The Garbage Deal That Was Anything But
CEOs and the bankers who advise them like to talk up the benefits of the deals they do, touting the synergies and earnings accretion they expect to achieve to justify spending on transactions. But those benefits don't always pan out, as evidenced by the takeover-related writedowns at companies from Toshiba Corp. to Priceline Group Inc.
That's why it's all the more rare to hear a CEO boast to investors that his company actually "underestimated the opportunity for improvement" at a target. Waste Connections Inc.'s Ronald J. Mittelstaedt, who spent roughly $8 billion in a deal for rival trash processor Progressive Waste Solutions Ltd., is one of the lucky ones.
The merger, just weeks away from its one-year anniversary in June, initially raised eyebrows because it was structured as an inversion, albeit one that complied with U.S. Treasury guidelines. (As part of the deal, Waste Connections moved its headquarters from Texas to outside of Toronto, where Progressive Waste was based.) Since then, the combined company's results -- including first-quarter earnings released Wednesday -- have reinforced the deal's logic and helped propel the stock to record highs. 1
In hindsight, instead of financing the deal entirely with stock, Waste Connections could have paid for part of it with at least some cash, a move that would have diluted its own shareholders a little less. In such a scenario, even though the company's debt-to-Ebitda ratio would have breached its target of roughly 3, its strong cash flow generation would have enabled it to quickly pay down borrowings. But this is a small quibble: after analyzing the deal on its own terms, we at Gadfly feel comfortable awarding it a "slam dunk." 2
Waste Connections has been able to extract synergies and cost savings far beyond what it expected. For instance, it projected $50 million in annualized expense reductions from merging overlapping sales, general and administrative expenses, and some longer-term savings from safety and operational improvements. In reality, that combined savings is likely going to be somewhere between $110 million and $120 million. And its focus on safety has had a real impact on employees: Accidents and injuries have decreased by more than 60 percent across Progressive Waste's former territory, which has in turn led to lower employee turnover.
Although the combined company's margin is still lower than Waste Connections's standalone 33.6 percent before the transaction, it's slowly making its way back up thanks to a push to shed some of Progressive Waste's lower-margin businesses. Already, it's expected to be 31.5 percent in the quarter ending June 30, putting it ahead of large rivals $21 billion Republic Services Inc. and $32 billion Waste Management Inc.
So, what's next? This week, Mittelstaedt admitted that potential sellers will likely hold off on agreeing to any deals while awaiting proposed tax reform, so it's good that Waste Connections seized its chance to snap up Progressive Waste when it did. It has since made small tuck-in acquisitions, including Groot Industries Inc., an Illinois-based rival with around $215 million in annual revenue. Expect the company to take a leading role in the "M&A bonanza" of industry consolidation that Mittelstaedt said he expects to occur when there is clarity on the direction for U.S. corporate taxes.
Waste Connections has been dubbed "the MVP of garbage" by some Wall Street analysts, while others joke that it's "picking up bags of money."
That's certainly been the case with Progressive Waste, a trash deal that's turned out to be a treasure.
It's also getting a hand from its exploration and production segment, where revenues are climbing because oil prices have bounced back, prompting a recovery in drilling in the Permian region.
Deals are ranked according to five grades (listed here from positive to negative): Slam Dunk, Polite Clap, Meh, Troubled and Cringeworthy. In assessing the performance of the Progressive Waste Solutions deal, we took into account the better than expected cost synergies and cost savings following the deal's close; the company's share-price performance; and the additional revenue obtained as a result of the transaction.
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