Mergers and acquisitions : the case of Portucel and AMS





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ABSTRACT

In pulp and paper industry, growing by acquisition is very common due to production capacity constraints.

Portucel Soporcel group is one of the biggest players within the Portuguese industry, known for having large forestry nurseries, and producing both pulp and office paper. However, with the declining demand of this kind of paper due to digitalization, Portucel needed to diversify its production. Therefore, Portucel decided to enter in the tissue paper market, by acquiring the most efficient manufacturer in the Iberian Peninsula: AMS-BR Star Paper. The goal wasn’t merely to be the owner of this factory, but to use their know-how to replicate its business model in Portucel’s plants.

This acquisition was announced in February 2015 and five months later was performed, with a purchase price of 80M, in which an unknown portion was meant to finance a project that was being undertaken at the time. This dissertation evaluates both companies and the synergies involved in the deal, in order to estimate the suitable purchase price and compare it to the real one.

After valuing both companies with DCF-WACC and relative valuation methodology, it is concluded that AMS has an equity market value of 33M€ and that synergies amounts 63M€, thus the acquisition price recommended is 77M€, paid all-cash.

Na indústria da pasta e do papel, crescer pelo meio de aquisição é bastante comum, dada a capacidade produtiva limitada.

O grupo Portucel Soporcel é um dos maiores produtores da indústria a nível nacional, e é conhecido por possuir consideráveis viveiros florestais, e pela produção de pasta e papel de escrita. Contudo, com a diminuição da procura deste tipo de papel, devido à digitalização, a empresa sentiu a necessidade de diversificar a sua produção. Assim, a Portucel decidiu entrar no mercado de papel tissue, através da aquisição da AMS-BR Star Paper, tida como o produtor mais eficiente da Península Ibérica neste sector. Contudo, o objectivo não era apenas ser proprietário de uma empresa produtora de tissue, mas usar o know-how que esta

empresa pode facultar, para mais tarde replicar o modelo de negócio nas outras fábricas da Portucel.

A aquisição foi anunciada em Fevereiro de 2015, e cinco meses depois, estava a ser concretizada por um preço de 80M€, em que certa parte destinava-se para o financiamento de um projecto em desenvolvimento. Esta dissertação avalia ambas as empresas e as sinergias provenientes da aquisição, com o objectivo de calcular o preço de aquisição recomendado, e posteriormente, compará-lo ao verdadeiro.

Depois da avaliação de ambas as empresas, através da metodologia DCF-WACC e do método dos múltiplos, foi concluído que a AMS tem um valor de mercado de 33M€ e que as sinergias somam um valor total de 63M€. Deste modo, o preço recomendado foi de 77M€, através de cash.

ACKNOWLEDGMENTS

I would like to express my profound gratitude and respect to my supervisor: Professor António Borges de Assunção, for his patient and availability through the whole time this dissertation was being written. His encouragement and insightful comments were also fundamental to complete this dissertation.

I am also very grateful to AMS company, for disclosing information, that was essential to write this dissertation.

I want also to express my most sincere gratitude to my parents: to my mother, for raising me and support me in the most difficult moments of my life; and to my father for inspiring me and giving me advice when I need the most. I have a special thanks to my sister, for being the first and the best teacher that I ever had, and to her husband, for making me believe in my capabilities. I am also very grateful to my grandparents: my grandmother for teaching me the first concepts of math, and let me be her biggest pride; and to my grandfather, for being the great person that I hope to become. I have also a special thanks to Elisabete, for being always available, even in the most inappropriate hours.

I would also like to express my deep gratitude to all my friends: Cátia, for being always there for me; Lamy, for the continuous encouraging through the dissertation; Laura, for being the best companion through the master degree; Carlos, Laurindo, Paulo and his girlfriend, Susana and her sister, and Vladimira for their true friendship and for the times we have spent together.

And at last, but not least, I have special thanks to Luna, for being part of my life for beautiful thirteen years. May her soul rest in peace.

LIST OF CONTENTS

1. INTRODUCTION ... 16

2. LITERATURE REVIEW ... 17

2.1 VALUATION ... 17

2.1.1 DISCOUNTED CASH FLOW (DCF) ... 17

2.1.1.1 WACC BASED APPROACH ... 18

2.1.1.2 ASSET LIFE ... 21

2.1.2 ADJUSTED PRESENT VALUE (APV) ... 22

2.1.3 MULTIPLES VALUATION ... 23

2.2 MERGERS AND ACQUISITIONS (M&A) ... 24

2.2.1 TYPES OF M&A ... 24

2.2.1.1 ACQUIRING A PRIVATE COMPANY ... 25

2.2.1.2 ACQUIRING IN DOMESTIC MARKET ... 25

2.2.2 PREMIUM ... 26

2.2.3 SYNERGIES ... 27

2.2.3.1 TYPES OF SYNERGIES ... 27

2.2.3.2 VALUATION OF SYNERGIES ... 29

2.2.4 METHODS OF PAYMENT ... 29

2.2.5 POST MERGERS STUDIES ... 30

3. INDUSTRY AND COMPANY APPRAISAL ... 31

3.1 PULP AND PAPER INDUSTRY ... 31

3.1.1 PULP SECTOR ... 32

3.1.2 PAPER & BOARD SECTOR ... 32

3.1.3 INDUSTRY MAJOR PLAYERS ... 34

3.1.4 M&A IN PULP & PAPER INDUSTRY ... 35

3.2 PORTUCEL ... 37

3.2.1 OVERVIEW ... 37

3.2.2 BUSINESS AREAS ... 37

3.2.4 FINANCIAL INFORMATION ... 39 3.3 AMS ... 41 3.3.1 OVERVIEW ... 41 3.3.2 BUSINESS AREAS ... 42 3.3.3 SHAREHOLDER STRUCTURE ... 42 3.3.4 FINANCIAL INFORMATION ... 43

3.4 CONCLUSION & DEAL RATIONALE ... 44

4. STANDALONE VALUATIONS ... 46 4.1 PORTUCEL VALUATION ... 46 4.1.1 REVENUES ... 46 4.1.2 EXPENSES ... 50 4.1.3 CAPEX ... 51 4.1.4 DEPRECIATION ... 52 4.1.5 NWC ... 52 4.1.6 TAXES ... 53

4.1.7 COST OF CAPITAL: WACC ... 54

4.1.8 OTHER ASSUMPTIONS ... 55 4.1.9 RESULTS ... 55 4.1.10 RELATIVE VALUATION ... 56 4.2 AMS VALUATION ... 56 4.2.1 REVENUES GROWTH ... 57 4.2.2 EXPENSES ... 57

4.2.3 CAPEX AND DEPRECIATION ... 58

4.2.4 NWC ... 60

4.2.5 TAXES ... 61

4.2.6 COST OF CAPITAL: WACC ... 61

4.2.7 OTHER ASSUMPTIONS ... 62

4.2.8 RESULTS ... 62

4.2.9 RELATIVE VALUATION ... 63

5. MERGED COMPANY VALUATION ... 64

5.2 VALUATION WITH SYNERGIES... 64

5.2.1 CACIA’S TISSUE PAPER PROJECT ... 65

5.2.2 OPERATING SYNERGIES ... 68

5.2.3 RESULTS ... 69

5.3 TRANSACTION ASPECTS ... 69

6. POST-MERGER ANALYSIS ... 71

6.1 REAL CASE ... 71

6.2 AFTER THE ACQUISITION ... 71

7. CONCLUSION ... 73

8. APPENDICES ... 74

LIST OF APPENDICES

APPENDIX 1: Portucel Consolidated Income Statement (Portucel’s Annual Reports) ... 74

