Why DS Smith shares jumped out of their box with SCA bid

Shares in DS Smith have responded well to the packaging specialist's 'transformational' £1.3 billion bid for a Swedish rival this week, although the deal is not without risks.

by Gavin Lumsden on Jan 20, 2012 at 16:20

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Why DS Smith shares jumped out of their box with SCA bid

Shares in Citywire Top Stock DS Smith (SMDS.L) have rallied after the recycled packaging specialist's £1.3 billion bid for SCA Packaging this week.

Arbuthnot Securities say the stock, up 4.3p to 234.3p today, is breaking through a six-month resistance point. However, the deal is not without its risks given the recession in Europe. In this video I look at the background to the DS Smith story and its strategy to become a leading player in its field.

DS Smith is a top 10 holding in Standard Life UK Unconstrained Equity fund managed by Ed Legget.

Is this really a good time to be making a big acquisition in Europe, with the eurozone falling into recession as a result of the sovereign debt and banking crisis?

That's the question shareholders in DS Smith are asking after the Berkshire-based specialist in recycled packaging launched a £1.3 billion bid this week to make it a leading player on the Continent.

DS Smith is paying 1.6 billion euros to acquire the packaging operations of Sweden’s Svenska Cellulosa Aktiebolaget – or SCA for short.

It's a big deal that will see DS Smith more than double in size. Its chief executive Miles Roberts hailed the transaction as 'transformational' for the group.

Yet although the opportunities are large, so are the potential risks as the company takes on debt to fund the takeover. With many European consumers about to experience a level of austerity not seen since the 1930s, the danger is DS Smith's figures could come unstuck.

So far, however, investors are backing the deal. DS Smith's share price rose this week when the takeover was announced, even though the acquisition requires a flood of new shares to be issued to raise money from shareholders.

Wisely, DS Smith has kept leading investors, such as 14% shareholder Standard Life, informed of its plans.

Moreover, shareholders can see the strategy behind the bold move and support it.

The acquisition of SCA Packaging is actually DS Smith’s third and biggest step towards its goal of becoming Europe’s biggest supplier of recycled packaging.

The first step came shortly after Roberts joined the group in 2010 as DS Smith bought Otor, its equivalent in France.

Then, at the end of last year, it sold Spicers, its office products arm, which was both non core and lower margin than the rest of the packaging business.

Roberts has a good track record and investors trust him. Before he joined DS Smith he ran and turned round McBride, a specialist supplier to supermarkets.

Using this experience, Roberts quickly pushed DS Smith towards its current strategy of focusing on recycled corrugated packaging. Here demand is growing as big retailers and consumer goods manufacturers seek to cut costs and meet their environmental obligations.

The group has a couple of advantages. It owns paper mills and is the largest provider of recycled paper, allowing it to supply its box-making factories.

These aren’t bog-standard boxes either. DS Smith specialises in the ready for retail segment where it supplies the likes of Cadbury’s and Kellogs with cleverly designed boxes that make it easy for warehouse workers to spot and access the goods. Its latest design is thinner yet stronger, than previous versions.

Ultimately, investors hope this could be a metaphor for the company. As it streamlines and expands DS Smith could also become thinner and stronger, leaner and meaner.

Let’s hope market conditions in Europe don’t get too mean either otherwise DS Smith could be put back in its box.