By Helen Chernikoff - Analysis
NEW YORK (Reuters) - The take on Republic Services Inc’s (RSG.N) bid for Allied Waste Industries AW.N depends on who you ask, with analysts seeing potential for higher trash hauling industry prices if it happens and investors worried that antitrust enforcers will object for the very same reason.
Despite rising a bit on Tuesday, shares of both companies are down since Friday’s confirmation of a deal in which Allied Waste shareholders would get 0.45 Republic Services shares for each of theirs, valuing Allied Waste at more than $6 billion.
Investors might also be fretting at the memory of past underwhelming trash hauler combinations, said Tim Ghriskey, chief investment officer of Solaris Asset Management, which follows the industry but does not own trash hauler shares.
“You still have the same routes to cover, it’s the same high gas prices, it’s still diverse geographies,” he said. “It’s not like you can close down local facilities or get rid of trucks.”
Since Friday, Republic Services shares are off 4.8 percent at about $32, while shares of larger rival Allied Waste have shed 6 percent to about $14. The broader Standard & Poor's 500 .SPX index is down 0.6 percent.
Those drops followed good gains for both since late March -- 32 percent for Allied Waste and 11.5 percent for Republic Services -- so profit-taking might explain some of the sell-off of both stocks, said Morningstar analyst Brian Nelson.
But their slump could also reflect investor concerns that the Justice Department would object to the deal on antitrust grounds, Nelson said.
The largest U.S. trash hauler, Waste Management Inc WMI.N, and Allied Waste and Republic Services, the next two biggest, already account for more than 60 percent of the U.S. landfill business, Merrill Lynch analyst Jonathan Ellis wrote in a note to clients.
Allied Waste reported 2007 revenue of $6.1 billion while Republic Services generated $3.18 billion.
The Justice Department could scuttle the deal or undermine a primary rationale -- the creation of savings in geographies where the two companies overlap.
By firing staff or making routes more efficient, for example, the combined company could save in the range of $250 million and $350 million, FBR Capital Markets analyst Brian Butler wrote in a note to clients.
But divestitures that the Justice Department would likely require due to competition concerns would reduce those savings to between $100 million and $200 million, Butler said.
“Most synergies would come from markets where they are currently competitors,” Morningstar’s Nelson said. “Is there enough competition where they would allow a combination?”
Analysts mostly emphasized the deal’s upside, however.
Citigroup’s Leone Young estimated the deal could add 10 to 15 cents to her 2009 Republic Services earnings per share estimate of $2.04. Required divestitures would be manageable, and outweighed by cost savings, she said in a note to clients.
The deal would benefit Allied Waste by elevating its credit ratings, Moody’s Investors Service wrote in a note on the deal. Moody’s rates Allied a B1, which is speculative or “junk” status, while Republic is rated investment grade, at Baa1.
Though Moody’s acknowledged Republic’s ratings could weaken through association with Allied Waste, a combined company would have a debt-to-total-capital ratio of about 50 percent, which should warrant an investment-grade rating, FBR’s Butler said.
More importantly, analysts said, a merger would help the industry overall. While trash haulers until recently had to sacrifice price to chase volume, fewer players would increase the potential for price hikes.
Goldman Sachs analysts told clients in a note their first impression of the deal was “largely positive” because it would enhance pricing discipline.
“We view the transaction as a win/win for both parties, with positive industrywide ramifications,” Citigroup’s Young wrote. “The positive pricing story will only be strengthened by this in our opinion.”
Higher prices would help Waste Management and another big hauler, Waste Connections Inc WCN.N, and analysts noted the latter could also benefit, in particular, since it would have the chance to buy any assets divested as part of the merger.
Republic Chief Executive “James O‘Connor always viewed a duopoly-type structure as the future of the waste industry and we could never get him to talk about how that was going to happen,” said analyst Anthony Fritz of Gabelli & Co. “Now we see it.”
Editing by Braden Reddall