Risk & Return Analysis
Advanced Disposal Services (NYSE:ADSW) is being taken private by Waste Management (NYSE:WM). The current merger spread is 4.9%, and the market is pricing in a 72.5% probability of closing. I estimate there is a ~12.9% downside if the deal breaks, so size the best according to your risk limit. A summary is provided in the table below:
Probability of Closing – this is a standard probability of closing in merger arb. See below for a graphical illustration. The idea is that the closer the current price is to the deal price, the higher probability of closing is priced in by the market, which should make intuitive sense.
Deal Break Price – peer group trading approximately unchanged or up since COVID-19 broke out. I used the unaffected price to estimate the downside if the deal breaks.
Source: Yahoo Finance
Waste Management is a North American, leading provider of comprehensive waste management environmental services. It owns/operates 219 landfill sites and 302 transfer stations. During 2019, WM’s largest customer represented less than 2% of annual revenue. As of Q1-2020, WM has ~$13 billion net debt vs. $46 billion market cap. It also has a $3.5 billion ($3.1 billion available) undrawn revolver.
WM is also a series acquirer. There has not been a single year since 2002, in which WM hasn’t done a large-scale acquisition. I believe the WM has in-house expertise and experience to integrate ADSW post-acquisition.
While the financial guidance was pulled in Q1, I think they are still relevant to think about the rationale for this deal. ADSW provided multi-year EBITDA and FCF guidance in the proxy statement, and WM provided FY2020 EBITDA and FCF guidance in its Q4-2019 earnings release. In the initial press release, WM also guided ~$100 million of projected annual cost and capex synergies.
Although the leverage ratio ticks up from 2.2x to 2.9x using 2020 guidance for both the acquirer and the target, the consolidated entity can still maintain a 15.5% FCF/Net Debt, which translates to plenty of positive free cash flow for deleveraging purpose.
Finally, ADSW is being acquired at ~10.2x EV/EBITDA, while WM is trading at ~12.3x EV/EBITDA, resulting in an accretive transaction for WM.
Remaining Milestone: DOJ Approval
The transaction is not subject to financing (and WM definitively has the financial capability to close the deal), and ADSW overwhelmingly approved the transaction. The last closing condition is for the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice to approve the deal.
The original timeline to close was Q1, but COVID-19 disrupted the process, and the DOJ has required divestitures worth more than $200 million in annual revenue. GFL (NYSE:GFL), who bought assets from WM before, has been rumored to be the acquirer. I think the fact that DOJ is requiring asset divestitures is a positive sign. Also, $200 million annual revenue is less than 2% of the consolidated entity, which doesn’t fundamentally change the transaction.
Today (June 10, 2020), on a conference call, the CFO of WM reiterated that,
“the statement that we made about expected timing is the best that I have at this time” (Q2-2020). More importantly, she reaffirmed that ADSW has good assets in good markets and that it also has a culture and an employee base that supports customers that “we look forward to welcoming into the WM family”.
I believe the financial and strategic rationale to absorb ADSW remains intact. The waste management industry is mature, and M&A is a big part of the growth strategy. There’s also a scarcity value for waste management companies with scale such as ADSW – if you don’t make a play now, your competitors might.
I think this take-private transaction will successfully close. The thesis is largely driven by the financial and strategic rationale for WM.
P.S. I plan to focus on writing about interesting merger arb opportunities like this one. Let me know if you will find it helpful. Thanks.
Disclosure: I am/we are long ADSW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.