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Ignoring Apollo

Thus Apollo spake unto the directors of the UK’s second-biggest packaging group, RPC (RPC), who were keen to sell their company. Apollo said it would make a distinctly low-ball offer – 782p a share in cash; but they had better take it or leave it because it was the only one the firm would make.

RPC’s directors gave a breathless “oh yes, please” and recommended Apollo’s offer. This has hacked off some of RPC’s institutional shareholders because the offer does look pretty unexciting. However, there is now a second suitor talking to the maker of stuff such as bottles for Heinz tomato ketchup and tins for Dulux paints – Berry Global (US:BERY), a packaging group floated by Apollo in 2012 and in which it still has a stake.

The background is the directors’ conviction that RPC must grow by acquisition. And the clear inference in their unconvincing recommendation of Apollo’s offer is that they feel that listed status shackles the group. Or, as they put it, “differing investor views on the appropriate level of leverage have been a constraint on RPC’s opportunities and growth”.

Without a counterfactual, we can never know, yet that statement does not readily tally with the facts. These past five years RPC has binged on acquisitions. It’s hard to imagine that its bosses could have done more without biting off more than they could chew.

Spending on acquisitions has dwarfed any other category of capital allocation, especially its internal equivalent, growth by capital spending. In the five years to 2013-18, capex totalled a bit more than depreciation – £680m against £574m – but that compares with almost £2.1bn cash spent on acquisitions. Meanwhile, almost all the funds for this growth were sourced externally. Cumulatively, RPC generated free cash of just £327m in that period while it raised just over £2bn in almost equal amounts of debt and equity.

Clearly, this leveraging has had the desired effect on performance. RPC has become a more productive beast – in 2017-18, gross profits per employee were 13 per cent higher than five years earlier even though employee numbers had more than tripled. In the same period, revenues rose by the same proportion while pre-tax profits quintupled to £317m and basic earnings quadrupled to 62p. Even the dividend, whose movements should be comparatively staid yet reliable, doubled to 28p.

True, free cash – arguably the best long-term measure of profitability – is lagging. It came in at 35p per share in 2017-18, barely more than half the accounting earnings figure. It is feasible to ascribe that to RPC’s acquisition-driven growth, sucking working capital, interest and cash taxes out of the group. Yet even free cash has been moving strongly in the right direction. In increments of approaching £50m a year, it went from nothing to £145m in the three years to 2017-18.

Besides, there is nothing wrong with RPC’s basic aim of growing by acquisition. On the contrary, in a low-growth industry such as packaging, where fixed costs are high and economies of scale especially powerful, it seems the one to pursue.

So why do RPC’s bosses seem so miffed? Quite likely because the share price has responded indifferently to their efforts. At its current 793p, it is 26 per cent lower than its peak two years ago. That said, it is still 50 per cent higher than it was five years ago, which compares with a gain of just 11 per cent from the FTSE All-Share index.

Not surprisingly, they see the solution in the arms of private equity where they can run RPC “without the costs, constraints and distractions associated with being a listed company”, as they say in the offer document. And there is the point – which somehow doesn’t get mentioned in the document – that they may well have the prospect of making even more moolah with RPC being private-equity owned than as a listed company.

Yet this brings little benefit to the people who currently employ them – RPC’s shareholders. All that Apollo’s bid offers them is a miserly 14 per cent uplift on the share price immediately before the directors announced they were in bid talks last September and an exit earnings multiple way below the average of RPC’s global peer group – 10.7 times forecast earnings against 14 times. True, the arrival of Berry Global may improve the exit returns, but don’t expect a bidding war – as Apollo’s offer is final it can’t be raised without special permission from the Takeover Panel.

In which case, RPC’s shareholders may have to make the best of a bad job. That would mean persuading New-York-listed Berry Global to include an equity component in any offer it makes, which would allow them to share in the future gains accruing from RPC’s acquisition strategy. Failing that, they should tell RPC’s bosses to stop whingeing, get on with the good work and don’t listen to masters of the universe.