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Sorting Out The Waste Disposal Merger Mayhem

Posted: Jul 15, 2008 14:34 PM by James Brumley

Tickers in this Article: AW, RSG, WMI, WCN

There's one thing I'm sure of: The waste disposal industry is screaming for consolidation. What that consolidation will ultimately look like, however, is still in question after trash king Waste Management (NYSE:WMI) surprised the industry Monday by going after the No.2 player Republic Services (NYSE:RSG).

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This was right after Republic Services had made its own bid for No.3 on the list Allied Waste Industries (NYSE:AW). There's an opportunity here for at least two of these companies, and one company's shareholders. To figure out which merger makes the most sense though (and to whom), let's take a closer look at the three primary names in question before coming to a conclusion. (To begin with the basics, read Mergers and Acquisitions: Introduction.)

It All Started…
In late June, Republic Services offered to acquire Allied Waste Industries for a little over $6 billion in stock. At the time this translated into a premium of about 4%.

Not wanting to see the second and third biggest trash haulers unite and possibly dethrone it from the No.1 spot, on Monday Waste Management offered $34 per share of Republic Services, about $6.2 billion.

Why Waste Management didn't opt to buy No.3 company Allied Waste, which likely would have been cheaper, has never been stated.

Which combo makes the most sense? That's the problem, and it depends who you ask. The most objective way to answer the question starts with a bird's-eye view of all three companies.

WM Under the Microscope
As the category leader, Waste Management has the most muscle to flex. As of the end of March, Waste Management had $466 million on the books, pretty much in line with prior quarters. Money will be tight, but it should be able back the offer.

Will an acquisition improve margins for Waste Management? Possibly, though not necessarily. Waste Management thinks the union could squeeze out an extra $150 million between the two organizations. I don't agree. Waste Management's numbers are in line with the industry's averages already, as are the Republic Service's.

Of course, Waste Management may be eyeing Republic's growth rate, expecting the "later" to look much better than the "now". Republic's quarterly earnings growth rate is a juicy 41.2% year over year . The problem is that Waste Management is generating income of $1.17 billion per year compared to Republic Service's $312 million, so it's going to take an enormous amount of growth from RSG to even make a dent in Waste Management's bottom line.

Allied Waste the Better Target?
Allied waste has been billed as the "smallest" of the three companies in question. "Small", however, is a matter of perspective. Allied Waste's market cap of $5.0 billion is less than RSG's capitalization of $5.7 billion, but over the last 12 months, Allied has actually generated a better top and bottom line. Fundamentally, Allied Waste looks a lot like the other two organizations … except in one area.

There's an irony in Waste Management's decision to go after Republic Services rather than Allied Waste. Between Allied Waste and Republic, Allied appears to be the better company and the better value. On a dollar-for-dollar basis, Allied Waste offers a bit bottom line and a much better top line, $6.1 billion in sales over the last twelve months, as opposed to $3.2 billion for Republic Services.

The kicker is Allied's 82% net income growth rate in the quarter ending March 31, 2008 compared to 2007, which jumped to $73 million versus $40 million in 2007. Republic Services had the right idea, but Waste Management didn't want to go for the low hanging - ahem - fruit.

Bottom Line
Of the two scenarios presented, an Allied/Republic merger should be (relatively) better for shareholders of those two companies than a Waste Management/Republic deal would be for their owners. In light of Waste Management's offer, though, an Allied/Republic deal is less likely, barring any unforeseen legal hurdle.

The ripple effect could be biggest for owners of a stock we haven’t even mentioned yet, Waste Connections (NYSE:WCN). It's the fourth-biggest player in the arena, but a distant fourth. If Waste Management snags Republic, Allied may have little choice but to team up with Waste Connections if either company wants to keep competing. Waste Connections might be the smallest, but quarterly revenue growth of 14.3% is actually the strongest performance of the four.

To learn how to dissect acquisition announcements, read Analyzing An Acquisition Announcement.

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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