Issues & Opinions

Based on the events of Friday afternoon, I’m reminded of the only phrase I can recall from Nancy Reagan’s tenure as First Lady: “Just say no”.

About an hour before Wall Street closed for the week, I got a call from an old friend who’s an equity analyst for an east coast hedge fund. He wanted to know whether it was possible that there was any truth to the rumor he’d heard about a merger in the waste industry.

That merger? Republic Services and Allied Waste Industries.

While it turns out that I should have just said no, that I had no idea, and moved on to other matters, I first told him that I’d heard no such rumor. Not that all, or any, rumors run through me before they’re generally available to the rest of the populace, mind you, but I do have some experience in the waste industry, including some related to M&A activity. So his question wasn’t out of place, my specific ignorance of this rumor notwithstanding.

I thought about it for a bit, and then, while allowing that of course anything’s possible, told him that this was highly unlikely, for a lot of reasons. For instance, have a look at these two track records:

One of those two report cards is decidedly not like the other, yet this is billed as a “merger of equals”. Hey - we’re in the 21st Century - so we’ve got to say whatever makes the kids feel good about themselves, I guess. Everyone gets a trophy! I realize, of course, that they’re roughly equal in market cap, with Allied being the bigger of the two by several hundred million dollars, but that market cap was smaller than RSG’s before the rumor of a deal leaked out, and with good reason.

Feel free to have a look for yourself - RSG has outperformed most of the waste industry by a noticeable margin in the last five years.

Some time ago, when Republic began its steady climb, Jim O’Connor, the CEO, articulated a strategy that said, in essence, “There’s a limit to the value of pure size in the waste business”, and he took the company off the hamster-wheel of non-stop M&A which had gripped the entire environmental services industry in the 1990s. He paid down debt, and in 2003, the board began paying a dividend, one which has grown just as steadily as has the stock price you see above.

Allied? Not so much in the way of fiscal discipline. They’re big, and have always had visions of growth, but have never, not since their initial “big” acquisition (Laidlaw?), many years ago, had a balance sheet that would be rationally rated as anything but highly leveraged. Even though a properly run company in the waste industry can generate a lot of cash (between big capital expenditure cycles, anyway), it’s proven impossible for Allied to meaningfully hack their debt load down to size.

There are good companies in the industry, there are average companies, and then there are bad companies. The three good ones are Waste Connections, Waste Management, and Republic Services. Allied is just average, and only looks average if you choose a short enough timeframe for analysis. Long term, it’s been a disappointment. BFI Canada is also average, but as a unit investment trust, pays a decent dividend, and has some excellent assets. (The bad ones, in case you’re curious, include Casella Waste, Waste Services, and the boondoggle known as WCA Waste Corporation)

So anyway, my thesis to my friend went, O’Connor and RSG decided long ago that since the waste business is, in its essence, a local business, it should be run that way, and stockholders would applaud. Applaud they have, and they’re better off for it.

By comparison, I continued, Waste Management (WMI), the granddaddy of the industry, and a fine company in its own right, maintains a pretense to being a single company, but they could just as easily be split into five pieces. The benefits that come from the corporate shared services (finance, brand building, HR, IT, &c) might not be as easily justified as they are in, say, a manufacturing environment, one with fewer ultimate end-customers. The lost touch with the needs of local market customers and the decisions that are made corporate-wide but which don’t fit in all markets/jurisdictions can make the all-encompassing shared service model look silly. Forcing square decisions into the occasional round hole of a local market might make the mandarins at Corporate happy, but make the customers unhappy. The corporate headcount & other overhead required to implement choices that don’t necessarily scale to infinity can sometimes be money ill-spent.

At a certain size, then, a case can be made that the whole is worth less than the sum of its parts.

And that’s the hymnal Republic Services has sung from for many years, carrying the tune admirably.

So, as I told my friend, their chasing a larger company, one structurally weaker than themselves, seemed ill-advised, and I figured that Mr. O’Connor would avoid doing such a thing.

Shortly after we were done talking, however, a teaser for this story hit my inbox, via the WSJ news alert service:

DEALS ALERT
from The Wall Street Journal.

June 13, 2008

Republic Services is in merger talks with Allied Waste Management, according to people familiar with the matter.

If completed, the deal would combine second and third largest trash haulers in the U.S., creating a formidable rival to U.S. market leader Waste Management. Should a deal come together, the companies are expected to bill the transaction as a “merger of equals.”

It will likely be structured as a purchase of Allied by Republic worth around $7 billion, or greater than $16 per share. Exact details of the offer — such as whether it is for cash or stock — are still unclear.

As a side note, there is no company of which I’m aware called “Allied Waste Management”, and I am just guessing when I assert that Thomson Financial is the culprit for this faux pas. Witness this snippet from a Forbes.com story on the deal, as it was written on June 13, 2008:

SAN FRANCISCO (Thomson Financial) - Republic Services Inc. (nyse: RSG - news - people) and Allied Waste Management Inc. (nyse: WMI - news - people) late Friday confirmed that they are in discussions regarding a possible merger.

So, yeah, there was a bit of confusion there, but it doesn’t change the fact that I was totally wrong.

Luckily, there wasn’t any particular fallout from my erroneous conclusion, aside from a bit of extremely mild embarrassment on my part. (That’ll teach him to ask me for such advice!) My reasoning remains valid, even though the results of that reasoning were useless.

Operating under the assumption that RSG really is driving this bus, perhaps their decline in revenue growth (3% in 2007, vs. 7%-8% in recent prior years) has caused Mr. O’Connor to go looking for a fixer-upper. And the fixer-upper he’s currently chasing is a tired horse with 2%-3% historical revenue growth, a debt-heavy balance sheet, and a sclerotic corporate culture. Allied’s got some good operating assets and good people, (along with some less exciting entries on both ledgers, as could be expected in any big company) but has taken a decidedly go-slow approach toward many important corporate activities, including resolving the capital structure that has arguably limited their growth.

Perhaps joining up with RSG can solve all that. And perhaps it cannot.

Mr. O’Connor is one of the best in the business (and made an unfortunate exit, on his own terms, from WMI 10 years ago, otherwise he’d probably be running that company now) but RSG has no meaningful recent experience at acquisition integration, nor does Allied, and RSG is buying into a company with more placque in its corporate veins than befits its own culture. If consummated, this merger could get more interesting than either party would prefer.

Or so I still believe. Even though I was wrong and should have invoked the Nancy Reagan Defense.

Bookmark to: