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2019-06-26 00:23:54

US Ecology (ECOL) and NRC Group (NRCG) have agreed to combine their operations in an attempt to gain greater scale. The deal makes sense on paper as a larger and more diversified environmental service player should be able to extract synergies, while the all-stock deal should make the deal accretive, given that NRC trades at a lower multiple, and synergies can be realised. Nonetheless, investors are not yet convinced. In fact, shares of US Ecology have dipped quite a bit, making this an interesting story to watch going forward.

Deal Terms

US Ecology has reached a deal with NRC Group Holdings to combine operations. US Ecology provides environmental service to commercial and government entities and focuses on complex waste management needs, which includes hazardous and non-hazardous waste, as well as radioactive waste. NRC Group provides environmental, compliance and waste management services, notably in marine, rail transportation, general industry and energy segment.

The all-stock deal values NRC at $966 million as the transaction is set to create a nationwide leader in industrial and hazardous waste management services. Upon closure, current holders of US Ecology will hold about 70% of the shares, with NRCG shareholders holding the remainder of the shares. The company is furthermore pleased with the potential of the oil spill removal services offered by NRCG, being only one of two national organisations which provide such emergency response.

Besides scale (read synergies) and broader services, US Ecology believes the deal will be accretive to adjusted earnings in 2020 to the tune of mid-single digits. That does not seem to be much accretion, but remember that this will be an all-stock deal. Accretion has to come from estimated synergies of $20 million a year, with upside coming from revenues and cross-selling synergies.

Pro Forma Impact

In February of this year, US Ecology reported its 2018 results. The company grew sales by 12% to $566 million. Pro forma EBITDA rose to $125 million on which the company reported net earnings of $50 million, as the company guided for continued growth in 2019. Operating with $332 million in net debt, excluding long-term closure obligations, leverage was reasonable, given the growth and stability of the services. With 22 million shares outstanding and shares trading around $62 ahead of the deal announcement, equity is valued at $1.36 billion. Including a $320 million net debt load by the end of Q1, I end up with a $1.68 billion enterprise value, equivalent to 3.0 times sales, 13.4 times EBITDA and an earnings multiple in the mid-twenties.

NRC Group reported its results a month later as deal-making made for a pro forma revenue number of $388 million on which adjusted EBITDA of $91 million was reported, for fairly similar margins as reported by US Ecology. With a $966 million enterprise value, NRC Group is valued at 2.5 times sales and roughly 10.5 times EBITDA, for relative more compelling valuation multiples.

The pro forma company will grow to $955 million in sales and $216 million in EBITDA, and that is excluding $20 million in anticipated synergies as well as organic growth in 2019.

We know that US Ecology reported net earnings of $50 million with 22 million shares outstanding in 2018. We furthermore know that shareholders will hold 70% of the shares going forward, indicating about 31.5 million shares outstanding following the deal. That suggests 9.5 million shares to be issued, which at $62 suggests a $589 million share component, indicating that $377 million in net debt is incurred, pushing up net debt load to about $700 million. With pro forma adjusted EBITDA totalling $216 million, or $236 million after synergies, leverage ratios come in exactly at 3 times, in line with expectations outlined by management.

With $91 million in additional EBITDA and a $377 million additional debt load, I peg additional interest costs at 4%, or about $15 million a year. Including $30 million in D&A charges, incremental adjusted earnings before taxes come in at $46 million. Assuming a 20% tax rate, that works down to $37 million. That suggests that total earnings could rise from $50 to $87 million as share count increases from 22 million to 31.5 million shares, meaning that earnings per share could rise by about half a dollar to $2.75 per share. That is much greater than the accretion predicted by the company, certainly as the analysis above excludes synergies. These synergies could be worth as much as half a dollar per share.

The Market Does Not Like It

Shares of US Ecology are down 8% at this point in time, corresponding to a $5 decline in the share price, representing more than $150 million in actual value if the to be issued shares are included. This is quite substantial in relation to the $66 million deal tag. I cannot really explain this, given the reasonable deal multiples and synergies, as it seems to be the case that the market does not like the diversification move.

This dislocation, with, in theory, a nice deal with real accretion, reasonable leverage profile, and much improved earnings power, is what makes me interested in the shares. While I don't consider shares to be a screaming buy currently, they certainly deserve a prominent space on my watchlist, as I am anxious to learn more about the deal and implications in the quarters to come.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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