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Morningstar | Waste Management Strikes Deal to Acquire Public Rival Advanced Disposal; No Change to FVE

Wide-moat waste-services leader Waste Management struck a deal to acquire all the outstanding shares of public rival Advanced Disposal, or ADSW, for $33.15 in cash, representing a total enterprise value near $4.9 billion when including $1.9 billion of ADSW’s net debt. Management expects to fund the deal with incremental senior notes. The transaction is slated to close in first-quarter 2020. The offer price is 22% above ADSW’s market price before the announcement, which increases the likelihood of shareholder approval. This is a sizable deal for Waste Management, which is acquisitive but has primarily focused on tuck-in opportunities in recent years. We weren't expecting this acquisition, but given Waste Management’s elevated tuck-in activity over the past year and broader industry consolidation lately, it’s not a complete surprise.

We expect additional details of the underlying quality of ADSW’s operations and the road map to synergies in the quarters ahead, but we don’t expect to materially alter our $76 fair value estimate for Waste Management as a result of the acquisition. Overall, when running the purchase price and ADSW’s performance numbers through our DCF model, our preliminary take is that Waste Management paid roughly a fair price for the firm, when including management’s targeted synergies. Naturally, there’s risk when it comes to achieving synergies, but acquisitions tend to be nicely accretive for Waste Management thanks in part to strong benefits from increased network density when new solid waste operations are folded in. We are currently giving management the benefit of the doubt, even though this deal is larger than usual.

Waste Management is a well-run and highly profitable waste hauler, but we still think the stock price is a bit lofty. The industry leaders are seeing strong growth within their traditional solid waste operations on the back of U.S. macroeconomic tailwinds, but this dynamic hasn’t escaped investors.

At first glance, the deal seems to make sense from a strategic perspective. Based in Florida, ADSW is the fourth-largest vertically integrated waste hauler (following Waste Connections), with a network of 41 landfills, 73 transfer stations, and 22 owned or operated recycling facilities. Thus, we suspect these operations will incrementally bolster Waste Management’s network density in the Midwest (including Illinois) and the South (including Florida). In terms of route density, scale matters in route-based businesses (in this case, collection through disposal) because it provides greater utilization and leverage over a vast cost base (costs linked to landfills, collection equipment, transfer facilities, and so on) relative to smaller providers. We note that ADSW’s adjusted operating margins have been in the mid- to high single digits over the past three years on average, compared with the high teens for Waste Management. Thus, we suspect Waste Management sees plenty of low-hanging fruit in terms of bringing ADSW’s operational quality and efficiently more in line with its own. Management anticipates more than $100 million in “annual cost and capital expenditure synergies.” ADSW will add about 10% to Waste Management’s top line.

Waste Management is paying approximately 11 times 2018 EBITDA (before synergies) for ADSW. This compares with Waste Management’s market valuation near 12 times EBITDA, which we consider a bit rich. That said, depending on the ultimate synergies the firm achieves (including the mix of cost-related versus capital-expenditure-related savings), the deal multiple could prove to be a more reasonable 9.5-10 times EBITDA. For perspective, our current fair value estimate for Waste Management implies an EV/EBITDA of about 9.5 times, which gives us a little more comfort regarding the purchase price for ADSW when also considering Waste Management’s solid cost-related execution in recent years and the usual density benefits it tends to secure when absorbing new operations into its network.