Description

Business Description:

Progressive Waste Services (BIN) is North America’s third largest full service waste management company that operates in three geographic regions:

1)      The crown jewel is Canada, which represents 55% of pre-corporate EBIT.  BIN’s Canadian business has the highest margins in the industry (36% EBITDA margins).  Canada is highly consolidated with 2 players (BIN and WM) having 70%-80% combined local market share.  For context, BIN’s Canadian GMs of 44.5% are 1,000 bps higher than WM’s—a result of route density, years of price increases and vertical integration.

2)      40% of pre-corporate EBIT comes from the US South East.  Here BIN’s margins are the second highest in the industry (27% EBITDA margins) tied with Republic Services (RSG).  Consolidation is a long term trend for the US waste industry but local market shares vary.  Some markets are highly consolidated like Canada while others remain very competitive.  We’ve seen local market share estimates in the US ranging from 40%-75% for the top two competitors.

3)      5% of BIN’s pre-corporate EBIT which comes from the US North East, the most competitive region in the waste industry.  BIN’s margins in the North East are the lowest in the industry (20% EBITDA margins).  We believe this business is marginally breakeven after allocating interest expense.  BIN is the last large public competitor with hauling capacity in the NE.  The majors have gotten out.  “Everyone knows you don’t go to Long Island.”  - CFO of one of BIN’s competitors. 

An important part of our attraction to BIN is the fact that present management is not responsible for BIN’s presence in this troubled region and they are cognizant of its depressing effect on BIN’s overall profitability and valuation.  They have a plan to improve profitability and recent actions and statements suggest they are open-minded to divesting it.  Our belief is BIN would be more valuable without owning this business.

Investment Merits:

1)      The business is predictable and easy to understand.  The industry is slowly climbing out of a cyclical downturn that has persisted for the past 5 years.  The industry’s largest player Waste Management has recently started singing a different song: raising prices and sacrificing volume. 

2)      New management is bringing a new focus on ROIC and their bench is deep.  There is an inflection in incentives in 2013 consistent with their new direction.  They have a plan to improve profitability and are beginning to execute. 

3)      The company is approaching the harvesting phase of growth investments made in 2012-2013.

4)      BIN’s valuation is moderately attractive in an absolute sense and compelling relative to peers.  On 2014 guidance/estimates, BIN has an approximate 8% FCF yield before growth capx (12.5x).  On this same metric, the peer average is 16x or a 6.2% FCF yield (peers being WM, RSG, WCN).  If BIN were to trade at the average of peers - 16x, it would be 30% higher today.  A SOP exercise is one support of the argument that BIN deserves to trade in-line with peers.

5)      The sum-of-the-parts is likely worth more than the whole: Munger’s ‘cancer surgery formula’ is relevant. 

6)      The waste industry has been consolidating for two decades.  BIN’s dominant presence in Canada, where it has a near-duopoly with WM, and status as the fourth largest player in N.A. overall, BIN will be a prime target during the next round of industry consolidation.  A private equity put option exists, which if exercised would likely induce a counter by RSG.

Expected returns:

Our conservative case expected return is a 13% IRR derived from a 2.2% dividend yield and 10% normalized FCF growth i.e. YE 2015 PT of $30 (+25% TSR) based on 12.5x FCF before growth capex of $2.40.

Our optimistic case expected return is a 30% IRR derived from the same methodology but augmented by a re-rating to a peer average valuation of 16x FCF before growth capx i.e. YE 2015 PT of $38.40 (+60% TSR).  We are optimistic on BIN’s re-rating potential stemming from a reversal of any of the factors that explain its current discount, which we discuss below.

Two notes about our 2016 $2.40 estimate of FCF before growth capx.  First, we realize this as just one approach to valuation among several.  Our choice of this method is to ease a comparison with other waste companies since there are varying amounts of growth capex at each and we want to be consistent.  We could just as easily consider our FCF estimate of $2.20 inclusive of normal growth capex in 2016 or use a DCF and value each growth investment separately.  Secondly, our estimate assumes modest top line growth in 2015 and 2016, consistent with a recovery in waste industry volume and price, but implicitly very little credit for management’s profit improvement plan, which we discuss later in this write-up.  We believe one or the other get us close to our model and both would provide upside to our current forecast.

