In August Advanced Disposal and its parent firm, ADS Waste Holdings Inc., announced that it is going public with an initial public offering (IPO).
The Ponte Vedra, Fla.-based Advanced has grown into one of the industry’s biggest companies in recent years, but has remained private. It got much bigger in 2012 when its owner, Highstar Capital, purchased Veolia’s U.S. solid waste operations for $1.91 billion. Advanced ranked No. 8 on the Waste 100 listing of largest industry companies this year.
Advanced said the proceeds from the sale will be used to repay debt. Renaissance Capital said on its website that the IPO could raise up to $100 million.
Waste360 talked with Michael E. Hoffman, industry analyst and managing director, Stifel, Nicolaus & Co. Inc., about his thoughts on the Advanced Disposal IPO and what impact it can have on the industry.
Waste360: What’s your assessment of Advanced Disposal’s decision to issue an IPO and where it’s at?
Michael E. Hoffman: I suspect they are running a parallel path. And it’s not Richard (CEO Richard Burke) and his team, it’s the private equity team making that decision. Their ultimate end game is the monetization of their position. Remember, Highstar (Advanced Disposal’s owner) sold a big chunk of Highstar to Oak Tree, and retained this fund that holds the ADS portfolio position. We believe they have time-line milestones to hit when they start monetizing that portfolio; otherwise, ownership begins to accrue to Oak Tree. I think there’s a little bit of, if you’re going to the public market, you’ve got to start that process sooner or later in order to create an orderly exit. You’re not exiting all in the first go, right? The stock market won’t let you do that.
So the parallel path is, what maximizes the valuation back to the equity investor Highstar, the public markets or the private markets? So run a parallel path, and at the point the documents are ready and the public markets open, if there is no strategic deal in the works on the private side, then go public.
From a going public standpoint, if Highstar didn’t have this time issue about the ownership, then one way or another the question becomes, does the leverage hamper ADS' ability to meaningfully improve the growth opportunities for the company?
In the near term, that doesn’t appear to have gotten in the way. When you think about ADS growth story, they’ve been able to steadily do tuck-in acquisitions. The balance sheet would probably prevent them from participating in anything meaningful.
Is there an urgency to go public because ADS want to grow faster? Probably not. We think the bigger issue is, the private equity guys are driving this decision. This is less about strategy of the growth of the company as much as it is the private equity guys are ready to take money off the table. That’s my opinion.
Now, what would motivate the equity investor to do that? (Months ago) we were looking at really good public market valuations. (But now) the stock market’s been under all kinds of pressure … nothing to do with the garbage business, it’s all geopolitical at the moment. It’s an interesting intellectual conversation of ok, now what’s the best alternative, the public market or the private market? Three or four months ago when the equity investor started putting documents together, the public market was probably a more attractive place than the private market. A month from now when an IPO might be happening … what will the capital markets look like?
The good news for Advanced Disposal: Trying to access the public markets, it couldn’t be in a better position fundamentally for the garbage industry. The business fundamentals are as good as they’ve been in a long time. There’s good volume, volume is filling up lots of excess collection capacity, so the pricing competitiveness that always exists in the business is less intense. The integrated companies are retaining more of price. Their challenge is, they don’t control the geopolitical. There’s lots of noise within the capital markets right now.
Waste360: Advanced Disposal said the intent with the IPO was to pay down debt? How do you see it playing out?
Michael E. Hoffman: I would be stunned if that weren’t the strategy. The typical pattern in private equity owned businesses that choose to use the public markets to recapitalize is that the public markets are loathe to let the private equity out on the first round. The institutional investors expectation is, “ok, I’m willing to now become party with you in doing this but you’ve got to stick around a bit.” So the private equity guy gets diluted, it shrinks their total position because you add new owners, right? And that capital is used to start deleveraging the balance sheet. Public markets tend to be willing to reward companies for doing recapitalization that takes risk out.
Working the leverage down would be deemed a positive reason to access the capital markets. This is a good management team, a nice set of assets, and an improving operating picture.
