Cleaning and sanitization major Ecolab (NYSE: ECL ) agreed to acquire Nalco Holdings (NYSE: NLC ) -- a world leader in water treatment, pollution control and energy conservation -- in a deal that helps shed light on Ecolab's emphasis on water-treatment services.
Ecolab said it will pay $5.4 billion in cash and stock for Nalco, as it looks to foray beyond its traditional cleaning services and venture into new markets. As part of the deal, Ecolab will also assume $2.7 billion of Nalco debt. According to the terms of the deal, Ecolab will pay either 0.7005 shares of its common stock or $38.80 per share in cash for each Nalco share, representing a 34% premium to Nalco's July 19 closing price.
How does Ecolab win?
With a 20% market share, Nalco Holdings is a world leader in water treatment services. The acquisition will help Ecolab creep into the lucrative water management business, which is valued at $6.4 billion today and is likely to be worth a whole lot more in the future when water scarcity becomes an important global issue. A Bloomberg report quoted Ecolab's Chief Executive Douglas Baker saying the deal will help the company expand in a world likely to see severe water scarcity by 2025.
While water treatment comprises 42% of Nalco's revenue, its two other business segments -- pollution control and energy conservation -- are also thriving. This should help Ecolab expand its presence in the industrial and energy markets, too. Right off the bat, Ecolab sees cost synergies of $150 million annually.
How does Nalco win?
Ecolab is a cash-rich company with high cash reserves and high operating income. The company is leveraged at only 28%. Such a strong balance sheet will be highly beneficial for Nalco, which is burdened by a $2.7 billion debt.
The two companies have similar service models in terms of water and air pollution control, and they cater to complementary industries. Moreover, they are both spread over 150 countries, making them compatible in terms of international services and quality.
Ecolab expects earnings per share of $2.52 this year, up from $2.23 that it reported in the year-ago period. Further, the company expects EPS to rise to $3 in 2012 as a result of this deal. This implies nearly a 20% growth in earnings, which is quite a positive projection.
Markets reacted strongly the day the deal was announced. Shares of Nalco surged 24.3%, but Ecolab slid 7.4% on concerns that the deal was too expensive. Broader concerns associated with Nalco's heavy debt remain. However, Ecolab may not be paying too high a price if the recent merger and acquisition deals in the specialty chemicals industry are anything to go by.
The Foolish bottom line
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Looking beyond the short-term concerns, this deal will broaden the scope of business for the combined companies and add significantly to the revenues. Moreover, the expected increase in earnings per share looks promising, too. Shareholders could expect favorable returns out of this stock.