Is FTSE 100 takeover target DS Smith a great buy?

A mega-merger between FTSE 100 giants DS Smith and Mondi has the City abuzz. But is there any value in buying stock in the takeover target?

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As I was scanning down the list of the best FTSE 100 shares to buy, I came across takeover target DS Smith (LSE:SMDS).

I thought: “Wow, that looks like a boring company. There’s absolutely nothing to set the heart racing there.”

It’s a paper and packaging company, after all. But on the other hand, DS Smith has produced very steadily rising earnings over the last three years, and boasts a healthy 5.7% dividend yield.

Then there’s the news that rival Mondi is considering buying out DS Smith to produce one of Europe’s largest packaging companies.

Six of one

Comparing balance sheets, the two companies are remarkably similar. Each has annual sales around £7bn and operating profits in the region of £400m.

DS Smith has a market cap of £4.4bn, while Mondi is slightly larger at £6.1bn.

The difference is that DS Smith has not done as well as Mondi in managing its working capital. This is the difference between a firm’s current assets (like property and inventory) and current liabilities (like wages or rent).

In other words, it’s the cash left over to be able to run day-to-day operations. Over the last 12 months Mondi has had working capital of around £2.1bn. DS Smith, on the other hand, has had negative £189m.

No wonder it’s Mondi considering the takeover and not the other way around.

List price

I’m not surprised the news came out, to be honest. Sometimes discussions slip out when the buying or selling party wants to test the market’s reaction.

Mondi made a “highly preliminary expression of interest” in acquiring its closest rival, DS Smith said in a market statement.

The DS Smith share price spiked 22% in the days after the announcement, but has fallen back a couple of percentage points since.

London has been abuzz with the news after a pretty tragic lack of new listings.

A swathe of big companies going public in the last 12 months have all chosen the US instead of the UK. These include the City commodities broker Marex and Cambridge chip giant Arm, which now trades on the Nasdaq in New York.

Emerging mergers

Two other FTSE 100 giants, housing companies Barratt Developments and Redrow, announced a surprise £2.5bn merger in February 2024. The higher-valued Barratt Developments said it would takeover its smaller rival to create a new joint business called Barratt Redrow.

But there are issues there, too. The UK’s competition watchdog may not allow the merger to go through. And a bigger joint company doesn’t always provide more value for shareholders.

In this case, there is also no guarantee Mondi will make DS Smith an offer.

With this kind of uncertainty around, both companies’ share prices could be volatile in the near future.

And at this stage, it is difficult to see what new shareholders could gain from taking positions in either company. Personally, I’d wait until any merger is completed before considering a new position here.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Tom Rodgers has no position in any of the shares mentioned. The Motley Fool UK has recommended DS Smith. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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