Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Leave it to a couple of garbage collectors to shrug off a little mess in the equity markets.

Rocky Start
Waste Connections shares recovered some of their losses for the year after the company announced the Progressive Waste merger.
Source: Bloomberg

Waste Connections, a Texas-based trash processor, announced on Tuesday that it's merging with Canada's Progressive Waste Solutions in an all-stock transaction. It's a gutsy move considering that as of last week, the S&P 500 was off to its worst start on record and Waste Connections' own stock was down about 10 percent for the year. Among the larger deals announced so far in 2016, the vast majority have included at least some cash component.

It's gutsy, but not crazy. The trash collectors had reasons to stick with stock. For one, Waste Connections already has a decent-sized debt load and the industry hasn't been one to push the boundaries financially (as my colleague Gillian Tan has noted.) And because the transaction is structured as an inversion -- in which Waste Connections will move its headquarters to where Progressive Waste is based outside of Toronto -- adding cash isn't straightforward.  

The Treasury has rolled out tougher guidelines over the last few years in an effort to deter companies from using inversions to secure lower tax rates in foreign countries, with lawmakers from both sides of the aisle deeming the maneuver tax-dodging. Those tighter restrictions take effect when the U.S. company's investors own more than 60 percent of the combined company. Because Waste Connections' holders will end up with about 70 percent of the merged garbage collector, the deal falls subject to those new rules.

Adding a cash component (as Pfizer and Allergan did in their similarly structured blockbuster inversion combination) could have helped the companies skirt the Treasury crackdown by diluting Waste Connections' ownership stake. But for the purposes of that construction, any cash would have had to be supplied by Progressive Waste, according to tax consultant Robert Willens. That may not have been an appealing option for the $2.7 billion garbage collector, given its own debt burden and smaller size. And there's not as much incentive for Waste Connections to pony up cash that won't help it with the ownership threshold.

The company still stands to benefit greatly from shifting its tax domicile, even with the stricter inversion guidelines. The new company will have an estimated effective tax rate of about 27 percent, compared with Waste Connections' current 40 percent. The Treasury has also largely been stymied in its efforts to prohibit earnings stripping, a tactic used by inverted companies to effectively shift profit to lower-tax countries and reduce the amount of income taxed at the U.S. rate, the highest in the industrialized world. That's a maneuver that Waste Connections should be able to use to its advantage.

Can't Touch This
The Waste Connections- Progressive Waste merger is another reminder that the inversion trend isn't going away.
Source: Bloomberg
Valuations derived from press releases and Bloomberg data.

The benefits of the deal -- which include not just tax savings, but the potential for cost cuts and an expanded North American footprint -- far outweigh the risks of using stock in a down market. Plus, Waste Connections is getting Progressive Waste for a bargain. The implied exchange ratio values the target at about $26 a share. Analysts had been estimating a takeout value of as much as $32.

Waste Connections' shareholders certainly seem happy: The stock climbed as much as 7.8 percent on Tuesday for the biggest intraday gain in more than three years.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net