Appleton acquisition to cut leverage to 3.1 times, proceeds may be used for more debt reduction

By Paul Deckelman

New York, May 16 - Appleton Papers Inc. has agreed to be acquired in a $675 million transaction by Hicks Acquisition Co. II Inc., an entity controlled by Texas leveraged buyout billionaire Thomas O. Hicks Sr. - a deal that is expected to bring the Wisconsin company's leverage ratio of net debt versus adjusted EBITDA down to 3.1 times from current levels around 3.9 times.

And Appleton executives raised the possibility that cash received as part of the transaction, as well as incremental earnings generated by a separate recent long-term supply agreement between Appleton and Canadian paper manufacturer Domtar Corp., could be used for actual debt reduction, among other purposes.

Appleton's senior vice president and chief financial officer, Thomas J. Ferree, said during a special Wednesday webcast announcing the Hicks deal that under the terms of the agreement, Appleton will receive up to $110 million of cash, net of fees and expenses.

Ferree said the cash may be used to reduce outstanding debt, or, alternatively, could be invested back into the company, used to buy back warrants or for other general corporate purposes.

Ferree said that "the transaction will be structured to preserve the company's external capital structure, including bank credit facilities, as well as first- and second-lien notes."

As of the end of the company's fiscal 2012 first quarter on April 1, the company's balance sheet showed total debt of $512 million, including $301 million of 10½% senior secured first-lien notes due 2015, $162 million of 11¼% second-lien notes due 2015 and the last remaining $32 million of 9¾% senior subordinated notes due 2014 out of an originally issued $150 million.

There were no outstanding borrowings under the company's senior secured revolving credit facility, which matures in 2015.

With $7 million of cash and equivalents on the balance sheet, net debt stood at $505 million, representing a leverage ratio of 3.9 times estimated pro forma 2012 adjusted EBITDA of $131 million.

Ferree said that assuming the receipt of the $110 million, the company's leverage ratio, pro forma for completion of the Hicks transaction, would drop to 3.1 times.

According to supporting documents released by the company in connection with the transaction, the $110 million would boost the company's cash and equivalents position to $117 million, more than offsetting an $18.2 million increase in the second-lien notes that would take place upon the change of control. That additional issuance would bring the outstanding amount of the second-liens up to $180 million and increase total debt to $530 million, but with the addition of the $110 million of cash, net debt would fall to $413 million, leading to the lowered leverage ratio, assuming no change in projected EBITDA.

Ferree said that the pro forma EBITDA figure assumes a full-year effect from the Domtar supply agreement, which was signed in February and which runs for 15 years. Under the terms of that deal, Domtar - North America's largest producer of uncoated free-sheet paper - will supply Appleton with most of the uncoated base paper which the latter needs to produce its various specialty paper products. That's part of the 105-year-old company's transition away from its historic role as just a mid-sized regular paper producer and expands its role as a niche producer of specialty products like thermal paper - widely used to print cash register, ATM and credit card receipts - and carbonless copy paper.

Appleton says that supply deal will help it stabilize its costs by enabling it to shed older, high-cost, non-integrated papermaking assets. Next month, for instance, Appleton plans to cease recycled fiber processing and paper production at its mill in West Carrollton, Ohio, although it will continue to operate the thermal paper coating operations installed there in 2008.

Ferree said the company projects that the Domtar deal and the closedown of most operations at West Carrollton should increase EBITDA by some $30 million annually on a run-rate basis.

Appleton's chairman, president and chief executive officer, Mark R. Richards, said that this incremental EBITDA "will be used to reduce debt and invest in our growing global thermal and Encapsys businesses." The latter operation uses the technology of microencapsulation, or the use of specialty chemical coatings to seal in flavors, aromas, freshness or other properties of a substance; such technology is widely used in the food, personal care products and energy industries, to name just a few. Appleton has a major contract to supply such encapsulation technology to consumer products giant Procter & Gamble.

Appleton is 100% employee-owned and has been since November 2001. Pro forma for the combination with Hicks Acquisition, Appleton's employee stock option plan will continue to hold a 37% stake in the resulting company, with Hicks to hold 63% at the deal's closing later this year, although the game plan is for Appleton stock to eventually trade publicly on the Nasdaq under the APVN symbol. Current management, including Richards and Ferree, will stay in place.

Appleton will change its name to "Appvion," a portmanteau that combines the words "applied" and "innovation" - a further reflection of the company's transition from an old-line paper company to a business focused on coating formulations and applications and microencapsulation technologies. However, the initial "App" also reflects the historic name of the company and its location since 1907 in Appleton, Wis.

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