Shares of Greif, Inc. (GEF - Get Report) tumbled 17.14% to $34.86 Thursday afternoon after the industrial packaging products and services company agreed to acquire Caraustar Industries, Inc. for $1.8 billion in cash, a transaction criticized by ratings companies and analysts.
The Delaware, Ohio-based Greif said it was buying the Austell, Georgia-based Caraustar Industries from an affiliate of H.I.G. Capital, a Miami-based private equity and alternative assets investment firm. The deal is expected to close during the first quarter of 2019, subject to customary closing conditions.
The shares tumbled as Moody's Investors Service said it put the Ba2 corporate family rating, Ba2-PD probability of default rating, and all instrument ratings of Greif Inc. under review for downgrade. Moody's said the review for downgrade reflects "the significant incremental debt, change in risk profile and the integration risk inherent in the transaction."
"The acquisition will increase Greif's revenue by 35% and add exposure to recycled boxboard product end-use markets," Moody's said. "Weaknesses in Greif's credit profile include inherent cyclicality and weak margins. The rating is also constrained by the commoditized product line and lengthy pass-throughs for raw material price increases and lack of pass-throughs for other costs."
In addition, BMO Capital Markets decreased Greif's rating from a "Outperform" rating to a "Underperform."
Greif said the transaction will immediately add to its earnings, margins and free cash flow, and is expected to create annual cost synergies of at least $45 million within 36 months.
"We have serious concerns about this morning's news that GEF is acquiring Caraustar for $1.8 billion," BBMO Capital Markets analyst Mark Wilde wrote in note Thursday.
Wilde said key issues with the deal included the fact Greif is levering up to 3.5 times just what the global economy is showing signs of slowing. Also, the company's record on mergers and acquisitions has been poor and Caraustar's operating performance has improved markedly under two private equity firms, limiting room for further gain.
"We note that Caraustar's results have been boosted by a sharp drop in wastepaper costs and rising recycled paperboard prices. We question whether these margins are sustainable," Wilde wrote.
Greif said in a statement that it expects the addition of Caraustar to increase Greif's U.S. sales to roughly two thirds of total consolidated sales from about half for fiscal 2018. In addition, the percentage of Greif's sales from paper packaging will expand to roughly half of total consolidated revenues compared to 23% for fiscal 2018.
Caraustar is a market leader in uncoated recycled paperboard and coated recycled paperboard, Greif said. The deal significantly strengthens and balances Greif's portfolio and expands its paper franchise by acquiring a vertically integrated leader in recycled paperboard manufacturing, Greif said.
"Caraustar offers an exceptional strategic and cultural fit for Greif," said Greif's President and CEO, Pete Watson. "Its complementary paper packaging and recycled fiber operations will drive significant free cash flow growth, improve balance and profitability within the Greif portfolio and increase Greif's exposure to U.S. industrial and consumer end markets."