Not long after Rock-Tenn (NYSE:RKT) finished its deal for Smurft-Stone, International Paper (NYSE:IP) has decided to make its own play for further consolidation in the packaging business. Late Monday, IP announced that it had launched a hostile offer for Temple-Inland (NYSE:TIN), but Temple-Inland quickly shot down the offer and implemented a poison pill. What remains to be seen now is whether IP can raise the stakes high enough to either persuade the board to change its mind or compel Temple-Inland's own shareholders to rise up and demand approval of the deal.

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The Deal
IP surprised the market with a $30.60 cash bid for Temple-Inland, a price about 46% above the company's prior value. If the deal happens, IP would pick up Temple-Inland's 4 million tons of containerboard capacity, over 2 billion square feet in gypsum wallboard capacity, and significant capacity in other building products like lumber and particleboard. Not only would the deal make the combined company a force in containerboard (with about 39% share) with all the attendant synergies of scale, but it would move IP further into the building products sector. For more, see Smurfit Stone Emerges From The Dead.)

Doth Temple-Inland Protest Too Much?
Poring over the "he said, he said" of the dueling press releases, it seems pretty clear that IP approached Temple-Inland and that Temple-Inland turned them down cold (a unanimous board vote against the $30.60 deal). Of course, as is part and parcel of such rejections, Temple-Inland loaded its response with mock indignation that IP would dare offer such a low price, called the deal opportunistic, complained that IP's comparables are unfair and so on. In other words, standard boilerplate language for a rejection.

I generally have little patience for target companies who respond along the lines of "how dare this company come in and offer our investors a guaranteed 40%+ gain", but I can see Temple-Inland's point here. First of all, the bid price seems to fall short a 50/50 split of the expected synergies of the deal. Furthermore, TIN is a valuable (and increasingly scarce) asset to IP and IP has access to extremely cheap debt. That seems like a cogent argument for IP to pay more - at least 10 to 20% more. (For more, see Understanding Mergers And Acquisitions.)

IP Needs to Sweeten the Pot
Considering Temple-Inland's staggered board and poison pill, it seems like IP would have its work cut out to make a hostile deal work. Moreover, if some of the predictions of higher interest rates in the post-QE2 world are accurate, the clock may be ticking on the company's access to low-cost debt.

Like most commodity products, containerboard is an industry that rewards scale and low production costs. What that means to IP is that a deal is worth doing, assuming reasonable terms. Still, the company has options. Packaging Corp (NYSE:PKG) would be an alternative in containerboard, assuming that what IP really wants out of a deal is more capacity in that market (as opposed to the cyclically downtrodden building products business). Less likely options might include Graphic Packaging (NYSE:GPK) or KapStone Paper (NYSE:KS) which, while "packaging companies" are more exposed to markets like kraft paper and "CUK board." (For related reading, see The Booming Business Of Container Leasing.)

At the same time, if the M&A pot really starts swirling, who knows what may happen. Perhaps Temple-Inland would look for a more friendly combination with Packaging Corp or a company like MeadWestvaco (NYSE:MWV) as an alternate strategy.

Bottom Line - Down, But Not Boring
A lot of packaging names have sold off as the economic recovery seems to be slowing. This makes a certain amount of sense as packaging is a derivative product - demand for packaging is derived from the demand for whatever is in the package. To that end, Temple-Inland has been an underperformer of late, but not dramatically so.

Rock-Tenn and Packaging Corp both look like names worthy of investor consideration today, but the fight between IP and Temple-Inland probably is not over yet. Figure on IP trying to sweeten the pot at least once or twice before facing a choice between really ratcheting up the pressure on Temple-Inland's board, finding a new target or standing pat with its current assets.

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