Deal of the Year

Eighteen months after first approaching Irish paper and packaging conglomerate Jefferson Smurfit Group about a potential buyout, Madison Dearborn Partners’ Sam Mencoff received word that his efforts had helped earn the Buyouts Deal of the Year award for 2002. Mencoff’s immediate reaction was to express thanks. Then he posed a more complicated question: Why, exactly, did his firm’s ?5.6 billion acquisition of Jefferson Smurfit beat out the other 282 buyout deals completed last year.

It’s important to acknowledge that the award selection process, by definition, is somewhat subjective. It’s not based on deal size, structure, industry target, equity partners, lack of equity partners or valuation-although all of those factors are obviously considered. The hope is that after agonizing over all the candidates, doing our due diligence, getting feedback from market players and carefully considering context, one deal will emerge as the obvious choice. And this year, to paraphrase a former Supreme Court justice, we knew it when we saw it.

The winning case for Madison Dearborn’s purchase of Jefferson Smurfit Group was fourfold. In each instance, Madison Dearborn either did something that most other firms didn’t, or did it better. First, the Chicago-based firm employed proactive due diligence to gain an inside edge before other private equity firms were even aware that Jefferson Smurfit was for sale. Second, Madison Dearborn successfully navigated through complex finance and trade regulations of three different countries. Third, the deal was the largest buyout of an Ireland-based company by a U.S.-based firm to date, and many market pundits think that it has set the stage for things to come. Finally, Madison Dearborn neither overpaid nor entered into an unfamiliar industry sector, both of which meant that the firm did right by its limited partners.

Behind Closed Doors

In an age when large buyout deals are most likely to be auction deals played out on the financial press, this year’s award winner was decidedly old school.

Madison Dearborn had spent much of the 1990s tracking Jefferson Smurfit as a competitor to the containerboard operations of portfolio companies like Bay State Paper, Packaging Corp. of America and Riverwood International. Throughout their passive due diligence, Mencoff and company became more and more enamored with a market-leading company and visionary management team that was among the first to champion industry consolidation, capacity rationalization and producing to demand rather than to inventory. “We were also attracted by the fact that [Jefferson Smurfit] was already pursuing a strategy of divesting non-core assets, reducing costs and simplifying the structure of the company, yet these actions had not been reflected in the stock price,” Mencoff explained.

By the early fall of 2001, Madison Dearborn and Smurfit management began working on a possible deal in strict secrecy. The first press reports of the negotiations wouldn’t leak until the following May, by which point a bid had virtually been made. The impact of this stealth process was that any interested private equity firms would be forced to play some serious catch-up while Madison was free to begin building shareholder support.

The only group to exhibit any serious interest was Texas Pacific Group, but the Fort Worth-based firm was never able to overcome its second-mover disadvantage. This was most apparent when a source within the firm groused to Reuters about the difficulties of getting access to Smurfit management. “Meetings are not getting scheduled,” the source said at the time. “Things are not moving forward, and the clock is ticking.”

Devil in the Details

The only reason that firms like Texas Pacific were even allowed to consider submitting competing bids was that Irish Takeover rules prohibit certain deal protections that are taken for granted in the United States. Not only does this mean that the original bid couldn’t include break-up or lock-up fees, but Madison Dearborn’s due diligence was not even deemed confidential work product.

Another Irish regulatory twist was that potential debt lenders would have to provide “certain funds” before the deal was actually signed. This was an especially tricky proposition considering that not only would such banks be banned from syndicating the deal ahead of time, but they weren’t even allowed to float trial balloons.

In order to secure all necessary financing and to satisfy shareholders, Madison Dearborn began by proposing to spin out to shareholders Smurfit’s 29.3% stake in a U.S.-based affiliate business named Smurfit-Stone Container Corp. (SSCC). Not only would this give ?1.1 billion in direct value to shareholders, but it also would preempt any potential antitrust concerns by U.S. regulators (although none were expected). Next, the deal essentially monetized certain non-core assets upfront by incorporating them into the purchase via a special-purpose vehicle. Madison Dearborn then loaded the remaining equity tranche with some of its limited partners and the private equity arms of Deutsche Bank, Merrill Lynch and J.P. Morgan Chase. The _3.8 billion debt package was underwritten entirely by Deutsche and Merrill Lynch, and then sold in the midst of what had been expected to be a tough market.

By August, Madison Dearborn received 83.2% Smurfit shareholder approval to sign off on the landmark deal, which served as the largest European LBO to date, the largest European public-to-private deal to date and the largest European high-yield LBO financing to date (?905 million). Equally important, it had gotten the deal done without encountering any regulatory static from either Ireland, England or the United States.

Open Field

For Madison Dearborn and its investors, this deal was a sure winner. The final price tag came in under analyst estimates (if the SSCC spinout is excluded), and the new portfolio addition should serve as a synergistic boon to the other paper and packing companies in Madison Dearborn’s active portfolio. More deals like this would certainly be welcomed with open arms.

Many in the Irish press, however, seem to view the Smurfit deal as good for everything but the local economy. First, they point out that the Irish public markets have lost what was once their sixth-largest company, and that similar deals could knock out other upper-echelon players. Second, they argue that Irish firms simply don’t have the money to compete with the massive wallets of Madison Dearborn or Merrill Lynch. For evidence, some local reporters have gone into extensive detail about the massive compensation package given to Michael Smurfit as part of the buyout.

Neither side of this debate, however, doubts that the Smurfit deal will encourage more U.S. firms to consider parking their overhanging dollars into Irish companies. Moreover, some market watchers in both the U.S. and Ireland have suggested that Madison Dearborn’s ability to avoid both financing and regulatory headaches could serve as a template for future deals.

If such imitators do come to pass, then the 2002 Deal of the Year winner will certainly have stood the test of time. And maybe that’s the best criteria we can go by.

<!–a href=””>Email Dan Primack