NEW YORK (TheStreet) -- With little fanfare, Goldman Sachs (GS) is playing a major role in the merger of Verso Paper (VRS) and privately held NewPage, two paper industry bantam-weights who may be in the process of completing the best merger of 2014.
Verso Paper's shares have risen more than 500% since the merger was announced on Monday. Goldman and other investors who will have equity in the combined company could see further gains.
Unpacking Goldman's role in the deal shows how the firm may participate in private investments even after regulations such as the Volcker Rule, to be implemented in 2015, go into effect. Volcker seeks to limit the ability of America's largest banks to risk their own capital in private equity and hedge fund investments. Both Goldman's investment bank and its merchant banking division, a key part of the firm's so-called Investment & Lending arm, are involved in the Verso Paper and NewPage merger.
On Monday, Verso Paper said it would acquire NewPage, a privately held competitor that emerged from bankruptcy in late 2012, in a transaction that is valued at $1.4 billion.
Verso Paper is controlled by Apollo Global Management (APO) after a 2006 carve-out transaction from International Paper (IP). Apollo IPO'd the company on the New York Stock Exchange in the spring of 2008. However, debt from the buyout combined with a downturn in the global economy and the specialty paper business proved a headwind that caused shares in the company to lose most of their value within a year.
Other similarly timed deals in the specialty paper industry faced dire prospects. Abitibi-Bowater, a January 2007 merger of Bowater and Abitibi-Consolidated slipped into bankruptcy in 2009.
NewPage, a firm acquired by private equity giant Cerberus in a 2005 leveraged buyout, also came to the verge of collapse after taking on significant debt to fund a $2.2 billion acquisition of the U.S. paper operations of Stora Enso, a Finnish paper, forestry and packing industry conglomerate.
In May of 2008, Cerberus hired Goldman Sachs to attempt an $805 million initial public offering of NewPage. Two years later, the IPO was pulled and in September of 2011, NewPage fell into bankruptcy. When NewPage exited bankruptcy just over a year later, Goldman owned the new equity in the company, while Cerberus had lost its equity investment, according to sources familiar with the situation.
And that's where Goldman's involvement in the merger with NewPage and Verso Paper comes into focus.
Goldman Sachs declined to comment.
GS Credit Partners
As Cerberus and the bankers at Goldman Sachs worked to list NewPage shares on the New York Stock Exchange in the spring and summer of 2008, another part of Goldman Sachs, the firm's mezzanine investment arm, Goldman Sachs Credit Partners, had already lent a total of $2.1 billion to the company. Filings with the Securities and Exchange Commission show that in December 2007, NewPage opened a $500 million senior secured revolving credit facility and a $1.6 billion senior secured term loan credit facility with GS Credit Partners.
Documents show that as a result of those $2.1 billion in secured loans, GS Credit Partners then played a key role in NewPage's bankruptcy process. NewPage, which counts one Goldman executive as a board member, also rejected a $1.425 billion takeover bid by Verso Paper in September 2012, a few months before the firm emerged from bankruptcy.
By way of its first lien debt, GS Credit Partners effectively owned NewPage's new equity were it to emerge from bankruptcy. That debt appears to have changed hands during NewPage's bankruptcy process, with Goldman distributing holdings to outside investors. By the time NewPage exited bankruptcy, first lien note holders were paid $103 million in cash and given new equity in NewPage. GS Credit Partners had distributed most of its interest to private clients during the process, according to a source directly familiar with the situation.
According to a May 2013 filing, Goldman retained an 11.3% interest in NewPage's equity. Asset manager Franklin Resources (BEN) held a 14.3% equity interest in NewPage, while JPMorgan Asset Management, alternative asset manager Oaktree Capital Management (OAK) and Centerbridge Partners held equity stakes of 12.6%, 12.1% and 10.4%, respectively, filings show.
Those equity interests are likely to translate into holdings in the merged Verso Paper and NewPage, if Monday's deal closes.
NewPage's post-bankruptcy equity holders will receive total cash and debt consideration of $900 million, consisting of $250 million in cash that is expected to be paid out as a special dividend during the deal's closing process, and $650 million of new Verso first lien notes that are also a stipulation of the merger. Those NewPage stockholders also will receive shares between 20% and 25% of Verso's common stock immediately prior to the closing of the merger.
For its part, Verso will finance the acquisition through $750 million in debt, which will be used to refinance some of NewPage's existing debt. Overall the $1.4 billion value of Monday's transaction is calculated by Verso Paper as consisting of $250 million in cash that will be paid to NewPage shareholders, $650 million of new Verso first lien notes, Verso common stock, and the refinancing of a $500 million term loan.
As part of the deal, Verso second-lien and subordinated debt holders are poised to see the par value of their claims cut by about 50% in the debt refinancing, which is scheduled to occur after the merger's closure.
What Is Verso Paper Worth?
If that sounds complicated, it is only scratching the surface.
Dig a little deeper and it is the 20% to 25% holding of the equity of Verso that may pay off the most for Goldman Sachs's mezzanine investment unit and NewPage's other post-bankruptcy holders.