APPENDIX 2: Portucel Consolidated Statement of Financial Position (Portucel’s Annual Reports) ... 75

APPENDIX 3: Expectations of the global price of wood pulp (source: IBISWorld) ... 76

APPENDIX 4: European cut size and total uncoated freesheet demand forecast by country and region (source: Portucel) ... 76

APPENDIX 5: Expected growth in salaries in Portugal (source: Portuguese Public Finance Council) ... 77

APPENDIX 6: Portucel income statement forecast ... 77

APPENDIX 7: Portucel DCF valuation ... 78

APPENDIX 8: AMS Income statement (AMS annual reports) ... 78

APPENDIX 9: AMS balance sheet (AMS annual reports) ... 79

APPENDIX 10: interest coverage ratio and default spread (Damodaran, 2014) ... 80

APPENDIX 11: AMS income statement forecast ... 80

APPENDIX 12: AMS DCF valuation ... 81

APPENDIX 13: Combined income statement without synergies ... 82

APPENDIX 14: Combined WACC ... 82

APPENDIX 15: Combined DCF valuation without synergies ... 83

APPENDIX 16: Combined income statement with synergies ... 84

APPENDIX 17: Combined DCF valuation with synergies ... 85

APPENDIX 18: Combined valuation with total synergies ... 85

LIST OF TABLES

TABLE 1: Portucel’s Key Financial Statistics [Source: Portucel’s Annual Report (2014)]

... 39

TABLE 2: Portucel’s Key Ratios [Source: Portucel’s Annual Report (2014)] ... 40

TABLE 3: AMS’ Key Financial Statistics [Source: AMS’ Annual Report (2014)] ... 43

TABLE 4: AMS’ Key Ratios [Source: AMS’ Annual Report (2014)] ... 44

Table 5: Revenues Growth ... 46

TABLE 6: Costs ... 51

TABLE 7: Capex ... 51

TABLE 8: Depreciation ... 52

TABLE 9: NWC ... 53

TABLE 10: Tax ... 53

TABLE 11: Portucel’s WACC ... 54

TABLE 12: Sensitivity Analysis ... 55

TABLE 13: Portucel's relative valuation... 56

TABLE 14: Revenues growth ... 57

TABLE 15: Costs ... 58

TABLE 16: Depreciation & CAPEX ... 59

TABLE 17: NWC ... 60

TABLE 18: AMS WACC ... 62

TABLE 19: AMS' sensitivity analysis ... 62

TABLE 20: Relative valuation ... 63

TABLE 21: Cacia’s tissue paper project with ams... 66

LIST OF FIGURES

FIGURE 1: Adjusted Present Value Fundamental Idea (Luehrman, 1997) ... 23

FIGURE 2: “What’s The True Value of an Acquisition” (Eccles Et Al., 1999) ... 26

FIGURE 3: Industry Consolidation Life Cycle (Deans Et Al., 2002) ... 36

FIGURE 4: Pulp and Paper Production [Source: Portucel’s Annual Report (2014)] ... 38

FIGURE 5: Portucel’s Shareholder Structure [Source: Portucel’s Annual Report (2014)] ... 39

FIGURE 6: Historical Daily Price [Source: Eikon Reuters Terminal] ... 40

FIGURE 7: AMS Shareholder Structure At 01-01-2014 [Source: AMS’ Annual Report (2014)] ... 42

FIGURE 8: AMS Shareholder Structure at 31-12-2014 [Source: AMS’ Annual Report (2014)] ... 43

FIGURE 9: Foretry revenues growth ... 47

FIGURE 10: Pulp revenues growth ... 48

FIGURE 11: Graphic paper revenues growth ... 49

FIGURE 12: Energy revenues growth [source: tradingecomomics.com – Eurostat] ... 50

LIST OF EQUATIONS

EQUATION 1: The Basic Logic of DCF Valuation (Luehrman, 1997) ... 17

EQUATION 2: Free Cash Flow To Firm (Damodaran, 2002) ... 18

EQUATION 3: The Basic Logic of DCF Valuation (Luehrman, 1997) ... 18

EQUATION 4: Weighted-Average Cost of Capital Formula (Luehrman, 1997) ... 18

EQUATION 5: Estimating Synthetic Ratings (Damodaran, 2001) ... 19

EQUATION 6: Estimating Cost of Equity (CAPM) ... 19

EQUATION 7: Estimating Beta (CAPM) ... 20

EQUATION 8: Adjusted beta (Damodaran, 1999) ... 20

EQUATION 9: Accounting Beta (Damodaran, 2002)... 20

EQUATION 10: Estimating Terminal Value ... 21

EQUATION 11: Estimating Reinvestment Rate ... 22

EQUATION 12: Estimating Growth Rate Using Reinvestment Rate ... 22

EQUATION 13: Most Common Multiples (Férnandez, 2001) ... 24

LIST OF ABBREVIATIONS

AfH Away from Home

AICEP Associação Internacional das Comunicações de Expressão Portuguesa APV Adjusted Present Value

BEKP Bleached Eucalyptus Kraft Pulp

BS Balance Sheet

CAPEX Capital Expenditure

CEPI Confederation of European Paper Industries

CF Cash Flow

CISC Cost of Inventories Sold and Consumed CMSC Cost of Materials and Services Consumed D Market Value of the Firm’s Debt

DCF Discounted Cash Flow

E Market Value of the Firm’s Equity

e.g. Exemplī grātiā

EBIT Earnings Before Interest and Taxes

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization

EPS Earnings per Share

EPS Earnings Per Share

EU European Union

EV Enterprise Value

EV/EBIT Enterprise Value to EBIT ratio EV/EBITDA Enterprise Value to EBITDA ratio EV/Sales Enterprise Value to Sales ratio FCFF Free Cash Flow to Firm GDP Gross Domestic Product

ha Hectare

HORECA Hotel/Restaurant/Café

IAS International Accounting Standards ICO Industria Cartone Ondulato

IMF International Monetary Fund IMF International Monetary Fund

IRC Imposto sobre o Rendimento das pessoas Colectivas (income tax) LPC London Pharma & Chemicals group

MTP Meet the Premium

NPV Net Present Value

NWC Net Working Capital

p.p. Percentage Point P/B Price to Book ratio P/E Price Earnings ratio P/E Price to Earnings ratio

PALOP Países Africanos de Língua Oficial Portuguesa (Lusophone Africa) PPE Plant, Property and Equipment

Rd Cost of Debt

Re Cost of Equity

Rf Risk Free Rate

Rm-Rf Risk Premium

ROE Return on Equity

ROIC Return on Invested Capital SCA Svenska Cellulosa Aktiebolaget

SG&A Selling, General and Administrative Expenses SVAR Shareholder Value at Risk

SynC Cost Synergies

SynR Revenue Synergies

T Tax Rate

TV Terminal Value

UK United Kingdom

US United States

WACC Weighted Average Cost of Capital WWF World Wide Fund for Nature

1. INTRODUCTION

This dissertation intends to focus on a specific aspect of Corporate Finance: Mergers and Acquisitions (M&A). Therefore, it analyzes the acquisition process that occurred in June 2015, between Portucel S.A. – one of the largest pulp and paper producer in Portugal - and AMS BR Star Paper S.A. – a tissue paper manufacturer.

