Overview: Revisions for MeadWestvaco’s capital allocation plans

Market Realist

Must-know: Starboard Value's activist position in MeadWestvaco (Part 6 of 6)

(Continued from Part 5)

Starboard suggests revisions for MeadWestvaco

Activist fund Starboard Value LP disclosed a 5.6% stake in MeadWestvaco Corp. (MWV) earlier last month. It  expects the packaging company, among other things, to improve its capital allocation.

Starboard noted in its letter to MWV’s board that the company’s capital expenditures increased over the past couple of years due to its investments in its paperboard mill in Covington, Virginia and its containerboard facilities in Brazil. It said that in 2013 alone, MeadWestvaco’s capital expenditures amounted to 9.4% of sales—significantly higher than most of its peers such as Packaging Corporation Of America (PKG), Graphic Packaging Holding Company (or GPK), AptarGroup Inc. (or ATR), and Rock Tenn Co. (RKT), Klabin (or KLBAY), and International Paper (IP). In addition, MeadWestvaco was the only company in its peer group to have negative free cash flow during the year.” The fund believes “MeadWestvaco’s lack of free cash flow has contributed to its discounted valuation relative to the peer group.”

During 1Q14, MWV’s capital spending fell to $66 million from $115 million in the 1Q13, due to lower overall investment in relation to the Covington biomass boiler, which was completed in the 4Q13. Starboard said MWV’s cost reduction initiatives and decline in capex will lead to a significant increase in its free cash flow in 2014. It added, “If management is able to exceed this target and bring margins in-line with its peer group, it would result in an even more dramatic increase in free cash flow by 2015. As a result, MeadWestvaco’s payout ratio would fall to an all-time low, thereby creating ample room to raise the dividend.”

In 1Q14, MWV entered into an accelerated stock repurchase program with certain financial institutions and repurchased $300 million of its common stock. This was part of the company’s previously announced plan to return $700 million of the sale proceeds from the divestiture of all of its U.S. forestlands to Plum Creek Timber Company (PCL), which completed on December 6, 2013. As a result of the accelerated program, approximately 7.5 million shares were retired. MWV said it anticipates receiving additional $94 million worth shares at the conclusion of the program by June 30, 2014.

In January, the board also approved a payout of approximately $175 million, $1 per share, in the form of a special dividend along with the regular quarterly dividend. MWV recently declared a regular quarterly dividend of $0.25 per common share.

Starboard said in its letter that MeadWestvaco shares are extremely undervalued, and that its net debt to earnings before interest, taxes, depreciation, and amortization (or EBITDA) ratio is “below its peer group average of 2.4x, despite the company’s lower cyclicality and compelling end-markets.” It said it believes MWV could borrow an additional $500 million and raise its net debt to EBITDA ratio to “execute a sizable share repurchase.” The fund added that a “Dutch Auction tender offer and subsequent open market repurchase would be a more efficient way to return capital to shareholders and provides the company with the most flexibility.”

On MeadWestvaco’s pension assets, Starboard said MWV “has maintained an overfunded pension for several decades, resulting in a $1.5 billion pension asset, which represents the amount of overfunding,  and over $120 million per year in pension income.” It suggested that MeadWestvaco could merge or be acquired by a competitor with an underfunded plan, and cited Rock Tenn Co. (RKT) and International Paper Co. (IP) as examples of companies with more than $1 billion pension liabilities. This could allow MeadWestvaco “to realize value from its pension asset and could result in substantial operational and financial synergies,” the fund added.

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