That really leaves open the question what capital market is ADS trying to go public in? Is it healthy, wide open, or are investors worried and not sure whether they want to gamble on IPOs and are sticking with things that they know and they’ve owned, or repositioning portfolios because of the things they’ve known and they’ve owned aren’t doing so well so they’re trying to find something else. Those are all things investors have to decide on at the time. Who knows what that public market is going to look like in 4Q15 or the first part of FY16?
Waste 360: How do you think this could affect them operationally? Will it increase acquisitions?
Michael E. Hoffman: The good news is, except for Deffenbaugh, which I admit would have fit ADS very nicely, I don’t think anything meaningful has been sold. The challenge for ADS on Deffenbaugh is that private equity owners of that business weren’t willing to give a buyer a tax step-up. Deffenbaugh was a very mature company, which meant it had almost no tax basis of the value of the assets in its balance sheet. When you buy a business like that you end up with an awful lot of non-deductible good will.
I suspect if there was room on the balance sheet ADS might have been able to finesse that deal. The problem is ADS is already sitting on enormous position of nondeductible goodwill and that would have exacerbated that position.
Waste360: Do you see Highstar as remaining the majority shareholder for the foreseeable future?
Michael E. Hoffman: Yes, Highstar cannot get out of ADS that fast, the public markets will not let them do that. Even if they did a $400 million deal–the current S-1 documents suggest the deal is $100 million–that’s too small, and it doesn’t meaningfully change the leverage. We’ve heard Highstar is targeting a $400 million offering. A $400 million offering, starts to move the leverage, ADS would end up with (a total leverage ratio) either a very high 4x or right on the low-end of 5x, down from something just over 6x. That moves ADS absolutely in the right direction, if it can really get a $400 million deal done.
ADS first path is, raise all primary equity capital, pay down debt, then deliver on the goods of your performance, the stock improves, and ADS comes back and takes another bite at the apple, and on that occasion there could be some secondary shares from Highstar in that deal. That is how private equity starts taking some money off the table.
Biggest challenge to a private equity buyer is ADS is already leveraged 6x. So now, how much more can it be levered? A strategic buyer is already looking at a big slug of goodwill, we can’t see Highstar giving anyone (private equity or a strategic buyer) a tax step-up since it didn’t take a tax step-up. So in our view none of the strategic buyers are willing to pay the valuation at which the private equity owner would want in order to sell ADS.
So that really narrows down the options to: the public capital markets.
Waste360: So how will this affect Advanced Disposal’s place as a major industry player?
Michael E. Hoffman: It starts the process of getting the balance sheet in a place where there isn’t anything that ADS can’t be involved in. At the moment, there are limits. Richard Burke and his team have had a lot on their plate to take this disparate group of businesses that now have been made into one operating ADS–Richard Burke has demonstrated repeatedly in his career in the garbage business he does this well–and is now a best-in-class operator. When an operator is doing something really well in one region you want to make sure you're are doing it in all the regions. That didn’t necessarily exist before all these portfolio companies, owned by Highstar, become one operating company.
The strategy does not change by doing an IPO. The biggest thing an IPO does is get the balance sheet in a position to participate in any meaningful new consolidation in the industry going forward. ADS is structurally limited in what it can do, because of the balance sheet. ADS can do the local tuck-in deals, but it can’t do much more than that, in our view.
We are not for a minute suggesting anything is going to happen, (but) what if in fact the board at Casella decides it is up for sale, can ADS look at it? What if Macquarie decides to monetize either Waste Corp. of America or Waste Industries? Or what if Summer Street decides it is ready to monetize its position? Then there are 50 private companies that are $25 (million) to $150 million in revenues. The bigger deals are harder for ADS to do when sitting on a 6x levered balance sheet.
We suspect ADS would like to at least be able to say, there’s a chair sitting at the table that has its name on it if it chose to sit down in the chair. At the moment ADS doesn’t really have that option for more just tuck-ins. If it’s a buyer'smarket to me the balance sheet is not as restrictive as you think. But it’s not a buyer's market, it’s a seller's market at the moment.