NewPage is already a far larger company than Verso Paper, with roughly $3.1 billion in annual revenue vs. just under $1.5 billion at Verso Paper. Combining the two firms may create synergies that pay off for all of the white-glove investors that are behind Monday's deal. It could also help to mitigate chronically falling revenue at both firms.
Sachin Shah, a special situations strategist at Albert Fried & Co., calculates that the merger could generate $175 million in cost synergies between Verso Paper and NewPage. Inclusive of merger-related synergies, he calculates that Verso Paper could generate $636 million in adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), a near 500% increase to the company's $134 million in trailing 12-month adjusted EBITDA.
Those synergies may also allow the likes of Goldman and Apollo, who both rode out a downturn in the paper industry and the global economy, to recoup investment losses or post gains. The synergies are also likely to be the reason investors have bid up Verso Paper's shares in the wake of Monday's deal, and not a short squeeze, as other media outlets have reported.
For now, the most interesting story for the ordinary investor may center on whether Verso Paper is valued properly after its 500% stock surge since Monday.
Shah, the special situations strategist, calculates that further share price gains are warranted, were one to give a merged Verso Paper and NewPage the same multiple that investors currently give Resolute Forest Products (RFP) (previously Abitibi-Bowater). Special items like net operating loss carryforwards, falling costs of capital and rising EBTITDA margins could also play to Verso Paper's benefit, Shah argued in a Tuesday note to clients.
The analyst calculates that Resolute Forest Products is trading at an enterprise value of 5.27 times its estimates 2013 EBITDA. Were investors to ply that same EV/EBITDA multiple to a combined Verso Paper and its estimated $636 million in pro-forma EBITDA, it would yield a market capitalization of $690 million and share price of approximately $10.75 a share, more than double current prices.
Overall, the combined company is expected to generate $4.5 billion in revenue, roughly the same amount as Resolute Forest Products.
After strong gains on Monday and Tuesday, NewPage shares were trading over 10% lower to $3.80 in Wednesday afternoon trading.
Shah thinks Verso Paper should trade at a premium to Resolute Forest Products and he calculates that Versa Paper has $1.9 billion in total federal and state net operating loss carryforwards that could add to the company's valuation. Were the deal to close and that analysis to bear fruit, it could turn Verso Paper and NewPage into the merger of 2014, according to Shah.
The Other Goldman Sachs
Of course, Goldman Sach's mezzanine credit investment arm isn't the only part of the bank that could generate a windfall from NewPage's run in private equity hands, its restructuring and its merger with Verso Paper.
Goldman Sachs was the lead arranger of buyout financing Cerberus needed to acquire NewPage from MeadWestVaco in 2005. The investment bank also was listed as a financial advisor to MeadWestVaco.
In that LBO, Goldman's trading division also played a role.
In May 2005, J. Aron & Company, an affiliate of Goldman Sachs, structured a derivative trade mixing options in natural gas, market pulp and the Euro, to hedge some of NewPage's business risks. NewPage payed a $72 million premium for the contract, which subsequently led to losses of $25 million in 2005 and $47 million in 2006. By 2007, NewPage carried the mark-to-market value of the $72 million premium it paid at zero, according to SEC filings. The option expired in 2008, and it's hard to know without seeing the contract, whether it was an effective hedge or not given commodity prices that moved against all paper producers in 2007 and 2008.
Representatives for NewPage declined to comment when reached by the TheStreet.
Goldman also arranged over $2.5 billion in financing that NewPage raised when it acquired the U.S. operations of Stora Enso.
As previously mentioned, the firm was hired to run the 2008 equity offering of NewPage, however, since the deal was pulled, it's unlikely the bank generated much in the way of fees. Nevertheless, Goldman's bankers played a hand in NewPage's bankruptcy process. Goldman Sachs led a $500 million term loan that helped NewPage repay its debtor-in-possession financing and exit bankruptcy. The firm was paid $9 million for establishing the facility.
Goldman Sachs, by the way, is also the adviser to NewPage in its merger with Verso Paper.
Goldman and the Volcker Rule
The Verso Paper and NewPage transaction is a good merger to watch for those interested in how Goldman Sachs may continue to make private equity and distressed debt investments after the Volcker Rule kicks in.
It seems GS Credit Partners was able to participate in an investment that may align with the tenets of the Volcker Rule, which seeks to curb a bank's total investment in alternative investments to just 3% of the firm's Tier 1 equity capital. It also may be a boon to clients of Goldman's merchant banking division.
At TheStreet reported, Goldman is likely to continue to make direct alternative investments after the Volcker Rule is phased in. However, the bank is also expected to pass on a significant portion of the deals it participates in to clients.
It means that unlike pre-crisis years, when Goldman averaged an equity commitment of between 30% and 40% in private equity transactions, its interest may now drop markedly. That could impact Goldman's earnings, which were reliant on marks to alternative investments for nearly 35% of the firm's pre-tax income in the first nine months of 2013.
For now, the merger of Verso Paper and NewPage looks to be a deal to watch in 2014. Bigtime investors are trying to salvage out bets on the paper production industry and this may be the type of cost-cutting combination that could work out.
-- Written by Antoine Gara in New York