Merger and acquisition (M&A) activity has helped forge the current makeup of the waste and environmental services industry. While M&A has been prevalent for decades, the rate of consolidation has only picked up in recent years. At Waste Today’s Corporate Growth Conference, which took place Nov. 18-19 in Chicago, a group of industry leaders discussed the current state of M&A in waste in a session titled “What to know about mergers and acquisitions.” Led by moderator Scott Sergeant, managing director of Houlihan Lokey, the panel consisted of J.F. Lehman & Company Managing Director Glenn Shor, US Ecology VP of Corporate Planning & Development Matt Dahl, and Valicor CEO James Devlin.
Looking at value
The accelerated nature of M&A and aggressive demand from buyers has led to historically high valuations. Whether the current valuations are reasonable, however, is a matter of perspective.
“Value is definitely in the eye of the beholder,” Shor says. “I think it is a very competitive market. When you’re talking about justifying very high multiples on a historic basis, there's a string of things that you have to believe to get comfortable that these values will continue—low interest rates, a supportive economic environment, there will be more capital chasing as many or fewer deals for the foreseeable future—[these are the things] that my underwriting brethren [are looking at today] to get comfortable paying the prices that we're seeing in the marketplace. But it’s a fine edge [to walk] to participate in these types of deals because if one of those things falls out of line, you can see a regression to more normalized valuation levels. So as a firm, we’re very cautious, we’re very disciplined.”
Shor notes that in the waste sector, he’s seen lenders continuing to increase their exposure and sizing. The result is a lending community that has grown more competitive and open to participate in M&A deals.
Dahl followed up Shor’s comments by noting that while valuations are higher overall than they have been, there is a wide discrepancy in the size of deals being negotiated in the waste space.
“You can see a clear trending valuation line escalating in terms of the average [price] in recent years, and I think the median valuation would show the same thing. But the variance when you’re talking about the range between the high and the low trending valuations has gotten wider over the last three years,” Dahl says. “And so, what I'm seeing in the market is a wide variety of transactions taking place, and each is driven by its own unique characteristics.”
Dahl says that low-cost funding has helped support the current valuation environment, but that US Ecology remains balanced in its M&A strategy by remaining disciplined regarding ROI.
“We like to think in terms of how we can deliver a return and where we can unlock value,” he says.
When looking at what multiple might be reasonable to pay for an acquisition, Devlin says there is no magic number. However, he says the right deal has to be predicated on due diligence.
“If a deal is strategic, it has the right financial characteristics, and it generates cash, then a theoretical number that's in the double digit for multiples is certainly reasonable. It obviously it comes down to discipline,” he says.
Room to grow
According to Shor, despite the historic M&A activity in waste, there are still clear delineations between the national, multi-regional, and smaller local companies. This fact keeps the possibility for continued consolidation throughout the industry a reality.
“I think you'll see the aggressive nature of private equity markets continue to drive platform-based acquisitions and add-on activity,” Shor says. “I think it's also happening in the corporate world [where we’re seeing] 50, 60, 70 transactions in this market this year. So, there's no doubt you'll continue to see consolidation. There are a lot of smaller businesses that exist out there. I think we've seen some multiple elevation not only on the bigger platform deals, but also with some of the smaller deals, as well. And that's just a sign of what's going on from a competitive standpoint in the marketplace.”
Dahl agreed with Shor’s assessment, saying that opportunities abound for those looking to grow.
“We've seen a lot of activity in some parts of the market. We're starting to see more consolidation and less fragmentation, especially on the permitted facility side of things,” he says. “There is still plenty of room to grow in terms of consolidation on the services side of the business, but there is a really healthy environment in terms of both capital getting deployed and the opportunity for really good operators to develop excellent localized businesses. So, I think that funnel will continue to get fed with great businesses and this sort of creates a healthy middle market for businesses to acquire. I don't see any reason to expect a slowdown in the pace of activity.”
Dahl continued by stating that with the transactions US Ecology has been involved with, it hasn’t felt like a “feeding frenzy” sparked by an excessive number of bidders. According to him, this lends credence to the fact that businesses are being valued appropriately.