The business is predictable and easy to understand. 

Revenue is driven by waste volume and price.  Waste volume is late cycle and driven by household formations and business activity.  Construction volumes, beginning to show signs of life, represent a cyclical kicker having gone from a mid teens percentage of revenue at the peak of the last cycle to a mid single digit percent today.  Recycling (or diversion) has been a secular headwind for 3 decades but is past the rapid adoption era, now representing 40% of the industry.  Volume growth of 1%-1.5% over the long term with a cyclical upturn to 2-2.5% from construction for a few years seems reasonable.  Pricing is directionally influenced by volume growth yet has remained positive despite 5 years of volume declines for the industry.  Vertical integration by the majors has led to two-thirds of landfill capacity being owned by RSG and WM.  As landfill tip fees represent ~30% of cogs for collection-only companies, taking up pricing on the landfills eventually feeds through to collection pricing, despite competition.  As collection volumes have started turning up during the past 6 months, collection pricing is accelerating and being augmented by price leadership at Waste Management.

Recent history of Waste Management.

WM has greater than 25% total market share but has barely grown in a decade (revenue is $14.4B in 2014 versus $12.5B in 2004).  After numerous failed adjacency acquisitions (~$2B of experiments) over the past several years, WM seems to be realizing that raising prices and cutting costs are their real value maximizing levers.  To illustrate, in Q3’13, WM’s core pricing on a SSS basis was up 3.9%, 160 bps higher YoY and the highest in over three years.  Yet, volumes declined .6% as WM walked away from low-priced volumes.  In Q4’14, core pricing on a SSS basis was up 4% again, while volumes declined 2.2%, partially due to a tough Sandy comp, but also due to management’s preference for price over volume.  Notably, all public competitors other than WM grew volumes in Q4 and also had steady to accelerating pricing. 

WM’s guidance for 2014 indicates pricing to be up >2% but volumes to decline 1%.  Notably, public competitors are guiding for pricing growth of 1%-2.6% AND volume growth of 1% in 2014.

This abandonment of volume for price appears to be a marked change in behavior by WM, the result of reorganization in the summer of 2012.  In speaking with WM, management believes they took two steps forward in 2004-2008 when the industry first achieved pricing power and 5 steps backward during the recession.  They gave us examples such as disposal prices in New England being $75/ton last cycle versus $60/ton now: the customer is paying less today than 10 years ago in a lot of areas.  Management has suggested they are in the second inning of raising prices as progress just started showing up in a meaningful way last fall.  They have also started taking similar steps on the recycling side e.g. starting to charge for the processing of recycling material whereas they have historically given some of the value of the commodity away. 

A reasonable argument can be made that WM’s price aggression in 2012 (most notable is a large contract with Home Depot they underbid RSG on by 7%-15% depending on which company you ask) explains a meaningful amount of the slower than expected pricing recovery the waste industry has experienced during the past two years.  David Steiner, WM’s CEO, is now on record saying he made a mistake back then and their go to market strategy today has changed.

Noteworthy is that in 2013, WM’s senior management’s long term compensation (LTIP) was predicated on achieving pricing of 2.6% as a target level and 3% as a max payout level and their performance shares vest based on ROIC over a 3-year trailing period.  Our guess is their internal pricing targets in 2014 will not be moving downward. 

While we can debate whether sluggish volumes or missteps by the industry behemoth are to blame for a delayed pricing recovery, it’s clear both of these factors are now moving in the right direction at the same time.  This provides a nice price and volume tailwind for all other players including BIN.

Is waste management a good business?  We ask this because low ostensible ROIC (~7% ROIC; ~12% ROTIC) and high capital intensity (capex is ~9% of revenue) suggest waste is a mediocre business.  We think profitability in the waste industry depends on how consolidated a market is.  BIN is a quintessential case study.  The company breaks out invested capital for Canada and the US separately so it’s possible to measure ROIC for each.  We study ROTIC to measure the profitability of each organic operation.  We calculate ROTIC in Canada to be in the low 20% range.  In contrast, ROTIC in the US appears to be 8-9%, weighed down by the US N.E. operation, where ROTIC is likely in the very low single digits.  On a consolidated basis, we calculate ROTIC of 11%. 