In every M&A, the aim is to combine companies’ different capabilities in order to become more efficient and offer the best competitive price. By acquiring AMS, Portucel hoped to gain knowledge about the tissue paper, a business area in which Portucel intends to enter. Nevertheless, consolidating the strengths of these two Portuguese players will result in more value creation than that. Thus, the goal of this dissertation is to analyze this acquisition and understand the possible financial and strategic reasons behind this deal, as well as the eventual synergies.

Since the acquisition process started in February 2015, most of the work developed in this dissertation will consider the present time to be December 31st of 2014, so that the data used will concern the end of the year previous to the operation.

The dissertation will be structured into five different parts. Firstly, a literature review that will provide the theoretical framework for the work that will then follow. Secondly, an explanatory section about the pulp and paper industry and the historical performance of both companies. In the third section, will take place the standalone valuations of both companies, together with the explanation of the main assumptions taken and the results achieved. The fourth section will present the valuation of both companies together, both with and without the possible synergies that can arise from the deal. In the last section the main conclusions are discussed together with a critical evaluation of the real acquisition.

2. LITERATURE REVIEW

Before analyzing the particular acquisition, in which this dissertation focus, it is important to understand how the analysis procedures would be developed; what the main findings in acquisition’s evaluations are; and find solutions for some possible upcoming concerns during this study.

2.1 VALUATION

In order to make a good acquisition, it’s imperative to know the fair price to offer for the target company. For that reason, an accurate valuation shouldn’t be disregarded, especially when the firm being acquired is private, as in this particular case.

Luehrman (1997) describes the valuation of a company as something that is dependent of three main factors: cash, timing and risk.

It is important to note that a well-done valuation supposes that no accounting trick must be taken into consideration, with the purpose of estimating the true firm value. Unfortunately, sometimes, that doesn’t happen once the target-company tries to overestimate the value of their assets using creative accounting (Cullinan et al., 2004).

2.1.1 DISCOUNTED CASH FLOW (DCF)

The most used approach when making a valuation is the Discounted Cash Flow (DCF) method (Bruner et al., 1998). The reasoning behind DCF is associated with the time value of money, once it lies on a connection between present and future value (Luehrman, 1997):

EQUATION 1: The Basic Logic of DCF Valuation (Luehrman, 1997)

In order to get a proper evaluation, is necessary to get the right cash flows, which means, the amount of cash that a company possess, after have paid all expenses - i.e. available to

both equity investors and debt holders. This type of cash flow is known as Free Cash Flow to Firm, and can be obtained in the following manner, according to Damodaran (2002):

EQUATION 2: Free Cash Flow To Firm (Damodaran, 2002)

In order to run a DCF valuation, we have to, as the name suggests, discount to present value, the expected cash flows projections, at a particular discount rate (Luehrman, 1997).

EQUATION 3: The Basic Logic of DCF Valuation (Luehrman, 1997)

The discount rate should be based on the historical riskiness of both the firm and its industry (Kaplan et al., 1996), and that’s why the most common DCF approach uses Weighted Average Cost of Capital (WACC) as discount rate.

2.1.1.1 WACC BASED APPROACH

The Weighted-Average Cost of Capital is widely used as discount rate, since it takes into consideration the after-tax cost of different sources of capital, weighted proportionately by its market capital structure (Luehrman, 1997):

EQUATION 4: Weighted-Average Cost of Capital Formula (Luehrman, 1997)

In order to compute WACC, it is needed some components such as: corporate tax rate (t), cost of equity (Re); cost of debt (Rd) and the portion of both debt and equity in the company value.

However, it is important to note that the weights of debt or equity must be measured in market terms and not book values, once this is one typical mistake, managers do when using WACC, according to Luehrman (1997). Another pitfall that they usually fall into,

according to Bruner et al., (1998), is to make risk adjustments to WACC, whether these adjustments should be made in cash flows and not in the discount rates.

Below, follows a deeper look on WACC components.

COST OF DEBT (Rd)

Cost of debt must reflect the current market rate that the company pays on its debt. Which means that, according to Damodaran (2001), the cost of debt should be measured as the yield to maturity (YTM) on long-term bonds, assuming that the company has bonds outstanding and that these are traded. However, if this assumption doesn’t verify, is also possible to estimate the typical default spread on bonds, considering the rating of the firm. If the firm isn’t rated, there are two different ways to compute cost of debt, according to Damodaran (2001): the first one relies on using the interest rate of the last long-term debt borrowed from a bank. The second approach suggests using a synthetic rating in order to get the default spread and consequently the cost of debt. This synthetic rating can be deduced through the interest coverage ratio (Damodaran, 2001):

EQUATION 5: Estimating Synthetic Ratings (Damodaran, 2001)

Note that the cost of debt that should be taking into account is the one after tax, once interest payments are tax deductible.

COST OF EQUITY (Re)

Cost of equity is the rate of return required by firm’s equity investors (Damodaran, 2001). CAPM, which is the preferred model to estimate equity cost according to Bruner et al. (1998), considers that the cost of equity depends on three different constituents such as: return on risk free (Rf), equity beta () and the market risk premium (Rm-Rf). Using these

components, cost of equity can be computed as follows:

Risk free rate can be represented as Rf, and is the component, from cost of capital, that

represents time value (Luehrman, 1997). Risk free rate can be defined as the return on a risk-free investment, being the last, an investment where the expected return is known with certainty (Damodaran, 2008).

BETA ()

The equity beta evaluates the risk of the company’s stock, in comparison to other risky assets (Bruner et al., 1998). It can be estimated by running a regression of stock returns against the market returns, according to CAPM.

EQUATION 7: Estimating Beta (CAPM)

Damodaran (1999) suggests adjusting regression betas, since the obtained beta can be biased, due to different available choices regarding the time period chosen. Bloomberg technique of smoothing beta is the following:

EQUATION 8: Adjusted beta (Damodaran, 1999)

Beta can also be obtained from published sources, and in that case the best estimation practice is using judgment, according to Bruner et al. (1998).

For private firms, it is possible to use accounting earnings information in order to compute beta. Damodaran (2002) suggests building a regression of the changes in the private firm earnings, against the changes in some appropriate equity index earnings:

In this case, the slope of the regression (b) will be the beta of the firm. Note that the type of beta given will depend on the earnings used in the equation: if operating earnings is used, then it would result in an unlevered beta, while if net income is used, a levered beta will be obtained (Damodaran, 2002).

RISK PREMIUM (Rm-Rf)

Market risk premium (Rm-Rf) represents the extra return that an investor expects to earn

considering the additional risk they have to bear (Bruner et al., 1998) and (Luehrman, 1997).

Damodaran (2015) suggests three different forms to obtain the market risk premium. The first relies on conducting a study in order to access investors’ expectations about equity returns. The second method predicts the risk premium through the historical equities returns in relation to riskless investments. The third method is based upon the present market prices to estimate the expected premium.

2.1.1.2 ASSET LIFE TERMINAL VALUE

Terminal value is the estimated value of the firm at some point in the future, taking into account everything after the terminal horizon (Luehrman, 1997). In order to identify ongoing free cash flows, a perpetuity growth model should be used in the following manner: the last year cash-flow should be divided by the result of subtraction between discount rate and growth rate (Luehrman, 1997). This considers that the terminal free cash flow would grow at a constant rate in perpetuity (Kaplan et al., 1996).

