Shares of waste collection, transfer, and disposal service provider Waste Connections (NYS: WCN) soared Monday on news that the company would acquire R360 Environmental Solutions in a deal worth $1.3 billion. The privately held R360 specializes in safely treating and disposing of the exploration and production (E&P) waste generated at oil and natural gas drilling sites. The high-growth E&P waste business, benefiting from the boom in North American natural gas production, is expected to offset slow volume growth in Waste Connections' bread-and-butter municipal solid waste business.
While $1.3 billion seems pricey for a company that takes in $300 million per year in revenue, R360 operates in a high-margin business. Founder and CEO Ron Mittelstaedt claimed in a statement that he expects R360 will add 4% to the company's operating profit (measured as earnings before interest, taxes, depreciation, and amortization). This could accelerate as Waste Connections leverages its scale to help grow R360's business.
Waste Connections has grown from a start-up in the late 1990s to America's third-largest waste disposal business, behind only Waste Management (NYS: WM) and Republic Services (NYS: RSG) , largely thanks to a history of good acquisitions that have added value and grown revenue. Based on Waste Connections' soaring share price, investors expect the R360 buyout to be more of the same.
The two companies do seem like a good fit. Waste Connections has pursued a growth strategy of staying out of the way of Waste Management and Republic Services, instead moving into less competitive markets like municipal solid waste disposal in smaller cities, suburbs, and rural areas where the national operators don't venture. R360 is one of the largest operators in the E&P business, which is highly regulated and sufficiently small that it remains relatively uncompetitive, something Waste Connections likes very much.
Further, R360's business activities, concentrated near areas with high output of oil and gas from unconventional sources, complement Waste Connections' existing infrastructure, particularly in Oklahoma and Texas. This offers the opportunity to gain efficiency through combining operations. In the trash business, getting high density along transportation routes is critical to maintaining strong profit margins, so adding additional volume along routes that Waste Connections already maintains should be all to the good. The R360 acquisition might also offer some synergy with Waste Connections' existing E&P waste processing facility in Louisiana.
The move comes after Waste Connections issued 12 million shares early this year, raising nearly $400 million in cash. Many analysts believed Waste Connections amassed the cash pile in order to bid for assets sold by Veolia Environnement (NYS: VE) , the French utility giant that spun off its North American waste division as part of a restructuring effort. Veolia, unable to compete with the economies of scale enjoyed by Waste Management and Republic Services in the U.S., wanted to withdraw from the business as soon as possible.
Waste Connections avoided Veolia's misfortune specifically by making a point of avoiding competitive urban markets. The company had hoped that Waste Management or Republic Services would buy up the assets en masse, and then draw out value by breaking up the organization and selling off operations in smaller markets that the national operators weren't interested in. Instead, Highstar Capital bought up the entire operation and kept it intact, leaving Waste Connections with a hoard of cash on its books. The R360 acquisition seems like a good way to deploy this capital.
Waste Connections will have to finance the remainder of the acquisition with debt, but despite its acquisitive history, the company has a strong balance sheet, with earnings covering interest expenses nearly 11 times. The added risk comes from R360's strong exposure to oil and gas prices, the volatility of which can affect pricing for waste disposal. Volumes of municipal solid waste have been largely flat or down in Waste Connections' core markets, as the recession hit booming suburbs and secondary cities hardest, so the company will come to rely more on the E&P segment for growth. This leaves the company more exposed to the commodity cycle than traditional trash haulers.
While Waste Connections has proven adept at managing acquisitions previously, this will get harder as the company gets bigger. Investors looking for the stability and reliability of solid dividend payers like Waste Management might want to stay away. Instead, the Motley Fool has assembled a free report on nine dividend stocks to own for the long haul. This report is only available for a limited time, so get your free copy now.
The article This Trash Collector Keeps on Truckin' originally appeared on Fool.com.
Daniel Ferryowns shares of Waste Management and Veolia. The Motley Fool owns shares of Waste Management.Motley Fool newsletter serviceshave recommended buying shares of Waste Management, Republic Services, and Veolia Environnement.Motley Fool newsletter serviceshave recommended creating a write covered strangle position in Waste Management. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.