Our takeaways: BIN’s Canadian segment suggests waste can be a fantastic business when a market is highly consolidated and vertically integrated.  BIN’s North East segment, on the other hand, suggests waste is a terrible business when a market is competitive.  On average, if the majority of markets are consolidated and vertically integrated as they are for the majors, waste can be a decent business.

New management is bringing a new focus on ROIC and their bench is deep.  There is an inflection in incentives in 2013 consistent with their new direction.  They have a plan to improve profitability and are beginning to execute. 

BIN has historically had poor ROIC.

Like most waste companies, BIN is a roll-up.  Starting from a smaller base ($2B 2014 rev), under the former CEO and founder, Keith Carrigan, BIN has grown faster than larger competitors WM and RSG ($14B and $9B 2014 respectively).  This growth has resulted in BIN having the lowest ROIC in the industry by new management’s own admission per a study they performed in December of 2012.  Specifically, pretax ROIC measured as EBITA/Total IC from 2000-2012 was 5.3% for BIN vs. 8.8%, 8.6% and 8.2% for WM, RSG and WCN, respectively.  Achieving the lowest ROIC among peers is a product of a lot of growth (acquisitions and organic), some of which has been value-creating and some of which has been value-destroying.  In 2013, BIN’s ROIC was 5.5%, not much better than their 10-year average.

New management and new focus on ROIC.

BIN’s new CEO and Vice Chairman, Joe Quarin, was promoted in January 2012, after a series of positions dating back to 2002 including President, COO, and CFO.  BIN’s new CFO, Ian Kidson, who came in August of 2012 from private equity, was formerly a Managing Director and Co-Head of TD Capital Mezzanine Partners, where he covered the waste services industry and led an investment in BIN at the company’s founding in 2000.

In October 2013, BIN announced that it’s consolidating its Canadian and US operations effective Jan 1, 2014 under its new COO, Kevin Walbridge, who was formerly VP, Canadian Operations.  Kevin Walbridge was VP, operations at Republic Services and slated to take over as CEO before leaving 2 years ago to join BIN.  His promotion to COO and new responsibility for all of Canada and the US coincides with the expiration of his non-compete from working in the US.  We think Kevin’s attraction to the opportunity at BIN speaks highly of Joe’s ability to recruit him, given his second in command position at a competitor 4x the size of BIN (an average employee doesn’t have a 2-year non-compete).  Dan Pio, COO of Canada, has assumed a new position of EVP, Strategy and Business Development.  Former COO, Bill Hulligan (70 years old) has retired and is now an advisor.  We view these developments as positive as BIN now has a well-defined C-suite that reports to CEO Joe Quarin.  It was not too long ago that BIN had senior executives dispersed around TX, FL and Ontario and lacked a clear cut unifying strategy.

For the first time, BIN’s 2013 proxy highlights ROIC at the corporate level.  At the divisional level, a capital cost for equipment in the field has been created by converting to EBIT-based compensation targets versus previous EBITDA-based targets. 

For the 2012-2014 period, management’s LTIP, which is 100% performance-based (not time-based), is calibrated based on targeted CFO of $1,186m (cash flow from ops) and ROIC of 7.75%, rated equally. 

The mechanics of achieving targeted ROIC:

We assume 7.5% ROIC as a target rather than 7.75%.  Starting from ROIC of 5.5% in 2013, there are three ways to improve to 7.5%, all else equal:

1)      Improve consolidated EBITDA margins to 30%.

2)      Reduce invested capital by $770m.

3)      Grow revenue by $320m without adding any invested capital.

BIN’s plan appears focused on the first two of these buckets with the majority coming from improved margins.

In terms of margins, they have laid out a goal of improving consolidated EBITDA margins from 26% in 2013 to the 28-30% range within 2-3 years (we interpret to imply 2015-2016) and believe they can achieve this from their existing asset base and self-help.  Improvement in pricing or the economy is noted as upside with respect to this goal.  Within the consolidated target are regional margin goals of “mid-30’s” for Canada (no improvement assumed as they are at 35% in 2013), “nearing 30%” for the US South East up from 27% in 2013 and “mid-twenties” for the US North East up from 20% in 2013.  There is no magic wand waving to achieving these goals but the company has talked about several initiatives that combined get them there.  Examples:

1)      Automating trucks is margin accretive because it turns a 2-person operation (driver and trash handler) into a 1-person operation while improving safety and productivity.  We believe BIN is less than 5% automated today but would like all of their residential business automated, which is 20-24% of revenue.  There is some incremental capital required to automate but not much since most trucks are fungible and upgrades occur during the normal replacement cycle. 