“You see a wide range of deals. The right deals are getting priced at the right valuation,” he says.
The importance of M&A
Being able to grow organically is important for waste operators, but nothing can fuel expansion quite like M&A activity.
According to Dahl, strategic M&A is a fundamental part of US Ecology’s operations.
“M&A is a core part of our strategic plan,” he says. “Each deal is a little bit different. We tend to look at the small tuck-ins as an opportunity to supplement our targeted 4 to 6 percent growth in our base business, so smaller transactions are an opportunity for us to supplement that growth rate. And we think we get credit for being a strategic acquirer. I think in today's market, being able to acquire and integrate assets is a key capability. However, for deals like the NRC transaction [we just completed], the market holds us to a different standard. We have to be able to show the ability to grow above and beyond [what the acquisition allows] and deliver organic growth and synergies on top of that.”
Devlin says that Valicor looks at M&A not only as a way to grow its footprint, but also to better reach its customer base. Since there aren’t as many regional or national players operating in the environmental side of the business, specifically with greenfield development, he says the company’s customers sometimes are forced to work with mom-and-pop operators that they are not as comfortable with. Through strategic M&A, he says that Valicor can enter these markets to fill the void in a region’s service offerings.
Dahl notes that US Ecology has also been driven into new markets by M&A via customers who yearned for a new provider in the area.
“We've been pulled into a number of different markets by customers who have asked us to be there,” he says. “Customers in the space are often looking for that trusted provider that can offer a spectrum of solutions and cradle-to-grave-type capabilities. That's been something that's supplemented our growth.”
Getting the deal done
The value of the right acquisition can be transformational for a waste business, but there can sometimes be hurdles along the way when negotiating a deal. One of the biggest challenges, according to Devlin, is negotiating with smaller companies that don’t have adequate legal representation.
“It can be quite challenging when you're trying to negotiate with the mom and pops when you don't have commercially reasonable counterparties on the other side,” he says. “Sometimes it would be a benefit to us if there were sophisticated legal assistance on the other side to help walk them through working capital adjustments, escrows, asset purchases and all the other nuances of a deal that are common to what we see every day, but completely uncommon to their legal representation in the space.”
Dahl says that these smaller operators looking to be acquired can help their cause by having representatives in place that can make sense of the financial history of the company and explain it clearly.
“It's becoming increasingly a challenge, especially over the last couple of years and particularly for the smaller tuck-ins that we look at, when it comes to getting the right help,” Dahl says. “On the financial side, these companies can help themselves by getting their house in order so that they can provide transparency around the financials and the story behind it. For us, that's an important piece of that due diligence—help us understand what the puts and takes are. To a certain extent, some of the adjustments that people try to incorporate actually get in the way of trying to understand the business. I think companies can be a little bit more transparent and clear about what the dynamics of the business are. This is something that can help push a deal over the finish line.”
Is now the time to make a deal?
Although there has been ample talk of a potential recession on the horizon, Devlin says that Valicor isn’t planning on slowing its activity solely based on the threat of a slowdown.
“People have been predicting the end of this economic cycle for the last five years. … I think if you're waiting for the economy to get better or worse, that's probably not the way that I would look at [your M&A strategy]. I think about, what are the fundamentals of the business? is it durable enough? Does it produce consistent cash flows? Those are our main concerns,” he says.
Shor says that from a lending perspective, J.F. Lehman & Company has acknowledged the potential for a recession, but is still very much open to the right opportunities.
“The easiest thing for me to do is to say no to a deal, to not invest money and say it's too risky because of the environment we’re in,” he says. “But we're in the business of generating attractive risk-adjusted returns for our investors. So, the way we do that is we remain disciplined. When we don't think we can bring enough impact to the situation to generate that attractive risk-adjusted return, we don't move forward on the deal. We've been one of the more active investors in the space for the last six or seven years, and we'll continue to try and find attractive opportunities that will be durable and consistent and visible through uncertain times. And those are hard opportunities to find, but when we do find them, we try and transact.”