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Market Update

International Paper's Hostile Acquisition of Temple-Inland Makes Strategic Sense

We believe the company could squeeze $200 million-$300 million of cost synergies from a combined organization.

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On Monday,  International Paper (IP) made a hostile offer to acquire  Temple-Inland (TIN) for $30.60 per share. The valuation is roughly 8 times enterprise value to our estimated 2011 EBITDA, which is roughly in line with  Silgan's (SLGN) recent acquisition of Graham Packaging (GRM). Should IP be successful in acquiring Temple-Inland, we think it will be able to reap significant cost synergies. However, we believe Temple-Inland may put up a fight and regulators will probably take a close look, which leads to uncertain timing around the proposed transaction.

Subsequent to IP's press release notifying investors of the bid, Temple-Inland rejected the unsolicited takeover proposal via a press release of its own. While we believe a merger of North America's largest and third-largest corrugated packaging companies is a strategically sound move that should generate significant synergies, IP may be forced raise its bid and may run into antitrust issues, since the combined firm will control almost 40% of North America's containerboard supply.

On May 17, International Paper verbally contacted Temple-Inland's chairman regarding a potential acquisition. Thereafter, the firms communicated via a phone call, an in-person meeting, and a few letters. Temple-Inland, which used  Goldman Sachs (GS) as a financial advisor and Wachtell, Lipton, Rosen & Katz as legal counsel, formally rejected the $30.60 offer on Saturday via a letter to International Paper.

Temple-Inland says the IP offer grossly undervalues the company and its prospects. It believes that the timing is quite opportunistic and that its earnings will improve in the coming years as a result of Box Plant Transformation II and an eventual rebound in the housing sector, which would benefit the firm's building materials segment.

There is also dispute regarding the likelihood of passing regulatory approval. The combined firm would control almost 40% of the North American containerboard market. IP CEO John Faraci is confident that the government will approve the merger, while Temple-Inland CEO Doyle Simons thinks that since the combined entity would have almost twice the market share as the number-two player, the merger would face serous regulatory issues. We believe regulators are likely to approve the merger. The key reason for our belief is that in 2009 another packaging company,  Ball (BLL), successfully acquired several  Anheuser-Busch InBev (BUD) plants, bringing its North American share of the aluminum beverage can market to 40%.

International Paper is no stranger to large-scale containerboard acquisitions. In 2008, it acquired  Weyerhaeuser's (WY) containerboard business. That acquisition delivered $500 million of synergies on about $5 billion of revenue. A combination with Temple-Inland would generate additional synergies from overhead reductions, operational optimizations, and sharing of best practices. While IP didn't want to put a figure on its anticipated synergies from a Temple-Inland deal, we believe the company could squeeze $200 million-$300 million of cost synergies from a combined organization.

We are placing Temple-Inland and International Paper under review while we further assess the impact of the proposed deal. However, we expect to increase our fair value estimate for both firms.

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Thomas Mullarkey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.