2)      Reducing maintenance costs 2% by centralizing purchasing at corporate rather than within districts.

3)      Reducing safety costs by 10-20% as a result of hiring a dedicated safety person focused on rolling training programs out across the country.  They have also changed the way the field is getting charged for accidents. 

4)      Firing customers who aren’t paying enough.  Some customers were not even covering disposal costs as former management was chasing volume instead of profit. 

5)      CNG – some capital required but fuel efficiencies are margin accretive. 

6)      Aging the fleet.  BIN has the youngest fleet in the industry at ~6.5 years on average.  RSG is at 7 and has recently decided to age to 8.  WM is at 8 years.  We estimate that depreciation as a % of revenue (and maint capex) can decline by 150-225 bps if BIN ages their fleet to 7.5-8 years.  The company is undecided what the optimal age is currently but they know it is older than where they are currently.  This will be a three year process. 

In terms of reducing invested capital, the lever here is aging the fleet.  We estimate they can reduce capex by ~$100m over three years if the average age of the fleet expands by 1 year.  If by 1.5 years, then ~$130m of capital can be taken out. 

What can these initiatives theoretically produce if successful?

On 2013’s invested capital of $2.84B, assuming none is removed but margins improve to 30% EBITDA and ROIC is 7.5% (GAAP, punishing them for very high intangible amort):

Assuming maint capex of 9% of revenue (mgt’s guidance is 8%-8.5% but we believe maint capex in the solid waste industry is 8.5%-9.5% of revenue for all companies), FCF would be $2.45/share.

Inclusive of normal growth capex of 1%-1.5% of revenue for total capex of 10% of revenue, FCF would be $2.25/share. 

The FCF estimates this exercise produces are pretty close to what we actually model for 2016: $2.40 of FCF before growth capex and $2.20 after normal growth capex.

Note: If management’s claim that their targets are achievable from their existing asset base and self-help is true, then these estimates may be conservative since our estimates assumes modest top line growth in 2015 and 2016, consistent with a recovery in waste industry volume and price, but implicitly very little credit for management’s profit improvement plan.  We believe one or the other get us close to our model while both combined would provide upside to our current forecast.

Talking the talk and beginning to walk the walk: 

Granted the comments below, taken from Q3’13’s earnings conference call, are scripted, we believe they capture the spirit of the intent of this management team to drive increased shareholder value and find it encouraging when any management team articulates what they are doing so clearly.

“We are starting to see our focus on free cash flow and return on invested capital influence the right behaviors throughout our company. Our field management group is making operational decisions better aligned with better asset utilization and capital preservation. We are witnessing the first signs of behavioral change that occurs when an organization links performance incentives with ROIC. These changes don't occur overnight. We are on a journey.”

“Earlier this year, when we aligned our field compensation with EBIT instead of EBITDA, we did so to encourage disciplined capital expenditure behavior. We believe that the alignment with ROIC is already resulting in a behavioral shift in our Company. Our field management group is placing a greater focus on repairing existing equipment and programs and maintenance programs with a corresponding reduction in capital expenditure requests. This has allowed us to reallocate some of our budgeted replacement capital to other opportunities within the Company. Quite simply, the focus is on making our assets better, not necessarily newer, while also being cognizant of maintaining a reasonable average age for our fleet.”

“Our Northeast team is optimizing pricing and productivity in each of our lines of business and rationalizing all of our assets. For example, in the second quarter, we divested a few routes in the Long Island market that did not meet our return criteria. Quite simply, we were just not the best owners of those assets.”

“The management team of Progressive Waste Solutions is now fully aligned to create value by primarily focusing on return on invested capital and pursuing accretive growth.”

The company is approaching the harvesting phase of past growth investments.

