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Daily Trouble
October 22, 1999

Waste Management Inc.

Ticker: (NYSE: WMI)
Phone: 713-512-6200
Website: www.wm.com
Price (10/21/99): $16 13/16

By Paul Larson (TMF Parlay)

How Did it Find Trouble?

One might say that Waste Management has been trashed and burned. It's also safe to say that the compacting the stock price has experienced is not without reason.

After the bell on July 6, Waste Management warned that revenue and earnings for its second quarter and the rest of the year would fall short of expectations. Before the announcement was made, the analysts were expecting the firm to earn $0.78 a share in the second quarter. Waste Management guided expectations to the $0.67 to $0.70 a share range. Not surprisingly, the stock was dumped the next day. An eye-popping 70 million shares exchanged hands, and the stock went from $53 5/8 to just below $34 in one trading session.

Waste Management was hit by an avalanche of analyst downgrades as no fewer than six brokerage firms lowered their ratings on the stock. As is commonly the case with companies that have had communications difficulties with the investment community, the class action lawyers got in on the act and accused the company and its management of a variety of securities improprieties.

As if one earnings warning in a quarter wasn't enough, Waste Management trashed the already lowered Wall Street estimates again on July 29. Telling analysts and investors to ignore its previous guidance from three weeks prior, Waste Management told Wall Street to expect earnings in the range of $0.58 to $0.60 a share in the second quarter.

The stock's second go around with an earnings warning wasn't nearly as dramatic as the first, but still quite impressive. Over 38 million shares traded the day after the second warning as the stock went from $31 7/16 to $25 15/16.

Piling on the bad news in rapid succession, on August 3 the company reported actual second quarter earnings of $0.58 a share, at the lower end of the scale Waste Management had told investors to expect. Moreover, after already canning its CFO a few weeks before, Waste Management later announced that the company's COO and ailing CEO were also resigning. To add insult to injury, the company also said that it was reducing its two previously reported quarterly earnings, including the much-maligned Q2 results, due to some accounting difficulties.

Waste Management hasn't made any major announcements in the past several weeks, but the stock's performance has continued to absolutely stink.

Business Description

Today's Waste Management was created when the Houston-based USA Waste Services acquired the old Waste Management company and took its name in the summer of 1998. The combined firm is the largest waste services company in the nation. Waste Management provides garbage pickup and transfer services and also operates many of its own landfills. The company handles roughly a quarter of all the waste services in the country.

Waste Management is a member of the S&P 500 index.

Financial Facts

Income Statement
12-month sales: $12,888.5 million
12-month income: ($530.0 million)
12-month EPS: ($0.99)
Profit Margin: N/A
Market Cap: $10,872.9 million

Balance Sheet (as of 6/30/99)
Cash and Equivalents: $81.0 million
Current Assets: $3,506.3 million
Total Assets: $22,991.7 million
Current Liabilities: $3,828.1 million
Long-term Debt: $10,932.4 million
Total Liabilities: $13,374.8 million

Price-to-earnings: N/A
Price-to-sales: 0.8

(*Note -- Financial results for Q1 and Q2 1999 are in the process of being restated downward.)

How Could You Have Seen it Coming?

When Waste Management first slashed its previously announced earnings guidance, that should have give shareholders pause for thought. When the company issued further earnings warnings and financial restatements, it was fairly clear that many discouraged investors were going to be looking for the door.

While the earnings for Waste Management have on occasion been positive, the cash flow characteristics underneath those earnings were nothing to crow about. For the past several quarters, capital expenditures have far outpaced cash flow from operations as well as the reported depreciation expenses. As they say, earnings are fiction and cash flow is reality.

The balance sheet also held some clues of the coming trouble. The company's voracious appetite for other trash companies has been fed largely by the copious use of debt. Increased debt always reduces the margin of error for both the company and its investors. Plus, companies that have vibrant cash flow generating capability usually don't have the level of debt seen at Waste Management.

Where to From Here?

Is one investor's trash another investor's treasure? This may very well be the case with Waste Management, but it won't happen without a dramatic turnaround. Luckily, there is a new management team guiding the company, and the company's interim CEO, Steve Miller, is experienced in turnaround situations. He was the CFO of Chrysler when it did its 180-degree turn in the '80s.

The company has said it intends to shed some of its non-core operations in order to pare down debt. Given that Waste Management is in hock for almost $11 billion, paying back debt seems like a prudent idea. However, there's no way of really knowing if the assets being sold will be liquidated above cost. This could have a hit on near-term profitability. After all, Waste Management isn't suffering alone in the waste industry; some of its peers, such as Republic Services (NYSE: RSG), have also had their share of Trouble. Finding a buyer willing to bid up for landfills and trash routes may not be easy.

Looking at the industry, the name of the game is still consolidation. However, given its size, Waste Management may be limited in the scale of acquisitions it can make in the future. In each of its recent mergers it was forced to sell off certain operations to appease the regulators who had antitrust concerns. Finding further deals that would make sense from an operational standpoint while keeping regulators at bay will be a challenge. With the high levels of debt and numerous operations from previous acquisitions still being digested, seeing Waste Management looking inward instead of outward may not necessarily be a bad thing.

The most important thing investors should consider is the story of Waste Management. The company is built on the premise that companies in the trash industry can realize economies of scale by consolidating operations. While operating margins at acquired operations have generally been increasing, the ultimate success of such a strategy is still an open question that potential investors need to consider for themselves.

Sadly, any sort of fundamental valuation can be thrown out the window until Waste Management comes clean and stays clean about its real financial picture. Until this happens, Foolish investors are probably best served to leave Waste Management right where it is -- in the dumpster.

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