Resolute Forest Products: Time To Book Profits (RFP)
Investment Thesis – Update
Resolute Forest Products’ (NYSE:RFP) stock soared more than 60% on Wednesday 6th July 2022, after the announcement that the company had entered into an agreement to be bought out by Canada’s Paper Excellence Group. The below analysis provides an update to my previous strong buy rating and explores the potential synergies of the deal and what it means for investors.
I started my research on RFP in late 2021, as the company was in the right direction of its transformation plan, has meaningfully deleveraged its balance sheet, and expanded profitability. However, the stock provided a better entry point early in 2022, and following my most recent update, I opened a long position in the model portfolio.
My initial target price of $19.40 was premised upon the company’s low Price/Book multiple, while the signs of operational improvement and gains from the company’s restructuring plans were relatively evident. Not surprisingly, five months later, I ended up booking profits of 81% and exiting my entire RFP position following the news. Below I provide my rationale why investors should consider at least trimming their position too.
Details Of The Transaction
Under this agreement, Domtar Corporation, a wholly-owned subsidiary of Paper Excellence, will acquire all the outstanding common shares of RFP by paying its shareholders $20.5 per share, valuing the company at about $2.7 billion. With a premium of around 64% over RFP’s closing price the day before, this seems like a lucrative deal in favor of both the company and its shareholders. Along with the cash consideration, the deal also offers the shareholders Contingent Value Rights (“CVR”) for the expected refunds of approximately $500 million paid by RFP as softwood lumber duty deposits through June 30th, 2022. The board has unanimously approved the deal, and shareholder and regulatory approvals are expected to complete in the latter half of the year, closing the deal in the first half of 2023. RFP will continue to operate as a standalone business unit after the acquisition.
Shareholders Should Consider The Deal Done
It is reasonable to expect the deal to successfully close within the suggested time frame since the owner of around 40% of RFP’s stock, Fairfax Financial Holdings, has already supported this agreement. In addition, no significant regulatory constraints are expected since there is little overlap in the geographical presence of the parties involved.
What Are The Potential Synergies?
Paper Excellence is a holding company based in Canada that manages businesses related to pulp and paper manufacturing. In November 2021, it completed the acquisition of Domtar Corporation as part of its growth strategy to enter the US market. Domtar is a fiber-based product provider, with 70% of its revenues coming from uncoated freesheet paper and the rest from selling market pulp.
By the end of 2022, Domtar also aims to enter the packaging market. The acquisition of Resolute brings diversification advantages to Domtar; RFP’s lumber business will reduce Domtar’s reliance on its free sheet sales. On the other hand, RFP will continue to implement its strategy of growing its wood products business. Being part of a large private group, Resolute will have access to capital and tools to make suitable acquisitions in the lumber and pulp business as well as to expand into other avenues.
For example, as part of the deal, Paper Excellence Group has also committed to conducting a feasibility study on the potential conversion of Resolute’s Gatineau, Quebec, newsprint mill to a packaging factory. Suppose Domtar successfully enters the packaging business by the end of 2022. In that case, Resolute will have access to technical resources as well as an established network to expand into the new venture. Moreover, rising investments for strategic initiatives to enter new markets are generally easier for privately held firms as opposed to firms that must convince public investors.
What Should The Investors Do?
Now coming to the big question, what should the investors do? Definitely, the stock has captured its potential upside, and there is little to no chance of another bull cycle in the near future. A more lucrative competitive bid is highly unlikely. There are high chances that the stock price would deviate around $20.5 unless a piece of significant news arises that may hint toward disruption of this merger process, chances of which are low. RFP’s stock price would follow the same trend that Domtar’s stock had after the announcement of the acquisition in May 2021; when the stock experienced a spike to $55.5, the bid and then remained at the same level until the acquisition was completed in November.
Thus, investors may decide to either close their position and capitalize on the upside or hold their position until their stocks are purchased at $20.5. In the scenario that an investor holds the stock till deal completion, they will be entitled to a CVR, in which case they may get a share of refund on estimated softwood lumber duties of approximately $500 million that Resolute paid in the U.S.
According to an analyst at TD Securities, the value of this CVR could be $3.98 per share if the company gets 80% of its deposits reimbursed in the next two years. However, this refund is contingent upon resolving the ongoing softwood lumber dispute between the US and Canada. The US has been charging antidumping and countervailing duties on importing certain softwood lumber products from Canada. This dispute has remained since 1982, with the latest round of disputes remaining unresolved since 2015. The dispute settlement process is underway at WTO. However, the terms and timing of a possible resolution remain unknown. Hence, I would not bet on any potential benefits from the CVR.
Considering the CVR uncertainty of $3.98 per share and the current shaky market conditions, RFP stock has already realized most of its upside potential. Therefore, I have already booked profits at $20.52 per share, using my proceeds for my next potential target.