EQUATION 10: Estimating Terminal Value

The growth rate is a fundamental component of the valuation, that tends to be disregarded by managers. As result, they tend to make overoptimistic projections, leading to high growth rates and overvalued firms (Damodaran, 2008).

In order to have unbiased valuation, estimating a proper growth rate is essential. Damodaran (2008) suggests three different methods. First approach relies on historical growth rates. The second one uses the growth rate estimated by the equity research analysts of the firm. The third method, which is the most accurate according to the author, relies on forecasting the growth rate taking into consideration two fundamentals of growth: the growth from new investments and the quality of the reinvestments. The first one can be obtained through the reinvestment rate and its return:

EQUATION 11: Estimating Reinvestment Rate

The second component can be defined as the growth resulting from managing investments in a more efficient manner, and can be estimated in the following way:

EQUATION 12: Estimating Growth Rate Using Reinvestment Rate

2.1.2 ADJUSTED PRESENT VALUE (APV)

Luehrman (1997) considers that WACC-based method is obsolete, since it is only appropriate for simple firms with static capital structures over the long run. The best method then, according to Luehrman (1997), relies on the principle of value additivity by using the DCF approach to value separately each kind of cash flow, in order to analyze financial maneuvers individually, such as interest tax shields, costs of financial distress and others. WACC, in contrast, considers all financing side effect together in the discount rate (Luehrman, 1997).

APV valuation can be split into five steps. The first one is elaborate the forecasts, followed by discounting the cash flows. Thirdly, an evaluation of the financing side effects is mandatory. Next, all the pieces should be added together, followed by the last step which is tailor the analysis (Luehrman, 1997).

2.1.3 MULTIPLES VALUATION

This kind of valuation estimates the value of a company using transaction multiples from its comparable firms, through one particular performance measure (Kaplan et al., 1996). According to Fernández (2001), multiples can be divided into three different groups: equity value multiples - based on the capitalization of the company; equity value and debt value multiples - based on the value of the company; and growth-reference multiples - based on growth considering the firm’s history, the market and the industry.

However, it is important to note that multiples valuation in order to be an accurate measure, two crucial assumptions should be verified. The first assumption claims that the comparable company should have the same level of risk and identical cash flows’ growth rate as the firm being valued. The second assumes that the valuation of the company should vary in proportion of the change of the performance measure (Kaplan et al., 1996).

The most commonly used multiples according to Fernández (2001) are the following: FIGURE 1: Adjusted Present Value Fundamental Idea (Luehrman, 1997)

EQUATION 13: Most Common Multiples (Férnandez, 2001)

Still, there are also some issues regarding the multiples valuation: their dispersion and their parameters’ volatility (Fernández, 2001).

2.2 MERGERS AND ACQUISITIONS (M&A)

Mergers and Acquisitions (M&A) have become a trend, once it is an accessible way for companies to grow. As a result, a lot of people have debriefed this topic, investigated and developed a lot of studies in the broad areas of this matter.

Plus, it is important to notice that M&A are much more than evaluating a firm and acquiring it. Effective acquires realize that they aren’t just buying financial statements, but also a huge range of capabilities (Cullinan et al., 2004).

2.2.1 TYPES OF M&A

M&A can be described as a very broad concept once it can take many different forms. According to Damodaran (2002), there are five different ways of making an acquisition: it can be a merger, which means that the target firm gets incorporated in the acquiring firm. It can also be a consolidation, where both firms - target and acquiring firm - conceive a new firm. It may take the form of a tender offer, in which, as long as discordant shareholders exists, the target firm endures. When all shareholders agree upon the acquisition, tender offer ultimately transforms into a merger. The fourth type of M&A is the acquisition of assets, where all the assets of the target company are bought by the acquiring firm. In a near future, the target firm ends up being liquidated. The last form of M&A is the buyout, in which the target firm is bought by its own managers and external investors.

It is also important to make the distinction between horizontal and vertical mergers: the first one concerns acquisitions within the same business, whereas the second one regards acquisitions within different kinds of businesses (Damodaran 2005).

Regarding the various forms of acquisitions, is also important to enlighten some particular scenarios in which this dissertation fits. These specific situations will be analyzed beneath.

2.2.1.1 ACQUIRING A PRIVATE COMPANY

In this particular acquisition, the target firm - AMS - is a private company, which means that there are some important concerns to be aware of.

Being private implies having higher cost of equity capital, once this kind of companies don’t have access to a large pool of capital known as equity public markets (Wruck, 2008). Considering these capital constraints, private firms can likely be better targets than publicly traded firms, since these firms are able to succeed under these tighter conditions (Damodaran, 2005).

Being a private company has also implications regarding the premium paid during the acquisition. Not knowing the actual market price of the target company, will influence the price offered, since the acquirer can make an offer equal to the target company intrinsic value, which means that no premium is paid (Eccles et al., 1999). Moreover, this is also a feature that makes private held companies more desirable, since market price may already include the value of synergy. This can lead managers to pay twice as much the value of synergies, and consequently overvaluing public companies. In the other hand, when acquiring a private firm, it is less likely having this market bias included (Damodaran, 2005).

2.2.1.2 ACQUIRING IN DOMESTIC MARKET

There are also concerns regarding whether the acquisition is performed in the domestic market or not. If an acquisition is local, then investors aren’t betting on risk diversification, once losses and profits will also be strongly related to the local market (Bruner, 2004).

When companies tend to acquire other firms from the same domestic market, in order to compensate for the risk, the profitability of the deal is focused on strategic choices, such as market share increase, firm’s diversification and growth (Bruner, 2004).

2.2.2 PREMIUM

The price of an acquisition is a very complex element, in which estimating the value of the target company isn’t enough. Moreover, it establishes whether the acquisition is destroying or increasing the value for the acquirer (Damodaran, 2005). According to Eccles et al. (1999) the true value of an acquisition can be structured into four different layers.

FIGURE 2: “What’s The True Value of an Acquisition” (Eccles Et Al., 1999)

The lower one is the intrinsic value, which represents the value of the company. The following layer is the market value. The difference in value between these two first layers reflects the premium added by the market, also known as market capitalization and reflected on the share price. This also corresponds to the accountant’s estimate of goodwill, once it represents exclusively the difference between market and book value (Damodaran, 2005). The third tier is the purchase-price that already contains the extra value demanded by the target firm shareholders. The difference between this layer and the intrinsic value is also known as the value gap. Finally, the last tier is the synergy value. The additional worth that this layer brings, is the value targeted to acquirer shareholders. This extra value embodies all the net present value of the possible cash flows, resulting from the union of both companies.

Noteworthy is also the fact that, there is no evidence regarding the relationship between the size of the premium and future firm returns, according to a piece of research elaborated by Eccles et al. (1999).

2.2.3 SYNERGIES

Damodaran (2005) defines synergy as the extra value created by bringing together the capabilities of two firms, taking into account that both companies couldn't generate it in an independent way.

Synergies are usually the driving force to enter in an acquisition process, since acquiring firm’s strategy is essentially based on them (Bruner, 2004).

It is also important to note that these synergies cannot be taken for granted, since in order to achieve them companies usually incur in a financial cost, according to the “synergies matching principle” (Sirower et al., 2006). Thus the value of the synergy should be computed taking into account the costs, in both cash and time, associated to its accomplishment.