BIN does an exceptional job breaking out the components of their capex as replacement versus growth.  The high level of detail in their disclosure and communication is relatively new.  During from 2012 to 1H2014, BIN will have spent $88m of capex on discretionary “infrastructure” projects they have earmarked with separate IRRs attached to them.  One such project is a gas plant in Montreal that costs $40m and is expected to produce $10-$12m of EBITDA with minimal capex associated with it. There is $20m of capex left to be spent in 1H’14 and some start-up costs will be occurring in tandem before the plant begins contributing to earnings starting in Q3’14.  The remaining projects are expected to generate $8-$10m of EBITDA and include such projects as a transfer station and material sorting project in Baton Rouge to supplement a facility they acquired in LA as part of an acquisition intended to create a center for regional recycling.

These growth investments have recently elevated BIN’s total capex to 13% of revenue in 2012, 12.6% in 2013 and 11.6% in 2014.  All else equal, we would expect BIN’s total  capex (maint + growth) as a % of revenue to decline again in 2015 to 10%, allowing FCF growth to shine.

Note: On an ongoing basis, we assume total capex of 10% of revenue with 8.5%-9% of this being replacement and 1%-1.5% representing growth.  We believe this is in line with the way management thinks about the business.  For the purpose of understanding, total DD&A of 14.2% is elevated beyond the actual capex requirements of the business due to 300 bps of intangible amortization from acquisitions and ~150 bps of landfill permit amortization also from acquisitions – both are cashless expenses. 

Caveat is a pending NYC disposal contract.

All else is likely not equal, however, in that BIN is the preferred bidder on a very large contract in NYC expected in 1H’14.  This contract is strategically important but the flipside is if won, capex will remain elevated and actual FCF will remain depressed for another couple years.  BIN has not disclosed all of the contract details but inferring by the economics of the first award of its kind which went to Covanta (CVA), we estimate this contract may have ~$110m of capex associated with it and produce EBITDA of $20-$30m.

Background on the NYC contract.

The city of NY has decided to spend $1B funding the construction of four marine stations to consolidate waste collections with two private companies.  The first award went to Covanta in 2013 and the city has announced that it intends to award the final two transfer stations to BIN.  BIN is now finalizing the contract details with the city. 

The NYC contract is important because it can transform the economics of BIN’s North East region.  One of the central problems in the N.E. is excess landfill capacity and BIN’s low landfill internalization ratio concentrated at the largest landfill in NY State, Seneca Meadows.  Landfill internalization is the ratio of tons that come from a waste company’s own collections.  It is a measure of how much of your destiny you control via pricing.  For example, it’s easier to take up pricing on landfill volumes if you own 70% of the collections than if you only own 50% as the business risk in a landfill comes from losing volume as you take up price.  We think BIN’s internalization in the N.E. is 50%-60% today and will be 65%-70% when they win the NYC contract.  Before acquiring additional collection companies in the N.E. during 2012, we believe the N.E. region’s internalization was below 50%.

The NYC contract will bring 1,800 tons/day of incremental volume guaranteed at CPI pricing for 30 years.  This comes in addition to the 1,200 tons/day BIN already receives from NYC.  Importantly, all of this volume will be going to BIN’s Seneca Meadows landfill.  Seneca Meadows’ capacity is 6,000 tons/day and it is already operating at maximum capacity.  Therefore, 30% of BIN’s lowest priced volume will be displaced—materially altering the economics of the region.  CPI pricing for 30 years may not sound heroic but when compared to declining landfill prices in Ontario and upstate NY the past five years, positive pricing guaranteed for 30 years is a game changer. 

We view the likely award of the NYC contract as a positive overall because it improves the value of BIN’s struggling N.E. segment for any owner of the asset.  That said, it would not be such a terrible thing if BIN does not win the contract because we believe its prospect is the only reason management has not gotten out of this segment to begin with. 

BIN’s valuation is moderately attractive in an absolute sense and compelling relative to peers.

The table below attempts to compare normalized FCF valuation for the four large waste companies.  To simplify we take consensus revenue and net income estimates, our estimate of DD&A and apply a constant 9% of revenue assumption to estimate maint capex to derive FCF.  We believe maint capex for all the solid waste companies is 8.5-9.5% of revenue; this is consistent with the depreciation level of the mature companies and in line with what they have historically actually spent on capex.  We make this constant assumption for the four large waste companies to eliminate the temporary variances peculiar to each company individually.  For example, BIN’s actual FCF this year is depressed due to growth investments while at the same time subsidized by lower cash taxes due to an NOL in the US.  Likewise, RSG and WM’s actual FCF this year are subject to small headwinds as a result of the expiration of bonus tax depreciation partially offset by increased stock based comp.  As the table highlights, BIN trades at 12.3x normalized FCF on 2014 guidance/estimates.  This compares to the peer average of 16x.  If BIN were to trade at the peer average, it would be 30% higher today.

