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A Note From The Editor:
For this month's Circular File, we were able to catch up with Michael Castellarin, Principal and solid waste point man for Clairvest, a private equity firm located in Toronto. Clairvest has made a number of investments in the solid waste industry, including stakes in Winters Bros. Waste and Hudson Valley Waste, which were subsequently sold to Progressive Waste and Waste Connections, respectively.
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More and Bigger Independent Haulers
In response to our last Circular File on solid waste industry statistics, one reader commented that the industry statistics don't seem to capture, or seem to underestimate, the number and often the size of independent haulers. Castellarin concurs, and therein lies the opportunity for, and perhaps even increasing interest in, the industry from private equity players. Particularly in certain markets, he believes that there are more consolidation and growth opportunities available than consensus opinion.
Why Waste?
Many positive underlying characteristics of the solid waste business--stability of cash flows, recurring revenue, the potential for fragmented customers, modest organic growth, and ability to achieve economies of scale—all attract private equity. However, as Castellarin notes, for a firm focused on providing equity capital to accelerate growth, the tendency of this industry to experience a “regeneration of entrepreneurs”, coupled with the increasingly capital intensive nature of the business, adds to the appeal. The economies of scale that can be achieved with capital investment allow for both margin and return on invested capital (ROIC) improvements, which are key criteria for private equity investment. With the above-mentioned number of independent haulers remaining with growth and acquisition opportunities, faced with increasing capital requirements (to be discussed further below), there is also a need for private equity investment.
More Processing Please
For haulers, the growing capital intensity is driven by the need for more processing/mining of the waste stream, which is in turn driven by sustainability/zero waste initiatives from both private customers and local government, coupled with high commodity (and energy) prices. Much of the focus is currently on single stream recycling and CNG-powered trucks in this regard, but in all likelihood, organics separation will also be part of the future mix. As Castellarin notes, this is also a longer-term risk for the independent haulers. The majors, notably Waste Management, with their size and substantial cash flow are using investments in single stream recycling and CNG-powered trucks as a competitive advantage to set them apart from other haulers in the eyes of a municipality or customer. If an independent hauler is not a first mover in its region, it runs the risk of being marginalized by the bigger players. The proliferation of alternative, but as yet largely unproven, waste-to-energy conversion technologies remains a wild card for the independent hauler. To the extent successful waste-to-energy developers emerge and remain independent, or in venture capital or private equity hands, there will likely be partnering opportunities for independent haulers; however, Castellarin sees this story more likely playing out—at best--in the late 2012-2013 timeframe.
State and Local Budget Issues Can Swing Either Way
Increasing government involvement in the solid waste industry as the direct or indirect result of budget shortfalls is a concern for Castellarin. Anything that leads to less open markets, such as flow control or increased franchising, is a potential threat, but obviously privatization is a positive. Right now, there are numerous examples of local governments going in both directions, with no common discernable trend yet, but rather pockets of either activity. Castellarin notes that could change quickly, however.
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Industry Resources
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Lull in Activity Likely Temporary
After a burst of private equity and M&A activity early in the year, it's been quiet on the transaction front lately, which Castellarin characterized as temporary. The credit markets remain conducive to private equity, and global economic and financial concerns make the more insular domestic waste industry relatively more attractive. Underlying interest and the level of activity occurring below the surface news remains robust, with no indication of an ending cycle. In addition to private equity, the strategic buyers are now more active and aggressive, and relative to 2005-2007, all are stronger with improved balance sheets, notably Progressive Waste and Waste Connections.
Regional Variations
The Northeast continues to be cited as the most active for private equity, simply given its density, cost of disposal and sheer number of players, who are relatively bigger per truck, given that density and cost of disposal. The mid-Atlantic and Southeast regions also remain very active on the M&A front, but dominated by the strategic buyers, both publicly traded and large regional independents (several of which are backed by private equity firms). The surprise this year may well be a pick-up in M&A activity in the Midwest, which previously was fairly quiescent.
Key Criteria for Valuation
For Castellarin, there are several key valuation parameters which are important, including historical revenue growth, EBIT and EBIT margin, the management team, the quality of the revenue (i.e., how much is recurring in nature and the degree of customer fragmentation) and the regional growth opportunity. But, he also notes that the state of the assets, especially the trucking fleet, the degree (if any) of environmental liability and the company’s insurance and safety record (TIRR) are all items that may not substantially raise the valuation, but can certainly hurt it. All that said, companies with $30+ million in revenue and over $5 million in EBIT are preferred.
Valuations on the Rise
As noted in previous Circular Files this year, valuations are trending up. For larger, "best in class" companies with some processing, recycling or transfer capabilities, acquisition multiples are heading to 8x+ EBITDA. For smaller tuck-in deals (or for the growth equity and often minority equity stakes that Clairvest prefers), a purchase multiple of 5.5x-6.5x EBITDA is still more typical; with the intent of a strategic buyer to bring that multiple down to 4x-5x with synergies. |
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We Want to Hear From You
We would like your feedback, thoughts, suggestions, etc., as we create future issues of The Circular File. Please send questions or comments to rita.ugianskis@penton.com or lyoung74@comcast.net. Your input will be invaluable.
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