Michael Fickes

The stock market isn't a source of much optimism lately. But upon completion of Republic Services' merger with Allied Waste Industries in early December, the FBR Group of Arlington, Va., immediately upgraded its rating of Republic shares to "outperform." FBR believes the combined company, which retains the name "Republic Services" but is based in Phoenix as Allied was, is positioned to move up to a target stock price of $35 per share. That's approximately the same price that shares of the old Republic commanded before last year's broad economic meltdown.

Republic Services is now the second largest waste company in the United States, with approximate annual revenues of $9 billion and $2.7 billion in earnings before interest, taxes, depreciation and amortization (EBITDA), according to FBR. The firm also agrees with Republic's contention that the merger will generate $150 million in business efficiencies. FBR based its target price on an assumed long-term revenue growth rate of 4.5 percent and average EBITDA margins of just under 30 percent.

In the four weeks following the merger's completion, Republic's stock price rose from just under $22 to about $25, an increase of about 15 percent — not bad given the terrible economy and stock market environment. Of course, stock performance depends on business performance, which is up to the company and its leaders.

"Our view is that we will continue to evolve and professionalize the business," says Don Slager, president and chief operating officer of Republic Services and former executive vice president and chief operating officer of Allied Waste. "We have a stronger footprint, and we picked the best managers from each company, so we have a stronger management team."

Slager says that after the initial integration work, management will begin to focus on the evolution of the industry and the growing emphasis on landfill diversion.

Integration Basics

Mergers can fail for any number of reasons. For example, the strengths of each company not complementing each other, the people not getting along, and the financial philosophies not matching. However, FBR stands behind its prediction that this merged company will outperform the rest of the industry.

Each side stands to benefit by the merger, as long as the integration goes well. Republic will triple in size, going from a $3 billion company to a $9.2 billion company. Allied will benefit from the combined balance sheet, which will show a better debt ratio.

"Republic Services grew by expanding across the Sunbelt," Slager says. "Allied wanted to get back into those markets, which for a variety of reasons we had exited."

The combined company has laid out a basic, step-by-step approach designed to keep the business up and running while the integration proceeds. "We aren't looking to transform the company in year one," Slager says. "We have to complete the basic integration. The first couple weeks of the integration were about communication."

During December and early January, managers from branches around the country met with employees, customers, community leaders and regulators. The goal, Slager says, was to put a new face on the company.

The integration plan calls for a number of intermediate goals. Offices in markets without a Republic-Allied overlap will have an easier time. The issues for those offices involve bringing the offices up to speed with new business processes.

But in areas with overlapping offices — such as Dallas — the offices must merge. That means deciding which office to retain or whether a new office is necessary. It also requires combining routes to prevent trucks from passing each other on the street, as trucks from competing companies often do. The new office also must consolidate information technology platforms, and billing and payroll systems.

Republic Services is sending out specialized teams to handle the basic integration jobs. A giant project management chart takes up an entire wall in the war room at the company's Phoenix headquarters and summarizes the basic integration tasks, showing when integration teams will arrive and what they will do. "We've done this for each of our 17 overlapping markets," Slager says. "We've been careful to give ourselves enough time to do it right, while being sure to do it fast enough to realize the financial benefits."

The Financial Benefits

Given the plunging economy, it might seem logical for Republic to ratchet back its expectations for the financial benefits that it believes will flow from the merger. "There may be changes," Slager says. "But not dramatic changes. People still make trash, and there is a floor that volumes won't go below."

The potential financial benefits produced by combining the two companies total about $150 million in efficiencies and will arrive over the next three years. According to FBR, about half of the savings will come from reduced selling, general and administrative (SG&A) expenses. The remainder will come from operational efficiencies. FBR says Republic is on track to realize $100 million of those efficiencies this year.

Company officials also don't think the economy's trouble will affect cash flow by very much. "As we look forward, we think the business will generate between $2 billion and $2.5 billion in free cash over the next three years," says Tod Holmes, the company's chief financial officer. "In addition, we'll sell the assets that the Justice Department will require us to divest."

FBR estimates that the divestitures will produce $500 million to $700 million (see "For Sale").

Free cash, then, will total about $3 billion over three years. What does the company plan to do with that money? "We'll continue to pay our dividend," Holmes says. "It's a healthy yield, about 3 percent, at the current stock price, and we'll probably improve it modestly. Over three years, then, dividend payments will cost about $1 billion."

Holmes goes on to say that the company plans to use the other $2 billion to pay down debt and bring the company's debt-coverage ratio (the ratio of debt to EBITDA) back down to Republic Services' pre-merger level of 1.7.

The debt-coverage ratio will be 3.2 after the merger, thanks to debt that remains from Allied Waste's acquisition of BFI several years ago. Even so, that ratio preserves Republic Services' investment-grade credit rating.

Over the next three years, Republic intends to pay off $2 billion in debt and reduce the debt coverage ratio to less than 2. "Along the way, we'll be looking for upgrades from credit rating agencies," Holmes says.

The Push Toward Green

While the merger teams carry out the basic integration and the financial team slims down the company's debt, the strategic teams will be looking at landfill diversion.

"The ton of trash is evolving and changing character," Slager says. "According to the [Environmental Protection Agency], Americans are producing more trash than ever but not putting more trash into landfills. So where is it going? We own the waste stream today. Now it's time to think more about aiding customers in their efforts to recycle and divert waste."

"Value in the future will come from diverting material from landfills," Slager adds. "Our business will change as we roll in more processing business and align with other companies that buy commodities to use in manufacturing."

Just in time for the new year, a new era for Republic Services is underway.

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FOR SALE

Required divestitures can complicate mergers between waste companies. But that doesn't seem to be a problem for Republic Services and Allied Waste. The U.S. Department of Justice determined that the merger would adversely affect competition in only 15 overlapping markets around the country.

Those markets are Los Angeles; San Francisco; Denver; Atlanta; northwestern Indiana; Lexington, Ky.; Flint, Mich.; Cape Girardeau, Mo.; Charlotte, N.C.; Cleveland; Philadelphia; Greenville-Spartanburg, S.C.; and Fort Worth, Houston and Lubbock, Texas.

The assets ordered divested include 87 routes, nine landfills and 10 transfer stations. Industry observers say that the scope of the divestiture is relatively small and that other waste companies hoping to grow substantially by acquiring divested businesses likely will be disappointed.

According to the Arlington, Va.-based FBR Group, the assets to be divested account for $87 million to $97 million of the company's EBITDA. Assuming a sale multiple of 6.5 to 7, FBR reports the total divestiture will equal the size of a waste company that generates revenues in the range of $560 million to $690 million.

Snapshot of the new Republic

Corporate name: Republic Services

Headquarters: Phoenix

New York Stock Exchange Symbol: RSG

Employees: 35,000

Operations: 427 collection companies, 255 transfer stations, 219 landfills, 86 recycling facilities and roughly 3,000 municipal contracts. Overall, the firm now has more than 13 million customers in 40 states.

Senior management: Chairman and CEO — Jim O'Connor (was with Republic before the merger); president and chief operating officer — Don Slager (was with Allied before the merger); and chief financial officer — Tod Holmes (was with Republic before the merger).