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Negative im-Pact?

Packaging company Pact Group (ASX: PGH) listed on the ASX on Tuesday, after raising $649 million through the sale of 170.7 million shares at $3.80 each.

And it seems Asian investors have gone nuts over the listing, with one investor reportedly telling former owner and current chairman  Raphael Geminder that it was the best float to come out of Australia in five years. Institutional investors are also said to have overcome their concerns about high gearing levels and related party transactions to oversubscribe for shares in Pact.

Pact is Australia’s largest supplier of plastic packaging, with around a 40% share of the market in Australia and New Zealand. It also has a small metals packaging division, which generates an estimated 9% of the group’s revenues. The company has 62 manufacturing plants and expects to generate $1.2 billion in revenues in the 2014 financial year. Products include yoghurt, cream and ice-cream containers, margarine tubs, food jars, meat and bakery trays, plastic tubes and cartridges, plastic bottle caps and steel drums.

Pact was a 100% privately owned corporation prior to the listing, with Mr Geminder to retain 39.8% of the company post-listing, and the role of Non-executive chairman of Pact.

Not all it’s Pact up to be

There are some concerns, including high levels of debt, related party transactions mentioned above, average profit margins, low levels of cash, the capital intensive nature of the business and Pact’s acquisitive nature.

We are also concerned about the payment of a $484 million dividend last financial year, resulting in retained earnings turning negative and despite the company reporting a net profit of just $45 million. Debt rose from $1.4 billion to $2.0 billion, suggesting the company borrowed to pay the dividend – just before it listed on the ASX. Additionally, Raphael Germinder’s Geminder Holdings will receive $565 million from the proceeds of the offer, but will still have a number of related party arrangements with Pact after listing.

Pact will also acquire several companies that Geminder Holdings either controls or has a substantial shareholding in, including Viscount China, Ruffgar, Plastop Asia, Weener Plastop and Cinqplast. The company is also in discussions to acquire packaging company Dynapack, which is 50% owned by Geminder Holdings.

From revenues of $1.2 billion, Pact is forecasting a pro-forma net profit after tax of $83.5 million, a margin of around 7% and 28.4 cents in earnings per share.

Valuation

On face value, the company doesn’t appear to be cheap, with the IPO priced at a P/E ratio of 13.4 (using pro-forma net profit), and an Enterprise Value (EV) to earnings before interest and tax (EBIT) ratio of 11.5 times. Despite raising $649 million from the float, Pact will still be hocked to the eyeballs with more than $600 million in net debt, with the ratio of Net Debt to EBITDA sitting at 3.5 times.

The company has made no less than 34 acquisitions in the past eleven years, and has made its intentions clear to make additional purchases in future, and potentially raising more equity to fund larger acquisitions. While the company boasts that it has grown EBITDA by 18% CAGR since 2002 – thanks to high depreciation and amortisation costs, EBIT has grown by just 4.4% over the period from 2011 to 2014.

Foolish takeaway

Don’t be fooled (lower case ‘f’) by the company’s glossy prospectus and rosy forecasts of growth in revenues, EBITDA as well as ongoing growth in its packaging markets. In this Fool’s view, Pact appears overpriced, with too much debt. Add in low forecasts for growth in EBITDA, and Foolish investors may want to let this one pass through to the keeper.

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Motley Fool writer/analyst Mike King does not own shares in Pact Group. You can follow Mike on Twitter @TMFKinga

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