Silgan Sees A Good Deal Crumple

By Stephen D. Simpson, CFA | June 20, 2011 AAA

Investors had many good reasons to be enthusiastic about Silgan's (Nasdaq:SLGN) announced merger with Graham Packaging (NYSE:GRM). Not only was the company in place to benefit from significant operating synergies and tax benefits, Graham would have given the company an invaluable plastics packaging business - an increasingly important consideration in a world that seems to be moving away from Silgan's traditional metal packaging.

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Unfortunately, Silgan was not the only company to see value in Graham's assets. New Zealand-based Reynolds Group Holdings came in near the eleventh hour and made a counter-offer that Graham's board could not refuse.

The New Deal
Graham informed Silgan and the market that another bidder had emerged and offered $25 in cash for each share of Graham Packaging. That was a significant improvement over the deal Silgan offered - a deal that had been worth about $19.56 at the time of the agreement, but one that incorporated a significant Silgan equity component (meaning that the actual deal value changed every day with Silgan's share price). On a fair like-for-like basis and considering Silgan's share price, Reynolds' offer was ultimately about 14% better and had the added benefit of being an all-cash deal.

The deal between Silgan and Graham gave Silgan three days to consider a counter-offer, but the deal ended when the companies could not reach a new agreement. Consequently, Graham will go to Reynolds and Silgan will walk away with a termination fee of $39.5 million (a little more than 50 cents a share) for its trouble.

What Now For Silgan?
Given the significant benefits that Silgan was likely to see from the deal, it is no surprise that the stock has come down since Graham first mentioned this rival offer. Interestingly, the stock has pulled back to the trendline that was in place before the deal rather than to its pre-Graham-deal level. That looks like better treatment from the market than investors should really expect. After all, the metal food can business is a low-growth market and packaging competitors like Crown Holdings (NYSE:CCK) (beverage cans) and Owens Illinois (NYSE:OI) (glass bottles) are all fighting for a relatively limited food and personal care packaging market.

Graham was an invaluable opportunity for Silgan to expand and diversify its business in plastic packaging. Certainly there are many plastic packaging manufacturers out there, but Graham had the rare distinctions of relatively little commoditization in its end markets and the number one share in markets accounting for about 90% of its revenue. Not only that, but Graham's food-heavy market exposure was a nice fit with Silgan's more personal care product-focused plastics business.

Can Silgan still do a deal? Maybe.

Silgan could consider a play for Constar (which is emerging from another bankruptcy) or try to convince privately-owned Plastipak to sell out. Other options could be trying to acquire the plastics packaging business of an existing competitor like Amcor or Ball (NYSE:BLL) but those deals would be less likely and less appealing. Overseas expansion is also a possibility, but there too are significant rivals like Rexam (Nasdaq:REXMY), Huhtamaki and Zhuhai Zhongfu.

Good News, Bad News
Silgan shares look to be worth some $5 to $10 less now that the Graham deal is no more, or $350 million to $700 million in market cap. That compares to the additional $265 million or so that Silgan would have had to chip in to keep the deal alive (assuming that a $26 price tag would have done the trick).

On that basis, then, it looks like Silgan may be making a "penny wise, pound foolish" decision not to increase its bid. It is all well and good for companies to show strict discipline when it comes to M&A, especially since so much M&A is ultimately unproductive and sucks away shareholder capital, but sometimes it does take money to make money. That is especially true in cases of relatively unique assets - though perhaps Silgan believes it has other acquisition options and/or can simply build its business organically. What's more, given the terrible record of debt-laden packaging companies falling into bankruptcy during downtowns, maybe the added debt and balance sheet risk just was not worth it.

The Bottom Line
Without Graham, Silgan looks slightly undervalued - enough to hold, but not really enough to justify a commitment of new money. Packaging is a pretty turbulent area these days, so investors should expect additional deals around the sector. Time will tell if Silgan made the right move here, but it seems fair to say that the loss of a significantly positive deal is a major setback for investors. (For related reading, also take a look at Analyzing An Acquisition Announcement.)

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