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Deltic Timber and Potlatch, Made for a Merger

5 min read

Deltic Timber Corp. of El Dorado was feeling pressure to get hitched, and when the Potlatch Corp. came courting from Spokane, Washington, the match was undeniable.

The companies “share nearly identical business models,” Potlatch Chairman and CEO Michael J. Covey said last week in a conference call. “The complementary businesses make us a natural fit.”

John D. Enlow, who became Deltic’s CEO in February and spent months pondering its future while a big shareholder group pushed for a sale, also saw a Potlatch union as “the best path forward.”

Last week, the companies announced a $1.2 billion all-stock deal that will give Deltic shareholders 1.8 Potlatch shares for every Deltic share, a roughly 7 percent premium for Deltic shareholders. Deltic specifically calls the transaction a merger.

“It’s a good deal. Not a great deal, but a good deal,” said Al Sebastian of Prospect Advisors LLC of Stamford, Connecticut, a close follower of Deltic. “The premium is on the low side, but Potlatch is the most logical buyer of these assets. Deltic has a diverse set of properties — timberland, manufacturing and a real estate segment. With all that in common, Potlatch clearly was the best buyer.”

Though the stock price premium didn’t bowl over market observers, Potlatch’s significantly higher dividend (an annualized $1.60 compared with 40 cents) offers “some compensation,” John Abbink wrote in SeekingAlpha.com. “But on the whole, I think Potlatch shareholders are getting the better end of the deal.”

Potlatch Breaks Ice
Covey said that Potlatch, which is structured as a real estate investment trust, made the first move in the mating ritual. “We approached Deltic about combining our companies several months ago,” he said in a conference call last week. “John joined Deltic … and quickly identified the opportunities I mentioned to optimize harvest levels and mill output. Over the next several months, we continued discussions, and we are pleased to have reached this agreement that benefits both companies.”

At $2.1 billion, Potlatch has about twice the market capitalization as Deltic’s $1.1 billion. The deal, set to close in the first half of 2018, will leave Covey as chairman and CEO; Enlow will be vice chairman and oversee the corporate integration.

The merger combines “two companies with outstanding assets, operational excellence and aligned values,” Enlow said in a statement to Arkansas Business. In the conference call, he said Deltic exploring a wide range of internal and external options “for the past many months,” concluding that the Potlatch merger will “maximize value “for both companies.”

PotlatchDeltic, the new company, will be based at Potlatch’s headquarters in Spokane, and its stock will trade on Nasdaq under Potlatch’s ticker, PCH. Deltic’s corporate offices in El Dorado will be the company’s southern operational headquarters, and the new board will have eight directors from Potlatch and four from Deltic.

Executives believe the combined company can increase timber harvest yields by 30 to 40 percent, significantly increase lumber and fiberboard production, and trim redundant costs. “While this transaction creates a much larger company, there is also an opportunity to reduce corporate overhead,” Covey said.

At the Employee Level
PotlatchDeltic will have some 1,500 employees, including most of the 547 employees Deltic had at the end of 2016. Combined market capitalization will be about $3.3 billion, and PotlatchDeltic will have about $700 million in net debt, according to a joint statement.

“As far as people working there, I don’t think you’ll see much effect” from the deal, Sebastian said. “There may be some overlap in senior management levels, but at the employee level, like the people working at the plants, I don’t think there will be much change.”

Anna Torma of Deltic investor relations said it was “premature” to comment on how the transition might play out, referring a reporter to a Frequently Asked Questions section of the merger announcements.

Matthew Pelkki, an economist for the University of Arkansas System’s Division of Agriculture, said he expects no brisk effect on the logging market. “In the near term, I don’t see major differences in the production of lumber or wood prices to landowners selling timber to either company,” said Pelkki, who is known for his expertise in Southern forestry.

The deal capped a relatively turbulent year for Deltic. Ray C. Dillon retired in October 2016 after 13 years with a $3 million severance package, including a $2.1 million cash payment and early vested “equity grants previously awarded.” D. Mark Leland, a company director who became interim CEO, denied speculation that friction with the board had played into Dillon’s exit.

In late February, as Deltic introduced Enlow as the new CEO, it also dismissed CFO Kenneth D. Mann, saying the board had become “aware that he misappropriated certain company assets for personal use.” In August, after 15-percent stakeholder Southeastern Asset Management Inc. of Memphis publicly accused the company of all but snubbing potential deals, Deltic announced that it was evaluating options to “maximize shareholder value.”

REIT Structure
The Potlatch union will convert Deltic, which Covey described as “one of the few remaining C-corps” in the timber industry, to a REIT, ensuring that the combined company achieves tax advantages. Under the conversion process, Deltic’s $250 million in accumulated earnings will be distributed to stockholders of the combined company by the end of 2018, 80 percent in stock and 20 percent in cash. The tax advantages of REIT status are included in the $50 million worth of “synergies” the companies identified in announcing the merger, along with bigger timber yields and increased lumber production.

(Generally, REITs don’t have to pay corporate income tax as long as they distribute at least 90 percent of taxable earnings in the form of dividends. Those dividends are taxed as regular income; they don’t get the same favorable tax treatment as dividends from other corporations.)

Deltic was advised on the deal by Goldman Sachs and Davis Polk & Wardwell LLP. Potlatch’s advisers were Bank of America and Perkins Coie LLP. The two boards of directors backed the deal unanimously.

Both companies were born shortly after the turn of the last century in pinelands some 2,000 miles apart: Potlatch in 1903 in the old-growth northwest forests, Deltic in 1907 in south Arkansas. Deltic was a part of Murphy Oil from the 1950s to 1996, when it was spun off.

“Deltic has a proud legacy that is deeply rooted in the Arkansas communities in which it operates,” Enlow told Arkansas Business. “We are excited to add a broadened geographic scope, and we are confident that this combination will be a win for all stakeholders.”

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