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Brokers Keen On Cleanaway-Tox

Australia | Dec 12 2017


Cleanaway Waste Management intends to acquire Tox Free Solutions, consolidating Australia's waste management industry, and brokers are largely positive about the merger.

-Significant areas in common but broadens Cleanaway's geography and exposure
-Synergies need to be realised to generate real value
-Unlikely another competitive bid for Tox Free will emerge


By Eva Brocklehurst

A pre-Christmas clean-up of waste management is heralded with the offer from Cleanaway Waste Management ((CWY)) for Tox Free Solutions ((TOX)), a competitor in the Australian market. Issues with market share are not expected, given the combined entity would still be the number two player.

The two companies have significant areas in common but the acquisition broadens Cleanaway's geographical reach and provides exposure to Tox Free's high-growth health segment. It also increases Cleanaway's exposure to the improving, and higher returning, liquids & industrial business.

Cleanaway will undertake a $590m underwritten entitlement offer to fund the acquisition, increasing its share count by 27%. The offer price for Tox Free of $3.425 represents a 30% premium to 1-month VWAP and 21% to the last Tox Free closing price.


Deutsche Bank believes the acquisition is positive, estimating it to be 2% accretive to value based solely on projected cost synergies, and suggests the forecast for $35m in annualised synergies by FY21 does not capture the improved industry structure, particularly for the liquids & industrial division. Nor does it capture Tox Free's more attractive organic returns.

Credit Suisse is more neutral. Excluding synergies, the broker finds the deal only marginally accretive, noting recent market downgrades to Tox Free. Nevertheless, Cleanaway management has runs on the board in executing turnarounds and acquiring a struggling business, a positive aspect. Synergies are required to generate real value and should become evident through cost reductions and improved industry structures, although the broker suggests this will take time to flow to earnings.

The positives are several and include a re-positioning of business, adding exposure to a recovering resources industry, improving the market structure in liquids & industrials and access to some higher quality business streams. Credit Suisse notes Cleanaway has achieved on most of its organic opportunities so the propensity for a positive surprise is reduced.

Meanwhile, Tox Free has more volatile end markets and its earnings profile has been a disappointment over recent years. Credit Suisse suggests the $35m synergy target partly addresses this but there is also an opportunity around intangibles.

Ord Minnett assesses the acquisition price is full, and the value accretion highly reliant on the expected synergies. The broker has always believed the waste management industry in Australia was a prime candidate for consolidation, but also an example of where earnings per share and value accretion are not always aligned.

The waste industry is very large and incorporates many segments with different barriers to entry and return profiles. The broker does not believe the accretion for Cleanaway will translate to the same level of value for shareholders, as a higher barrier to entry and return on assets in Tox Free represent a relatively small portion of earnings.

Acquiring Tox Free should diversify Cleanaway's earnings and provide material benefits, UBS believes. The broker does not include the acquisition in forecasts, pending approval of the deal. Preliminary estimates of the earnings accretion are around 12% in FY19, incorporating the full $35m in synergies.

UBS expects Cleanaway to grow revenue at 5.3% compound over FY17-20, based on forward-looking economic data and the specific drivers that affect the waste management industry in a positive way. Over the next three years the broker forecasts a -$45m reduction in operating costs and business efficiencies, representing 3.9% of the company's cost base.

UBS upgrades to Buy from Neutral, as the issues round restructuring and transition have largely been resolved and Cleanaway management is now able to focus on day-to-day operations. Reasonable top-line growth, aided by a marginally stronger macro economic backdrop, is expected to represent the start of a multi-year earnings upgrade cycle for the company.

Tox Free Dividend

Ord Minnett also suggests is unlikely another competitive bid for Tox Free will emerge, given the limited number of industry participants that could target a similar level of synergies. The extent of the company's ability to distribute available franking credits is to hard to assess, even though the consideration in the transaction could be influenced by the special dividend.

The scheme agreement allows Tox Free to declare and pay a fully franked first half FY18 dividend of 5c per share. It also allows for Tox Free to pay a special dividend ahead of the scheme's implementation, reducing the cash consideration payable by Cleanaway to Tox Free shareholders.

Cleanaway Waste has three Buy ratings and two Hold on FNArena's database. The consensus target is $1.57, signalling 6.5% upside to the last share price. This compares with $1.43 ahead of the announcement.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.

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