We think the following reasons may help explain why BIN’s discount persists:

1)      We believe investors mistakenly place too much emphasis on the 5% of BIN’s pre-tax earnings that derives from the struggling US N.E. region.  This is a terrible business that barely breaks even after allocating interest expense but it is simply not enough of the value to move the needle.  This blemish in the US N.E. is overshadowing BIN’s premier Canadian operation which is the envy of the industry and the majority of BIN’s value. 

2)      BIN’s P/E on GAAP numbers looks higher than peers.  On GAAP earnings, BIN trades at 22.7x 2014 GAAP EPS versus peers at 19x on average.  Here is the largest distortion to BIN’s income statement: DD&A is 14.6% of revenue in 2013 versus 9.5%-11% for peers.  Within BIN’s 14.6% is 350 bps of intangible amortization ($63m) from acquisitions and ~150 bps of landfill permit amortization (another form of intangible amort from acquisitions that we estimate).  There is no incremental cash associated with either of these expenses.  They are accounted for by selling expense to maintain customer lists and landfill cell construction capex. 

3)      Recent results and 1H’14 expectations incorporate temporary earnings headwinds including the weakening of the CAD dollar, the closing of a landfill in Calgary in 2H’13 that continues to impact 1H’14 comparisons, difficult Sandy comp and start-up costs in 1H’14 from a new gas landfill facility in Montreal that doesn’t produce earnings until 2H’14. 

4)      BIN’s actual FCF has been depressed in 2012-2013 and will remain so in 1H’14 due to growth capex.  Some analysts are failing to give credit for these investments since their associated earnings have not yet fully been produced.  At one extreme as an example, the Macquarie analyst actually builds a permanently higher level of capex into his DCF model with no corresponding future benefit for the growth this capex should produce e.g. his EBITDA growth forecast for WM, RSG and BIN are identical yet he models perpetual capex as 13% of revenue for BIN and 9.5% for WM and RSG!  This makes no sense. 

5)      Many waste analysts look at waste companies on the basis of EV/EBITDA.  On this metric, BIN’s discount is smaller but still 12%.  We think EV/EBITDA fails to appreciate BIN’s lower tax rate of 31% by virtue of 55% of pretax income originating in Canada.  BIN’s EBITDA to FCF conversion is 33% higher than WM and RSG.  It should trade at a higher, not lower, multiple of EBITDA, all else equal.

6)      Per Factset, 41% of shareholders are Canadian, a legacy of being an income trust prior to listing on the NYSE in 2009.  The Canadian stock market trades at a discount to the US. 

7)      During the CEO’s first year in 2012, consensus expectations were missed repeatedly.  We think new management is beginning to hit their stride. 

Leverage does not explain any of BIN’s P/FCF discount as peers are all very close to one another (BIN at 2.8x Net Debt/EBITDA vs. 2.9x peer average).

Bottom Line: we are optimistic that all seven of these factors that explain BIN’s current discount have potential to reverse over time.  Taken collectively, the prospect for BIN’s re-valuation closer to peers seems strong. 

BIN’s sum-of-the-parts is likely worth more than the whole.  Munger’s ‘cancer surgery formula’ is relevant. 

Described in his lecture at his lecture at USC’s Marshall School of Business, Munger’s ‘cancer surgery formula’ applies well to BIN’s N.E. segment:

“I've had many friends in the sick-business-fix-up game over a long lifetime. And they practically all use the following formula - I call it the cancer surgery formula: They look at this mess. And they figure out if there ' s anything sound left that can live on its own if they cut away everything else. And if they find anything sound, they just cut away everything else. Of course, if that doesn't work, they liquidate the business. But it frequently does work.  All they had to do was to cut out all the folly and go back to the perfectly wonderful business that was lying there. And when you think about it, that's a very simple model. And it's repeated over and over again.”

