Should You Buy It? Scrap International Paper

International PaperIP bought Weyerhaeuser's WY containerboard and packaging businesses Monday for $6 billion. But given the 13% decline in the stock -- which closed Wednesday at $27.44 -- since the acquisition was announced, the market is suggesting that International Paper may have received the short end of the deal.

IP paid all cash in the deal, which is expected to close in the third quarter. The purchase includes more than 70 box-making sites, nine containerboard mills and 19 recycling plants that employ more than 14,000 people. But the company had just $905 million of cash on the balance sheet at the end of 2007, compared with $6.6 billion of total debt. (My prime role here at TheStreet.com is to analyze value stocks, which I do regularly for TheStreet.com Value Investor service.)

As a result, IP is going to finance the deal with a $2 billion term loan and a $4 billion 18-month bridge loan. The major credit ratings agencies have all put the company's credit rating on watch for a potential downgrade, following the deal. Standard & Poor's currently rates it BBB, which is one level away from junk status.

With that in mind, I'm here to answer readers' questions: Should you buy it? Has the risk from International Paper's acquisition been priced into the stock, or should investors continue to avoid the shares?

The stock has received three analyst downgrades since the news hit, but not everyone on Wall Street has turned sour on IP. According to Bloomberg, the company has seven analyst buy ratings as well as seven holds.

One of the top reasons cited for the downgrades is that the recent acquisition reconcentrates IP's revenue back in the U.S. The company will now generate about 20% of its EBITDA (earnings before interest, taxes, depreciation and amortization) overseas in 2007, compared with 30% the year before. Management had previously set a target to ultimately generate 50% of its total EBITDA overseas.

So, what was IP's motivation for the Weyerhauser deal? In a word: scale. The purchase makes IP the world's largest maker of containerboard and corrugated boxes, and management believes that it can cut annual expenses by $400 million within three years, including $175 million in the first year. With these lower costs, management expects the purchase will expand EBITDA margins to 14.4% from 12.8% in 2007.

Despite the company's own bullish outlook for the deal, I believe the company is taking on too much debt in a volatile credit market. IP is also increasing it domestic exposure in an environment of slowing domestic growth.

As a result, readers should avoid shares of International Paper, which could trade down toward the low-$20s over the coming quarters.

International Paper is not included in TheStreet.com Value Investor model portfolio. David Peltier writes regularly about value stocks such as BPBP, Campbell SoupCPB and WinnebagoWGO.