Given the complexity of computing synergies, some companies prefer to ignore them rather than base an acquisition on untrustworthy values. However, such approach can be detrimental. To dodge this problem, firms may consider using a due diligence process in order to tell apart between the different types of synergies; estimate them and their probability of attainment. Note that this due diligence should also consider the negative synergies of the acquisition (Cullinan et al., 2004).

2.2.3.1 TYPES OF SYNERGIES

Synergies can be classified in many different ways. Cullinan et al. (2004) suggests that synergies should organized by its source, resulting in four different classifications: firstly, synergies that come from eradicating repeated activities; secondly cost savings from erasing shared operations costs; savings from facilities restructuring; and lastly synergies from having new channels to leak firm’s production.

However, according to Bruner (2004), synergies should be divided into three different kinds: “cost savings”, “revenues enhancements” and “financial synergies”.

These five types of synergies will be now individually addressed according to Eccles et al. (1999):

“Cost savings” come from eradicating all the activities that are no longer needed after the consolidation of the firms or from economies of scale achieved with the deal, therefore these synergies tend to be higher when the deal is made within the same country and industry.

“Revenue enhancements” comes from selling more or exercising higher prices as a combined firm compared to both operating standalone. However, these aren’t easy to estimate, once post-merger reactions may be unpredictable.

“Process improvements” comes from the transferal of efficient practices and competencies between both companies. Frequently, this kind of synergy plays an important role on the strategic rational of the deal, since the acquirer may be interested in some special skill that the target possesses, or vice-versa.

Most “financial engineering” synergies happen due to the enlarged size of the new company formed after the acquisition. This newly increased firm is able to easily meet financing requirements, benefit from surplus cash, offset currency positions and refinance debt at a better borrowing rate. If the acquisition was financed with a loan, then the firm will also benefit from a lower WACC. Still, this is no good motive to enter a deal (Eccles et al., 1999).

The last type is “tax benefits”. Note that these tax advantages couldn’t be reached by each firm individually. These aren’t easy to identify and is important to discriminate between “tax structuring” and “tax engineering” (Eccles et al., 1999). The first concept allows the enforceability of the deal, whether the second ensures that the tax rate of the combined firm is equal or lower than both tax rates combined afore the deal.

Damodaran (2005), on the other hand, acknowledge only two types: operating and financial synergies. The first kind is thenceforth split into four categories: economies of scale, larger pricing power, additional functional strengths and market growth. Conversely, financial synergies parts into three different kinds: increased debt capacity, tax benefits and diversification – e.g. when a public traded firm acquire a private business, since investors from the latter can diversify at a lower cost and with less difficulty (Damodaran, 2005).

2.2.3.2 VALUATION OF SYNERGIES

In order to impact the value of the deal, synergies should affect at least one of the components of the valuation process: cash flows, growth length, growth rates and cost of capital (Damodaran, 2005).

Synergies can’t all be valued in the same manner. Therefore, it will be distinguished two different methods to estimate them, according to their nature.

Damodaran (2005) suggests three steps to valuate operation synergies: first, value independently each firm involved in the deal, using DCF and WACC approach. Then, the previous results should be added together, in order to obtain the value of the combined firm without synergies. To conclude, the outcomes of the synergies should be included, which means reevaluating growth rates and cash flows. As result, the difference between the second and the third step should provide the value of operating synergies.

Contrariwise, financial synergies should be addressed individually and by its sources. Firstly, regarding tax benefits, the value of the synergy is the “present value of the tax savings” subsequent to the deal (Damodaran, 2005), such as those coming from higher depreciations. Lastly, regarding debt, the value of the synergy should be equal to the firm’s value increase, caused by the growth in debt capacity alone.

Besides these methods to evaluate synergies, managers often overpay for them (Damodaran, 2005). One of the most usual mistakes when valuing synergies is using an erroneous discount rate, since combined firm’s cost of capital is the one that should be used to discount synergies cash flows (Damodaran, 2005). Another common error is forgetting the negative synergies (Cullinan et al., 2004).

2.2.4 METHODS OF PAYMENT

Another important issue of M&A is the methods of payment, since, for instance, cash deals normally require debt to finance them, which compels firms to be disciplined regarding the interest payments (Sirower et al., 2006).

Plus, Bruner (2004) elaborated some studies proving that stock-based deals typically give negative returns to the buyer’s shareholders, whereas cash-based deals provide a range of returns from zero to positive. The author has also concluded that this effect intensifies along the size of the deals.

2.2.5 POST MERGERS STUDIES

Sirower et al. (2006) has concluded that the first reactions to the deal are suggestive of future returns; therefore is worthwhile to assess the deal profitability. To do so, investors’ required returns can be used as measurement benchmark. With that point of reference, there are three different possible results: whether the value is destroyed, preserved or created. In the first scenario, the return is less than the requirement by the investor, in the second, the investors earn just what they had required and, in the last case, the deal returned more than the required by the investor (Bruner, 2004). EPS can also be used as benchmark, if so lower EPS after the deal label it as dilutive, whereas higher earnings correspond to an accretive deal (Damodaran, 2005).

Furthermore, Bruner (2004) suggests three possible classifications for a lucrative deal: “weak form”, “semi-strong form” and “strong form”. The first is achieved when investors are better off than before, since the share price have increased. The second is attained when shareholders are in a more advantageous position than if they invested in a comparable investment, since their required return was surpassed. The last form is accomplished when shareholders are better off compared to a hypothetic situation where the deal didn’t take place (Bruner, 2004).

Damodaran (2005) suggests to stalk the new firm’s value after the deal, in order to confirm and evaluate the existence of the synergy:

EQUATION 14: “Market Acessments at Time of Merger” (Damodaran, 2005)

Where V(AB) is the value of the combined firm, V(A) and V(B) the value of each company operating independently.

3. INDUSTRY AND COMPANY APPRAISAL

This dissertation portrays a hypothetic view of the real acquisition between Portucel, S.A. and AMS BR Star Paper S.A. Since these two companies operate in the Pulp and Paper Industry, this section provides an overview of the referred industry, pursued by an analysis of both companies. The intention is to give some framework to the acquisition, in order to find the reasoning behind the deal.

3.1 PULP AND PAPER INDUSTRY

Pulp and Paper Industry is one of the largest industrial sector in the world, using 40%1 of all the wood traded globally. In Europe, for instance, in 2014, there were 628 companies2

and 920 mills2.

This vast industry can be split into two different sectors: Pulp and Paper & Board sector. In the pulp sector, the core business consists in the transformation of wood into pulp, which can in some cases involve the exploitation of forests. Afterwards pulp can be exported or used to produce paper.

Nonetheless, paper and board can be also produced using non-fibrous materials and recycled paper. As a matter of fact, in recent times, wood pulp has lost his leading place to recycled paper, as the most consumed raw material2 _{in paper production. This is only}

possible due to the increased awareness of sustainability concept. For instance, in Portugal, the recovery rate of recycling paper was 63%3 _{in 2013.}

Apart the raw material used, pulp is then transformed into paper. After produced, it can be exported or converted into different kinds of products: graphic paper, tissue paper, packaging board, and others.

Some companies in the industry produce both pulp and paper, exploiting vertical integration of the value chain activities.