While difficult to precisely measure, we think the tail is wagging the dog with respect to some portion of BIN’s discount to peers.  We believe BIN should be valued similarly to peers on a P/FCF basis (+30% higher).  BIN’s Canadian business has strategic and scarcity value.  Instead, it is currently BIN’s N.E. segment, a whopping 5% of pre-tax earnings, that has garnered the majority of recent investor attention.  This business has ~4% EBIT margins and is likely barely breakeven after allocating interest expense. 

BIN will be a more valuable company if management continues divesting poor markets concentrated in the N.E., like it started to do in Q2’13.  This will shrink the top line, invested capital and capex but grow the bottom line and improve ROIC.  It’s tough for management teams to shrink but BIN has already shown willingness to do so in Q2’13 when they divested routes in Long Island they were not the best owner of.  Management openly admits they are not married to any of their assets.  Before they start the process in the N.E. on a larger scale, however, they believe they should address the low hanging fruit their turnaround plan aims at and pursue the NYC contract while it is on the table. 

The reality is the N.E. segment is worth more with the NYC contract in hand when 50% of the volume at Seneca Meadows will be guaranteed for 30 years at CPI pricing.  Had they sold this region six months ago, they would have had to convince a hypothetical buyer of the option value the N.E. has when it wins the NYC contract.  Now that BIN is on the verge of winning the contract we believe this asset is becoming more valuable to any owner. 

An interesting option would be to sell the N.E. region after winning the NYC contract but before spending the capex .  We think this would in fact be the value maximizing outcome because it would garner the value of having the contract in hand without incurring the time (and expense) of paying for it to reap the full rewards starting 2 years from now. 

Accelerating the simplification of the company around its crown jewel in Canada and better than average US S.E. business would likely enhance BIN’s enterprise value more and faster (time value of money) than realizing the potential upside from fixing a terrible business in the US N.E. representing 5% of total earnings even if it can become 10% of total earnings and less bad.

Taking this thought to an extreme, giving away the N.E. may create more value than fixing it.  Our SOP-derived P/FCF multiple for BIN is 16x, which coincidentally is the same as the peer average multiple illustrated previously.  In our simple SOP, we arrive at 16x for BIN by assuming WCN’s 17.5x multiple for the 55% of earnings BIN’s Canadian business represents, 15.5x for the 40% of earnings BIN’s US S.E. business represents (ave of WM and RSG) and just 6x earnings for BIN’s US N.E. business.  If we put 0 on the N.E., the implied P/FCF multiple in this exercise only falls to 15.7x, which is still 27% higher than BIN’s current 12.5x P/FCF multiple!

In reality, we think BIN’s N.E. business could be sold for ~5x 2013 EBITDA, or $380m.  Smaller deals have been getting done in the 5x-6x EBITDA range in 2012-2013 and even Casella Waste, which is unprofitable trades at 7x EBITDA.

Admittedly, this exercise may only help prove the opposite of our argument.  Namely, that the US N.E. segment’s drag does not explain BIN’s discounted valuation.  We grant that interpretation as consistent with our earlier identification of six other factors that may explain the discount.  Nevertheless, we think the logic of divesting the N.E. is self-evident. 

What makes a sale of the N.E. more passable now is the fact that new management is not responsible for BIN’s presence there.  A fellow by the name of Charles “Mickey” Flood, former President and Director of BIN, had full authority under former CEO and founder, Keith Carrigan, to enter and compete in this region through the acquisition of Winter Brothers.  We’ll let you come to your own inferences about the names “Mickey” and “Winter Brothers.”  We understand his tactics were driven around volume gains not profitability and he began working in the industry at age 15. 

Interestingly, as part of Joe Quarin’s review of operations in 2011 before becoming CEO in 2012, his most significant action was taking an impairment of the North East operation worth $360.6m.  Why not finish cleaning up here?  No pun intended. 

The waste industry has been consolidating for two decades.  BIN’s dominant presence in Canada, where it has a near-duopoly with WM, and status as the fourth largest player in N.A. overall make BIN a prime target during the next round of industry consolidation.  A private equity put option exists, which if exercised would likely induce a counter by RSG.

Consolidation and vertical integration among the majors has improved rationality making the industry more profitable the past 10 years versus the prior 10 years.  There aren’t many large consolidation plays left.  The behavior of Waste Management when Republic merged with Allied Waste in 2008 is illustrative of what may eventually happen to BIN.  In 2008, WM offered to buy Republic for $34/share (notably RSG trades nearly flat at $33 today, 6 years later!) to thwart off its rival from merging with another competitor.  Dave Steiner, WM’s CEO, stated about his company’s offer at the time: “This is clearly a once-in-a-lifetime opportunity.” 

