Investors are enthusiastic about the deal as WM shares jumped higher by as much as 4%. In our view, there is good reason to be bullish on the deal. First, the acquisition significantly expands WM’s footprint since ADSW is the fourth largest solid waste company in the country. The addition will specifically bolster WM's presence on the East Coast.
To put its size and scope into perspective, WM served around 20 million customers last year. Tacking on ADSW's 3.0 million customers, its lead over its next closest competitor, Republic Services (RSG), just expanded to roughly nine million customers.
Together, WM and RSG handle more than half of the country's garbage collection. Now, with ADSW consolidating into WM, the competitive landscape is getting more difficult for smaller operators such as Waste Connection (WCN). On the other hand, WCN may now find itself becoming an acquisition target in this game of market share grab.
Financially speaking, the deal also looks like a good fit. WM expects the acquisition to be immediately accretive to adjusted EPS and cash flow, generating more than $100 mln in annual cost and capital expenditure synergies. Longer-term, it anticipates margin improvement and enhanced free cash flow conversion, driven by incremental benefits from operating and capital efficiencies.
In order to generate these financial benefits, WM had to pay a reasonable price for ADSW. Based on our analysis, that indeed looks to be the case. In its Q4 earnings press release, ADSW guided for FY19 adjusted EBITDA of $440-$452 mln. At the mid-point of that outlook, that translates into WM paying about 11x FY19 expected adjusted EBITDA. For a couple points of comparison, RSG and WCN are trading at 9x and 13.5x projected FY19 adjusted EBITDA, respectively.
If there is a blemish to this deal, it's that with it, WM piles onto its already hefty debt load. As of December 31, 2018, it had total long-term debt of $9.6 bln. Now, with the addition of ADSW's $1.9 bln, that balloons up to nearly $11.5 bln, which will take its annual interest burdens close to $50 mln.
The good news, however, is that WM generates a substantial amount of free cash flow, enabling it to comfortably handle this. When WM announced its Q4 earnings on February 14, it also guided for FY19 free cash flow of $2.025-$2.075 bln. That strong outlook enabled it to raise its annual divided by 10% to $2.05/share, which is on top of its existing $1.5 bln share repurchase program.
With the company now taking on a major acquisition, there might be some concern that it is being stretched too thin, in terms of capital expenditures. However, even with the increase in its dividend, its dividend payout ratio remains feasible at about 40%. This indicates that WM is still keeping a majority of its earnings to pay off debt, add to cash reserves, and/or to reinvest in the business.
Key Takeaways: This acquisition looks like a win-win for shareholders of ADSW and WM. The $33.15 price takes ADSW shares to all-time highs, up a considerable 40% on the year. WM, meanwhile, instantly bolsters its market share, earnings growth, and cash flow generating capabilities. Additionally, WM is a very shareholder friendly company, returning plenty of capital through dividends and buybacks. The one risk investors should be mindful of is WM's expanding debt load, but its healthy cash flow generation does mitigate this concern.