1_WWF

3.1.1 PULP SECTOR

North America is the biggest pulp producer4 _{in the world, and Europe is the second largest.}

Within Europe, the largest producers are Sweden and Finland4_{. Still, in Europe,}

consumption of pulp is bigger than its production4_{, therefore this continent imports}

frequently from Latin America4_.

In Portugal, in 2011, Pulp industry’s turnover was 1.241M€5, and represented 1,2%5 of Portuguese exports. Portugal is the 3rd largest4 European producer of pulp, and approximately 70%5 of eucalyptus and pine wood for the industry is sourced in Portugal. Since 1992 to 2014, has been recorded a growth of 0,3%4 in pulp production. However, since 2007, pulp production has been decreasing4_.

It is expected that wood’s price will rise6, due to the increase in demand for woody biomass energy. As result, pulp production costs will be higher, and producers will only have two available choices: either increase the price or bearing lower margins. The first option is the riskiest, once paper producers could react to this increase by using less wood pulp in their production, taking into account the other raw materials substitutes.

The pulp sector can take advantage of some upcoming opportunities such as technological improvements, to increase resource efficiency. And also bioeconomy, which relies on using the entire potential of wood to produce a vast range of products such as textile, cosmetics, food, pharmaceuticals, fuels and chemicals et cetera.

Regarding the hurdles of pulp sector, trade barriers and protectionist subsidies7 _{by non-EU}

countries are creating uneven competition within the sector, affecting, namely, wood exports. Moreover, the high energy and gas prices in Europe7_{, set the sector at competitive}

disadvantage in a global scale.

3.1.2 PAPER & BOARD SECTOR

Paper segment adds 18B€4 _{to the European GDP and provides employment to 1,8M}4

people just in Europe. In Portugal, this sector represents 3,5%5 _{of all exports.}

4_{CEPI (2014) “Key Statistics: European Pulp and Paper Industry”}

5_{AICEP (2013) “Investing in Portugal Pulp & Paper Industry”}

6_{POYRY (2013) “Pulp Market in Transition”}

From 1992 to 2014 it has been recorded an increase in paper production of 1,5%8_.

However, since 2007, paper production has been decreasing8, replicating pulp production trend, mentioned above.

Identical to pulp sector, paper sector should also seize the opportunity concerning technological improvements, in order to increase resource efficiency, especially regarding water consumption and CO2 emissions, with the purpose of meeting the sector’s objectives

established by CEPI.

Within the paper segment it is possible to identify different kinds of products: tissue paper, graphic paper - uncoated sheet papers and coated printing papers – and paperboard. The last kind is used mainly to produce boxes and other containers, being therefore irrelevant for this dissertation and won’t be further scrutinized.

3.1.2.1 GRAPHIC PAPER

The demand of graphic paper, also referred to as office paper, has been decreasing over the last years. Since 2007 until 2012 it has dropped 2,5%9_{. From 2013 to 2014, the production}

dropped 3,1%8 _{and the consumption 1,4%}8_{. This decrease is mainly associated with a}

decline in usage of this kind of paper, due to the proliferation of digitalization.

3.1.2.2 TISSUE PAPER

Tissue paper is usually divided into the following types: toilet, facial, towel, napkin and others. However, the paper used in production should differ according to each type, since its end usage have specific quality requirements. Toilet paper is the most important type, once it accounts for 56,3%10 _{of the global consumption of tissue paper.}

Besides this classification, tissue paper can also be split into two categories: “At-Home” and “Away-from-Home” (AfH). The first kind concerns domestic purposes and represents more than three-quarters10 _{of global tissue consumption, whereas the second is intended for}

HORECA channel and accounts only for 23%10 _{of worldwide tissue consumption.}

8_{CEPI (2014) “Key Statistics: European Pulp and Paper Industry”}

Between 1993 and 2013, global consumption of tissue grew 3,4%11_{. In Portugal it has}

grown 7,4%11 between 1993 and 2003, and in the following ten years, it grew 1,5%11. From 2013 to 2014, tissue paper production has grown 0,4%12.

Despite this positive trend, growth rate was lower11 in 2009 due to the economy’s global recession. Nevertheless, tissue consumption isn’t very sensitive to cyclical variations in the economy, given that it is a necessity good and consequently a basic level of consumption is generally maintained. On the other hand, tissue paper’s demand is strongly correlated with population growth and other demographic changes.

Forecasts suggests that, between 2013 and 2023, the global demand of tissue paper will grow by an average of 3,6%11 _{annually, Western Europe by 1,5%}11 _{and Portugal by 2,6%}11_.

Tissue doesn’t normally face many substitution threats; though, it depends on the tissue segment at stake. For instance, the increasing demand for hand-drier machines and both textile and nonwoven wipers, is threatening the paper towels usage. In the others sectors of tissue, substitution effects aren’t so overwhelming. Still, a paperless toilet has been invented in Japan, but it didn’t gain much acceptance.

The main trend in tissue paper sector is towards higher quality products. Plus, customers are realizing that private labels aren’t synonym of “inferior quality” – over the past 10 to 15 years, the share of private labels has grown11 _{in Western Europe. Then again, in Portugal,}

in the last 2 to 3 years, it has declined.

Another noticed tendency is product extension. Renova showed to be already ahead, being responsible for one of the most well-known paper product extension: colored toilet paper.

3.1.3 INDUSTRY MAJOR PLAYERS

The biggest producer of paper in Europe is Germany13_{, responsible for almost one quarter}

of all European production. Following Germany, on the list of biggest paper producers, are both Sweden and Finland13_{, who are also the largest pulp producers, as mentioned before}

[3.1.1]. In fact, the largest European companies in the industry are Finnish and Swedish: Stora Enso (Finland), UPM-Kymmene (Finland) and Svenska Cellulosa Aktiebolaget

11_{Data provided by AMS Company (2014)}

12_{CEPI (2014) “Key Statistics: European Pulp and Paper Industry”}

(SCA) (Sweeden)14_{. These three companies produce both pulp and paper. In fact, SCA is}

also the biggest tissue paper supplier in Europe, having a capacity share of slightly less than 32%15. Still in terms of tissue paper, the second largest European firm is Sofidel Group (Italy), with a capacity share of 12,4%15. Apart from Europe, other major players in the tissue segment are Georgia-Pacific, known for “Colhogar” and also as office paper producer, and Kimberly Clark Corporation, known for “Scottex” and “Kleenex” brands. In Portugal, the major players in the pulp sector are Portucel Soporcel group – that will be addressed with more detail later on [3.2] - and Altri Group. Altri, who operates three pulp mills - Celbi, Celtejo and Caima -, is one of the most efficient16 _{eucalyptus pulp producers}

in Europe, exporting 90%16 _{of its production. Altri, whose turnover reached 543M€}16 _in

2012, manages 84K ha16 _{of forests and is also a producer of electrical power using biomass.}

Regarding the tissue paper segment, the key players are: Renova, AMS-BR Star Paper – that will be addressed with more detail later on [3.3] -, Suavecel Group and Pampilar. Fapajal, Natural and Socigene are also notable companies, but who only operate in the AfH sector.

Renova, the most remarkable, has a capacity share of 1,1%15 _{compared to all European}

producers. It took the tenth position in European ranking, after Gomà-Camps left the joint venture with AMS, that will be scrutinized later on [3.3.1.2]. Renova’s brand is available in more than 50 countries16_{, and is the European leader regarding the colored toilet paper}

segment.