BIN’s status as the fourth largest player overall and coveted position in Canada make it a prime candidate for consolidation.  We see RSG as the most likely suitor given its lack of presence in Canada yet shared dominance with WM in most US markets.  WCN and ADS (owned by PE) are also logical candidates.  If BIN were to self-elect to be taken private by PE, we believe a counter offer would be likely just as WM went hostile on RSG in 2008.

“Any waste company would love to own BIN’s Canadian business.”  -PE owner of a waste company.

Notably, private equity has a history of involvement in the waste industry.  Recent activity includes:

• Advanced Disposal was taken private by Highstar in 2007.  ADS is the largest private operator and 6^th largest waste company overall.
• Waste Industries was taken private by Macquarie and Goldman in 2008.  Waste Industries is the 7^th largest player.
• WCA Waste was taken private by Macquarie in 2012.  WCA is the 9^th largest player.
• Other PE firms that have current involvement in the industry include New Mountain Capital and Clairvest.
• Other PE firms that have historically been involved include Apollo, DLJ and Blackstone.

We calculate the average deal valuation of the largest 6 transactions in N.A. of the past 15 years to be 9.3x EBITDA.

BIN’s 2014’s EBITDA is $533m.  After adding the contribution from infrastructure investments not included in this amount which we estimate to be about $10m, EBITDA is $543.  This figure is before any of the aforementioned initiatives to improve profitability, which may improve EBITDA to ~$620m.

Assuming an average multiple of 9.3x EBITDA before any credit for their profit improvement initiatives, we estimate a takeout today could occur at a valuation of $5,050 EV less net debt of $1,516m = $3,534mkt cap, which is a stock price of $30.70, +23% upside. 

Importantly, BIN’s EBITDA to FCF conversion is 33% higher than WM and RSG (44% vs. 33%), a function of their Canadian business.  BIN should trade at a higher multiple of EBITDA, all else equal.

Given’s BIN’s lower tax rate, strategic and coveted position in Canada, we would not be surprised if it were to sell for a higher than historical average multiple in a takeout scenario.  Today’s low cost of debt financing combined with PE’s willingness to leverage waste assets at 6x EBITDA versus public companies at 3x is also supportive of a higher price.

If BIN were to be taken out at 10x EBITDA before credit for their profit improvement initiatives, it would sell for $34, +36%.

At 11x EBITDA before any credit for their profit improvement initiatives, BIN would sell for $38, +53% upside.

Interestingly, at the recent Credit Suisse conference, RSG said one of the reasons they have not increased their dividend and share repurchases more is in order to maintain flexibility for a potential larger deal down the road. 

Lastly, BIN’s CFO comes from a private equity background and understands that option is available if the public market continues to undervalue the company. 

Catalysts:

1)      1H’14 headwinds (CAD dollar, landfill closure in Calgary, start up expenses at gas landfill facility in Montreal, difficult Sandy comps) dissipate by 2H’14 at the same time that earnings from the gas plant begin contributing.

2)      Margins in the US N.E. begin improving, lending credence to management’s profit improvement targets and alleviating the focus on this trivial value driver of the enterprise allowing investor attention to revert to BIN’s superior profitability in Canada and the US S.E. region.

3)      Margins in the US S.E. improve, consistent with management’s profit improvement initiatives for that region and a broader recovery in waste industry fundamentals.

4)      BIN’s FCF improves as growth capex from 2012-1H’14 concludes as total capex as a % of revenue declines from 13% to 10% (outside of winning the NYC contract, which we view as strategically valuable).

5)      More US-based investors begin to recognize BIN’s compelling relative valuation versus waste peers.

6)      The waste industry enters its next round of consolidation when it is probable BIN will take center stage.

Risks:

1)      BIN’s discount persists as none of the possible explanations for it reverse.

2)      Waste industry fundamentals in the US do not improve, in contrast to the past 6 months of improvement.

3)      The Canadian economy remains subdued perhaps due to a slowdown in China and/or declining commodity prices.

Catalyst