondi.

Medium-term savings of around £413mn certainly look attractive, significantly higher than what investors had been discussing in the early days of deal speculation. There’s a lot of scope to drive efficiency gains, from integrating plants and sharing technology to using the new combined scale to push for better terms with raw material suppliers. To us, the deal makes a lot of sense.

But as ever, it’s not a done deal until both shareholders and regulators give the green light. Back to business, DS Smith's resilience in tough conditions has allowed it to mitigate some of the macroeconomic headwinds currently faced by its customer base.

The group's a key supplier of cardboard boxes to the e-commerce and consumer goods sectors, including 'shelf-ready' options for supermarkets. Looking further ahead, demand for these segments is benefitting from structural growth drivers—consumers are keen to shift away from plastic packaging, and reliance on e-commerce is a trend that's here to stay.

Input costs have been falling, but the latest trading update confirmed that volume declines over the first half and lower prices have caused revenue to fall. The good news is cost savings have absorbed some of the impact, so operating margins shouldn’t be affected in a major way and volumes picked up toward the back end of the year.

We're cautiously optimistic that volumes will continue to improve. There are early signs that customers, like Amazon, are back in the market after reducing packaging levels last year to cope with lower end-consumer demand. We’re also starting to see easier comparable periods acting as a tailwind.

Looking at the balance sheet, despite the increase in net debt levels, 1.7x cash profits is still a level we're comfortable with. The lack of cash generation seen in the first half was disappointing but we're hopeful that this was a blip rather than a trend. It's something to keep an eye on though.

DS Smith is in a good position with exposure to attractive end markets and we continue to like the business. The valuation will now likely be led by developments with the International Paper deal. In these situations, there’s always added risk, with upside in the short term likely to be limited by the implied deal price.

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