3.1.4 M&A IN PULP & PAPER INDUSTRY

M&A is a path to follow when it becomes too expensive to obtain organic growth for a particular company. However, the need for M&A varies alongside firms’ life cycle. Deans et al. (2002) considered four different maturing stages: opening – emerging market requiring technology investments; scale – growing markets; focus – slow growth and characterized by a few companies taking off the market; balance and alliance – little or no growth, where firms are coerced to acquire or merge to maintain sales and reduce costs.

14_{PWC (2012) “Global Forest, Paper & Packaging Industry Survey”}

In 2002, Deans et al., considered that pulp and paper industry was situated in the end of stage two – scale. It is possible to assume that, in 2014, this industry may be established at the third stage, since growth isn’t as much as before [3.1.1] [3.1.2.2], and companies are consolidating in order to dominate the market. This assumption is only applicable to North America and Europe, given that pulp and paper industry tend to have regional markets. One of the latest industry M&A trend recorded is US companies selling its mills in Europe. For example, Georgia-Pacific sold its Italian mills to Lucart group in 2012, and, in the same year, sold to SCA all the tissue mills and converting plants located in seven European countries. Kimberly Clark’s mill in Italy was also acquired by an Italian company (ICO) in 2013.

Another observed tendency is the acquisition of new mills to increase production capacity. For instance, Sofidel Group has done it in 2010 when acquired LPC group from UK, with mills in Belgium, France, Sweden and UK, and again in 2013, by acquiring NTG papermill from Fabio Perini also in UK.

In Portugal, this last trend is also witnessed. In 2001, Portucel bought the remaining shares of Soporcel from Papercel. Portucel’s chairman stated at the time, that the deal made

Portucel “more competitive and able to participate in the international consolidation”. In 2006, Altri has also bought Celbi for the same purposes, and more recently, in 2014, Pampilar acquired Pestrafil, a producer of tissue towels and toilet paper, that was bankrupting.

3.2 PORTUCEL

3.2.1 OVERVIEW

Portucel can be described as a producer of uncoated writing and printing paper, and bleached eucalyptus kraft pulp (BEKP). It has a turnover of 1,217 _{billion €, which}

represents almost 1%17 _{of Portuguese GDP. Is the leading European producer of BEKP and}

uncoated woodfree paper, and also in the production of certified forestry plants.

Portucel Group operates in Portugal, Spain, France, Belgic, Netherlands, Switzerland, UK, Italy, Germany, Austria, Poland, Turkey, Morocco, Mozambique and the US. Roughly 95%17 _{of paper and pulp is sold around 123 countries, representing nearly 3% of}

Portuguese exports of goods.

Portucel was born in 1953 through the creation of Cacia mill. In 1964, Portucel acquired Socel in Setubal to produce more pulp. It started to sell to Europe in 1972. In 2000 Portucel acquired Inapa, with the intention of manufacturing writing and printing papers. One year later, Portucel acquires the entire share capital of Soporcel and becomes known as Portucel Soporcel Group. In 2003, Semapa, a holding company, acquired 67,1%17 _{of Portucel. Later}

on, in 2009 a new paper mill is inaugurated at Setubal, followed by another one in 2011. Portucel’s strategy for the future includes business diversification and expanding its industrial base abroad. Portucel’s biggest challenge is to find a strategy to dodge the disuse of office paper [3.1.2.1].

3.2.2 BUSINESS AREAS

Portucel’s major business areas are pulp and paper. These are manufactured in three plants in Portugal: Cacia – that only produces pulp; Setúbal and Figueira da Foz – both producers of pulp and paper.

FIGURE 4: Pulp and Paper Production [Source: Portucel’s Annual Report (2014)]

The other business areas of Portucel are energy and forests. Energy is produced from bio fuels in cogeneration, as power, steam and electricity. Steam is only used for internal consumption; contrariwise electricity is sold to the national energy network. Portucel is also the largest producer of biomass’ energy in Portugal. The forestry business segment comprises a total area of circa 120 ha18_{, and yields eucalyptus wood, used in the production}

of pulp, and also cork and pinewood that is sold to third parties.

The domestic consumer recognizes Portucel by its successful brands: Navigator, Discovery, Pioneer, Inacopia, Explorer, Soporset, Inaset and Target.

3.2.3 SHAREHOLDER STRUCTURE

In 2014, Portucel’s major shareholder was Semapa, followed by Seinpar Investments, a company that also belongs to Semapa holding.

Portucel held 6,58% of its share capital, and the remaining 18% is owned by minor shareholders.

FIGURE 5: Portucel’s Shareholder Structure [Source: Portucel’s Annual Report (2014)]

3.2.4 FINANCIAL INFORMATION

Portucel’s sales have been increasing over the last years, mainly due to paper business, contrasting with the graphic paper trends expectations [3.1.2.1]. Still, this growth is associated to the conquest of new markets outside Europe and to the network expansion of clients inside the continent. Despite the increase in sales volume, gross profit was lower in 2014 compared to the previous years. This decrease was triggered by lower prices in both pulp and paper, leading to lower margins.

In 2014, Portucel achieved a net income of 181,5 million € and generated a free cash flow of 236,819 million €.

TABLE 2: Portucel’s Key Ratios [Source: Portucel’s Annual Report (2014)]

Net Debt to EBITDA ratio reduced over the years, indicating that Portucel’s ability to pay off debt increased. On the other hand, ROE indicates that shareholders are getting less return, which labels Portucel as a less attractive investment. However, it seems that market doesn’t agree, since price-to-earnings ratio has been increasing over the years, suggesting that investors forecast an optimistic future performance and are willing to pay more for Portucel’s shares.

In 2014, Portucel’s stock performance was exceptional given the Portuguese stock market environment: PSI20 registered its third largest decline in value in its history and two firms were removed from the index.

FIGURE 6: Historical Daily Price [Source: Eikon Reuters Terminal]

On the first half of the year, Portucel’s stock price increased and reached the high of 3,80€. In June, share price dropped given that a dividend per share of 0,28€ was paid. Since the dividend payment, Portucel felt some difficulties to recoup, especially due to the negative impact of the Portuguese market, which overlapped with the largest trading volume recorded in that year for Portucel’s share. In the end of 2014, share price was at 3,09€.

3.3 AMS

3.3.1 OVERVIEW

AMS is a Portuguese private-held company sited in Vila Velha de Rodão, who produces as paper, and then transforms it into different kinds of tissue paper. The company is known as the most efficient tissue producers of the Iberian Peninsula.

Its history begins in July of 2007 as AMS Papermill and Converting. But only in August 2009, it started to produce paper, under the name of AMS-Goma Camps.

In 2012, and from that year forward, the company has been nominated as one of the 100 best companies to work for in Portugal.

In 2014, AMS altered its own denomination to AMS-BR Star Paper, after a change in its shareholder structure, where the 35% minority shares of Gomà-Camps were sold. This change was essential, in order to complete the fourth phase prospected in the initial project. This last stage is acknowledged for the “expansion” phase, where the intention is to double AMS’ production capacity, what requires an investment about 40 million €.

Also in 2014, AMS has won an award related to its project “AMS – Thinking Ahead”, which supports good practices in terms of environment and regional economy. These procedures on which AMS was awarded for, are also firm’s differentiation point from other paper producers: the exploitation of pipeline competitive advantage. This pipeline connects AMS to its supplier (Celtejo – Altri Group), in order to transfer pulp between companies. This innovation isn’t only beneficial for the environment, but also cost efficient in terms of transportation, and regarding steps reduction in the production process.

