FrontFour Capital Letter to Polymer Group
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As you are aware, FrontFour Capital Group and Zelman Capital have been significant shareholders of Intertape Polymer Group for the last several years. We own approximately 2.8 and 1.0 million shares respectively, collectively representing 6.5% of IPG's total shares outstanding. We were each attracted to IPG's stock after conducting significant due diligence which supported the investment thesis that a combination of: (i) a U.S. economic recovery, (ii) IPG's improving margin profile due to SKU rationalization, (iii) lower operating costs including the transition to the newly constructed Blythewood, SCfacility, (iv) returns of capital via dividends and share repurchases and (v) more recently lower input costs due to energy complex weakness would collectively drive significant cash-flow and earnings growth.
We also believe that IPG is a highly attractive acquisition candidate due to its strong market position within its product lines. We write this letter to you and the Board of Directors as we believe that IPG's shares are worth approximately CAD $23 per share, representing upside of 52% to the current market price. Additionally, we strongly believe that IPG is a highly sought after strategic asset that would garner a significant premium from either a strategic buyer or private equity sponsor with a pre-existing portfolio company within the packaging space. In summary, we believe that there are a number of steps that management can take to unlock value.
While we acknowledge that IPG's operations and financial position have significantly improved over the last five years, the Company's shares now trade at a significant "management discount" and the stock has become a "show-me" story. This dynamic exists due to recent Company missteps, including the downward revision of fourth quarter 2014 earnings stemming from manufacturing issues and the more recent delay of full production by 12 months at the Blythewood, SC tape production facility. As a result, IPG's shares currently trade at 6.6x 2016E EBITDA and a 9.4% free cash flow yield (based on Street consensus estimates), representing a material discount to its North American packaging peers1 (9.6x EBITDA and 7.0% FCF yield). Based on 2017 estimates, the valuation discount is just as dramatic as forecasted margins reflect the full benefit from Blythewood plant productivity savings with IPG shares trading at 6.0x EBITDA and a 10.5% free cash flow yield versus 9.1x and 7.6% for the peer group. Given the Company's strong position with 60% of sales derived from products with a #1 or #2 market share in their respective categories, U.S. centric revenue base, attractive margin profile and commensurate free cash flow generation, this discount is unwarranted. We believe that there are a number of immediate actions that the Company must take to close this valuation gap including: (i) increasing net leverage to 2.5x 2015E Net Debt/EBITDA to repurchase additional shares, (ii) improving disclosure relating to IPG's capital expenditure plan, (iii) pursuing a listing on a US-based stock exchange and commensurate US equity analyst coverage and (iv) refreshing the Board of Directors to include individuals with U.S. packaging industry experience. Based on our discussions with numerous shareholders of IPG, we believe that a significant percentage of the shareholder base is supportive of these actions.
We urge you and the Board of Directors to take the following actions immediately:
(i) Increase Net Leverage to Repurchase Additional Shares – We appreciate the opportunity set the Company has in terms of incremental bolt-on acquisitions and are supportive of your acquisition strategy. We also applaud your recent stock buyback activity of over 1.5 million shares repurchased since 6/30/15, yet we continue to believe that the Company is over-capitalized with equity. As you recently articulated, the pipeline of potential bolt-on acquisitions for IPG represents a total purchase price of $150 million. In the unlikely scenario where you were able to execute on all of these transactions, assuming a 7.5x aggregate purchase multiple 100% financed with debt, the Company's net leverage would increase from 1.5x to approximately 2.0x, thus still leaving you with ample capacity to meaningfully increase share repurchases. At IPG's current valuation of 6.6x 2016E EBITDA the Company has the ability to borrow at rates under 2.5% to repurchase IPG shares, which are trading at a dividend yield and free cash flow yield of approximately 5% and 10%, respectively – this would be highly accretive to shareholders. We believe that management should take net leverage to 2.5x 2015E EBITDA which would still allow the Company ample debt capacity to pursue its bolt-on acquisition strategy. We also note that leverage would come back down to approximately 2.0x 2016E EBITDA within 12 months in this scenario due to EBITDA growth and free cash generation after dividends.
(ii) Improve Disclosure Relating to Capital Expenditures – On the fourth quarter 2014 earnings conference call held in March 2015, you stated that IPG's estimated "annual maintenance capex is generally between $12 and $15 million" and continue to reiterate 2015 capital expenditure guidance of $32 to $37 million. Apart from an incremental $5 million of capital earmarked to finish the ramp at the new South Carolina plant earlier this year, the remaining bucket of capital expenditures beyond maintenance has been dedicated by Company management to vaguely-outlined "high-return projects." Additionally, the Company has guided that it will incur approximately$30 million of total capital expenditures for each of the next few years. However, the disclosure surrounding where the growth capital expenditures will be allocated and the corresponding return profile associated with such expenditures has been non-existent.
We would like the management team to provide increased disclosure regarding the return profile, timing and scope of the future projects. Quantifying the margin/earnings uplift from future outlays will allow investors and sell-side analysts to properly model these investments.
(iii) Pursue Listing on a US-Based Stock Exchange – In addition to deriving most of its revenue from the United States (83%), IPG also has the majority of its manufacturing footprint located in the United States (87% of net PP&E). The Company reports in US dollars and its executive headquarters is located in Sarasota, FL. This profile makes IPG's shares a natural fit to be dual-listed on a U.S.-based exchange where it would receive increased coverage from U.S.-based analysts who cover a much larger universe of packaging companies relative to their Canadian counterparts. A larger institutional following in the United States would not only allow investors to benchmark IPG's favorable operating and financial metrics versus US-based peers but also likely increase the stock's liquidity. Both increased analyst coverage and liquidity will lead to multiple expansion.
(iv) Refreshing IPG's Board of Directors with Independent Packaging Industry Expertise – As the Board is currently constituted, there is a glaring lack of packaging industry expertise. We believe that the Company would benefit from the addition of several new directors with packaging industry experience to provide strategic guidance on positioning the company for growth and broader operational execution.
1 North American packaging peer universe includes Bemis Company (BMS), Crown Holdings (CCK), Sealed Air (SEE), Avery Dennison(AVY), Berry Plastics (BERY) and CCL Industries (CCL CN).
Pro Forma IPG Equity Valuation
To illustrate the positive impact through increasing net leverage modestly and repurchasing shares we point to the calculation below.
We believe the pursuit of the recommendations outlined in this letter along with strong execution at the Blythewood plant will lift the valuation of the Company. An appropriately valued equity currency will give you the option to issue shares in an accretive manner should a larger acquisition(s) opportunity present itself.
Over the last few years of our respective stock ownership we have enjoyed a constructive dialogue with IPG's management team. While we have considerable experience effecting shareholder-friendly strategic actions by directly seeking board representation through the solicitation of proxies, we do not believe that such action is necessary at this time. We hope to continue this rapport and would like to see you implement our recommendations as we strongly believe that doing so will create significant shareholder value.