Shares of Advanced Disposal Services (ADSW) fell sharply on Wednesday after Waste Management (WM 0.60%) announced it would be buying its shares at $30.30 per share in cash instead of the initial agreement of $33.15 per share in cash from April 2019.
Here's why this is good news for shareholders of Waste Management.
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Benefits of the acquisition
Waste Management is an industry leader. It has the largest waste collection, transportation, and disposal business in the United States. Advanced Disposal is the fourth-largest solid waste company in the US. It mainly serves customers in the eastern portion of the U.S.
Waste Management's acquisition of Advanced Disposal will grow the company's footprint in North America. Since Advanced Disposal's complementary assets and customer base align with Waste Management's business model, Waste Management expects to "generate more than $100 million in annual cost and capital expenditure synergies." This basically means that joining the two businesses should make them more efficient and profitable.
The acquisition reduces Waste Management's competition, thereby increasing its already large moat. It also makes Waste Management a bigger business, allowing it to generate more cash flow and, potentially, grow its margins and dividend distributions. Waste Management's business has enjoyed a steady increase in net income and cash flow over the years, all while the company has raised its dividend for 17 consecutive years. The company has already approved another 6% dividend raise in 2020 and yields 2.1% at the time of this writing.
What the discount means
All in all, the acquisition seems to be a good move for Waste Management, and the recent news only sweetens the deal. Since Waste Management is financing the acquisition with bank debt and senior notes, it naturally wants to get the best price possible.
When Waste Management first negotiated to buy Advanced Disposal back in April 2019, it was at around a 20% premium. But the new price of $30.30 per share is around the current price of Advanced Disposal shares, meaning Waste Management gets to pay the market price, around $4.6 billion, instead of the originally agreed-upon premium price of $4.9 billion. This is unfortunate news for Advanced Disposal shareholders who thought their shares were worth $33.15 based on the previously agreed-upon terms.
Something to watch
This acquisition already looked good. And at a cheaper price, it now looks even better. The main downside is that it will add more debt to Waste Management's balance sheet during a time when financial strength is arguably more important than operational strength.
WM Financial Debt to Equity (Quarterly) data by YCharts
Waste Management's debt to equity and debt to capital -- two key financial metrics -- have been on the rise along with the company's total long-term debt. Not all debt is bad, and in the case of buying Advanced Disposal, it's probably going to be money well spent. Still, Waste Management's debt will be something to monitor over the next few quarters.
Long-term strength
Although Waste Management is somewhat insulated from the challenges of the COVID-19 pandemic since trash and recycling is a part of our everyday lives, it's not immune. Slowing construction projects, less industrial production, and fewer people working all mean less waste, which could impact Waste Management's commercial and industrial sectors, which together made up 70% of collection revenue and 46% of total revenue in 2019.
Still, it looks like a good value stock in this market and has traditionally been less cyclical than other industrials. It also benefits from many high-probability tailwinds like an increasing overall population, an increasingly industrializing population, and pro-environmental sentiment -- which are a few reasons why investors are paying a premium for Waste Management.