All these cost’s reductions allow AMS to be one of the most efficient company in the industry and able to practice highly competitive prices.

AMS strategy for the future is to continue to invest and keep the sustainable growth, having in consideration that this is a capital intensive industry, with permanent changes, where the need to adjust the product to the market need is demanded.

3.3.2 BUSINESS AREAS

As said before, AMS produces paper and transforms it into tissue. It operates in both segments: at-home (toilet paper, kitchen rolls, napkins) and AfH tissue.

AMS produces mainly Private Labels for the major retail chains in Portugal: Sonae (Continente), Jerónimo Martins (Pingo Doce, Amanhecer, Mastercheef) and Mosqueteiros (Intermarché). Its own brand is Amoos, and is also the producer of LimpaBem (Unapor group) and Nocel brands.

3.3.3 SHAREHOLDER STRUCTURE

As mentioned before [3.3.1], shareholder structure of AMS changed in 2014. Below, is presented the structure in the beginning and in the end of the year, so the changes can be noticeable.

FIGURE 7: AMS Shareholder Structure At 01-01-2014 [Source: AMS’ Annual Report (2014)]

All shares belonging to Gomà-Camps Portugal SA, were totally acquired by Suburbs SGPS, Lda. The minority shareholder António Ferreira, also sold its shares to Boncarton company. Is is also important to note that, the nominal value of the share was 5,00€.

FIGURE 8: AMS Shareholder Structure at 31-12-2014 [Source: AMS’ Annual Report (2014)]

3.3.4 FINANCIAL INFORMATION

AMS generated 51 million € in revenues in 2014. This is an astonishing value for a company with only five years of existence, especially regarding the troubled Portuguese economic environment that was paired with AMS’ activity initiation. As the company matures it is typical that revenues’ growth stabilizes over time, something that can be easily noticed for AMS.

TABLE 3: AMS’ Key Financial Statistics [Source: AMS’ Annual Report (2014)]

Gross profit has been raising, however its margin doesn’t record the same trend. A possible explanation is related to the lower margins coerced by AMS customer’s: retailers. This is usual when retailers face highly competitive environments, characterized for severe

intensive if the producer manufactures retailers’ private labels, as happens in AMS case. Both EBITDA value and margin have been increasing, despite the decline in gross profit, which demonstrates that a better management is being carried.

In 2014, debt refinancing reduced financing costs in 44 p.p.20 in comparison to 2013, which also contributed to a higher net income.

TABLE 4: AMS’ Key Ratios [Source: AMS’ Annual Report (2014)]

Net Debt to EBITDA ratio reduced over the years, indicating that AMS’ ability to pay off debt increased. Which means that if AMS maintains the level of debt and its EBITDA, the company would be able to pay out debt in 3 years. Noteworthy is also the fact, that AMS is considerably under the other Iberian tissue players’ average ratio, that was 5,2221 _{in 2013.}

ROE indicates that shareholders are getting higher returns compared to 2013, which identifies AMS as a more attractive investment. Note that ROE is computed used equity book value, and not market value, since AMS isn’t a listed company.

3.4 CONCLUSION & DEAL RATIONALE

Regarding pulp and paper industry life cycle present stage, it is crucial that companies grow through M&A, where successful businesses, such as Portucel, buy small competitors or other market leaders, such as AMS.

Plus, it is recommended that Portucel enter in a new business area regarding the future challenges that are meant to come, concerning woodpulp – less demand in paper production; and graphic paper – having less usage due to digitalization.

Deciding on the tissue paper market is advantageous, since it opposes to pulp’s cyclicality - risk diversification; and uses pulp as raw material, meaning that Portucel can be its own supplier benefiting from vertical integration.

20_{AMS’ Annual Report (2014)}

AMS is the best company choice to enter tissue business for many reasons. The main motive could be associated to the competitive advantage of the pipeline, which makes “AMS the most efficient and profitable tissue manufacturer in the Iberian Peninsula”22. Moreover, replicating this idea in Portucel’s pulp plants, provides industrial and logistical competitive benefits to Portucel group, positioning it as one of Europe’s most competitive producers. However, entering tissue market and implementing the pipeline, demands a lot of knowledge that can be collected by acquiring all the intangible and tangible assets of AMS.

Furthermore, AMS main supplier is Altri, number one competitor of Portucel in Portugal, which sells 50%23 _{of its manufacture to tissue producers. By acquiring AMS, Portucel may}

have a bit of control over Altri.

All these purposes guide Portucel to the acquisition of AMS, in order to move to a new business area: tissue paper.

4. STANDALONE VALUATIONS

This chapter exhibits the valuations of both companies individually, in order to value the deal and subsequently the merged company with synergies included. To value both companies, it was used the methodology presented in the literature review: DCF valuation method using WACC based approach. This choice, over APV approach, is related to both companies’ capital structure that is expected to remain fairly stable. Complementary, relative valuation technique was also used for both companies.

4.1 PORTUCEL VALUATION

The first step while valuing a company using DCF method is obtaining its components such as: EBIT, Depreciation, CAPEX and NWC. In order to find the first two elements, is mandatory to forecast the income statement. Please note that the explicit forecast period chosen was 6 years, from 2015 to 2020.

4.1.1 REVENUES

Revenues were forecasted according to Portucel’s division of segments: forestry, pulp stand alone, integrated pulp and paper and energy.

TABLE 5: Revenues Growth

Forestry segment revenues are determined by the number of trees cut-down and sold. Taking into account that a eucalyptus needs 12 years24 to be fully-grown, it is possible to predict the growth of revenues based on the growth of trees planted 12 years before the explicit year. Only eucalyptus life expectancy was taken into account, since pine, cork and other species only represent 0,25% of Portucel’s biological assets.

Since intersegment forestry revenues are dependent on pulp production, and internal demand is priority, those will cannibalize external sales.

FIGURE 9: Foretry revenues growth

4.1.1.2 PULP

For the explicit period, two factors were taken into account: firstly, the pulp production expectations that foresees an average annual growth of 0,8%25 _{for European countries.}

Secondly, it is expected that pulp price will rise at an annualized rate of 1%26 _{from 2015 to}

2017, resulting in higher revenues [appendix 3].

24_{Data from Portucel.}

Regarding office paper revenues growth predictions [4.1.1.3], it is expected internal lower demand of pulp, thus creating the opportunity of higher external sales of pulp, given that plants are running at maximum capacity.

In 2015, there were also other considerations: Portucel will increase by 20% the production capacity of Cacia site, which is responsible for 21% of all pulp production.

FIGURE 10: Pulp revenues growth

4.1.1.3 INTEGRATED PULP AND PAPER

Graphic paper’s revenues have been growing over the years due to Portucel’s ability of exploring new markets, and thus avoiding the effects of the lower demand tendency. In 2015 it is estimated that Portucel will face a saturated market, and surrender to market predictions for Western Europe [appendix 4].

FIGURE 11: Graphic paper revenues growth

4.1.1.4 ENERGY

Portucel started to produce electricity in 2005 in order to cover their energy demand. Pleased with the success, they invested in this sector over the years, and, as result, Portucel is now able to cover its own needs and sell the surplus. Therefore, energy revenues until 2020 are based on Eurostat electricity production predictions for Portugal.