In Late June, Fort Lauderdale, Fla.-based Republic Services, the third-largest hauling firm in the country, made major headlines when it reached an agreement to purchase Phoenix-based Allied Waste Industries, the nation's second-largest hauler.

According to the terms of the all-stock deal, Allied stockholders would receive 0.45 Republic shares for each Allied share they own. The combined company would be called Republic Services and be headquartered in Phoenix. Its annual revenues would exceed $9 billion and have a market capitalization of approximately $12 billion.

Officials from both companies praised the deal — which, pending customary shareholder and regulatory approval, could close in the fourth quarter of this year — and began the arduous task of planning the integration.

However, Republic's summer was only beginning. Suddenly, in addition to planning its marriage with Allied, the firm found itself fending off the feverish advances of the richest kid in town.

Apparently none too thrilled about the prospect of its two biggest rivals joining forces, Houston-based Waste Management, the industry's largest hauling firm with more than $13 billion in revenue in 2007, made an unsolicited, all-cash offer in July to buy Republic and derail the merger. In making the offer, Waste Management CEO David Steiner released a statement saying that his company's $34-per-share offer would provide “a better and more certain value alternative to Republic stockholders” than the Allied deal.

Republic rejected the offer four days later and reaffirmed its commitment to the Allied deal. In his notification letter to Steiner, James O'Connor, Republic's chairman and CEO, claimed that Waste Management's proposal “seriously” undervalued his firm and added that the offer would “deny Republic stockholders the opportunity provided by the merger between Republic and Allied.” He also wrote that a Republic-Waste Management combination would raise regulatory concerns.

Refusing to take no for an answer, Waste Management quickly laid the groundwork for a hostile takeover attempt by filing for federal approval to acquire a more than 1 percent stake in Republic. Such requests initiate antitrust investigations by the U.S. Justice Department.

In a late July conference call to discuss his firm's second-quarter financial results, Steiner noted that his firm is preparing a response to Republic's rejection letter and said Waste Management still is “looking to do a transaction with the cooperation of Republic.” He also would not rule out a possible hostile takeover attempt of Republic.

To protect against such a takeover attempt by Waste Management, Republic recently adopted a “poison pill” plan. Also called a stockholder rights plan, the poison pill would penalize anyone who acquired more than 10 percent of Republic common stock (for entities already holding more than 10 percent, the threshold would be 20 percent) without the firm's approval.

The goal of a poison pill is to make an unwelcome potential acquirer call off a takeover attempt. Republic hasn't specified its penalty. Among the various techniques, though, the takeover target might allow existing shareholders — but not the potential acquirer — to buy more shares at a discount and therefore dilute the shares held by the firm attempting the takeover. The takeover attempt in turn is made more expensive.

That's where the situation stood as Waste Age went to press. [For the most up-to-date coverage of this story, visit www.wasteage.com.]

So, what makes Republic an appealing potential partner?

Solid Foundation

“Republic is an investment grade company,” says Leone T. Young, a research analyst who follows the waste industry for Citi, a New York-based financial services company. “Of the three major waste companies, Republic has the strongest balance sheet. It has the lowest debt-to-capital ratio in the industry.”

Either a Republic-Allied or a Republic-Waste Management combination would probably produce value for shareholders, Young says. “In our preliminary analysis, we estimated that the Allied-Republic merger would be accretive between 10 to 15 cents per share without synergies,” she says. “Synergies would add another 15 cents per share.”

“Synergy” refers to cost savings that the combined companies would generate. Young's analysis found that a combined Republic and Allied would see annual operating costs decline by about $100 million. The savings less taxes would flow directly to the bottom line.

“If Waste Management were to acquire Republic, our preliminary analysis indicated that accretion would total approximately 25 to 30 cents,” Young says.

Another way of looking at the combinations is to note that the effect of the lower operating costs would be to increase cash flow, which presumably would raise the stock price. “With increased cash flow, we have the ability to raise dividends and pay down debt,” says Tod Holmes, Republic's chief financial officer.

It is important to note that while Young's analysis projects $100 million in cost savings in the first year after either potential transaction, Republic's projections, calculated only for the merger with Allied, project $150 million in synergies by the third year of combined operations. Waste Management, meanwhile, estimates that a merger with Republic also would ultimately produce $150 million in annual operational savings.

Republic has earned the respect of the broader business community by refusing to chase revenues at the expense of profits. The Allied-Republic merger makes sense to Republic and Allied because of the powerful effect the firms say the combination will have on profits and on shareholder value.

“The value proposition of an Allied-Republic merger does not exist any place else,” Holmes says. “Think of it this way, the combined entity will be worth about 8.5 times EBITDA.”

“EBITDA” stands for earnings before interest, taxes, depreciation and amortization. It is a measure of cash produced by a company's operations. The Republic-Allied merger would add about $150 million in synergies or cash freed up through cost reductions to EBITDA and raise the value of the merged company by about $1.3 billion (8.5 multiplied by $150 million), Holmes says.

In addition to the potential benefits that either merger would have for shareholders, other waste services may benefit from asset divestitures that could be ordered as part of antitrust investigations by the U.S. Justice Department. An article by the mergermarket news service that appears on the Financial Times' Web site (www.FT.com) in late July notes that firms such as Folson, Calif.-based Waste Connections; Lombard, Ill.-based Veolia Environmental Services; Raleigh, N.C.-based Waste Industries and Toronto-based BFI Canada are some of the larger waste firms that may be interested in buying divested assets.