Analyzing GFL's Strategic Alternatives

Since going public in March of 2020, GFL’s operational performance has been exceptional.  The company has more than doubled both revenue and EBITDA, while taking its leverage ratio down from over 6x to its current ~4x.  In growing both its earnings and reducing its leverage, one would expect ample value to be created for shareholders.  As impressive as its operating results have been, its stock price performance has been lackluster.  Management has taken an admirable, long-term approach to dealing with this.  Their approach has been to continue to deploy capital into new platforms and high ROIC tuck-in acquisitions, while culling non-core assets and slowly de-leveraging.  Under their current course, they should hit a leverage ratio near 3.5x by year end, which is a level that should assuage any investor concerns about it.   To compound the concerns over leverage, the company has a large shareholder, BC Partners, that is slowly exiting its position.  This overhang has probably prevented purchases by new investors who do not want to step in front of a large seller.  As noted, management has been inclined to let their plan play out over the next year.  So, it was a bit surprising that there were reports in early June that the company was reviewing strategic alternatives.  Bankers live and die by their fees; it would not surprise me if a banker worked up some alternatives and then leaked them to a reporter to put the company in play.  Let’s review each of the alternatives, and the pros and cons of each.

Alternative 1: Do Nothing

This approach was probably fine, if not one of the preferred approaches, before the news was announced.  Now, it would probably not be viewed well by the market if this is the approach the company pursues.

Alternative 2: Sell the Entire Company

This approach is probably the second-best approach in my mind, but also probably the hardest to execute.  This approach requires a price that is acceptable to both BC Partners and the CEO.  Additionally, unless this company is sold to a strategic, it will likely require the CEO to roll his equity.  I don’t know his appetite to do this.  If it is sold to a strategic, there will be ample anti-trust hurdles to clear.

Alternative 3: Sell Environmental Services (ES) Business

This seems like the preferred approach.  The original article on the strategic alternatives listed the ES sale and had specifics around it, leading me to believe this is a likely option.  It mentioned a price of CAD$7B, which works out to 14x EBITDA.  A sale at that price would allow GFL to de-lever to ~1.4x trailing Adjusted EBITDA.  GFL could then re-lever to a modest 3.0x and use the proceeds to buyback ~60% of BC Partners position in GFL.  This is my preferred approach as it concentrates the business into higher-quality municipal waste assets, immediately de-levers the company, and mostly solves the BC Partners overhang issue.

This is my preferred approach on its own merits.  However, there is an additional benefit.  I previously wrote about Secure Energy Services (https://310value.substack.com/p/secure-energy-services).  A 14x transaction of ES will illustrate the extent of Secure’s undervaluation, as it trades at 7x.  Additionally, it may put Secure in play, as it was disclosed that GFL participated in the auction of Secure’s assets that were sold to Waste Connections.  GFL was likely hampered by its leverage issues when bidding on those assets.  If ES sells to any company other than Waste Connections, ES may be interested in combining with the balance of Secure.

Alternative 4: Replace BC Partners (and possibly their other sponsors) with New Financial Sponsors

This alternative kicks the can down the road on the overhang issue, and initially may be appealing to management.  It is akin to the do-nothing approach in the sense that it allows the company to remain as it is and to de-lever over the course of the next 6 to 9 months.   However, it may limit the company’s options in the future.  Let’s assume that the company replaces BC Partners with a sovereign wealth fund.  Let’s also assume that the market reacts poorly to this news and the company’s stock sells off.  After six months without a re-rating management may want to revisit selling ES.  At that point, there would be less of a need to de-lever, as de-leveraging would have occurred naturally over that period.  Excess capital from the ES sale would then likely be used (aside from their normal course tuck-ins) for a buyback.  However, the new sponsors would not likely want to be taken out that soon, which would leave the public float as focus on the buyback.  This would make the sponsor overhang issue even worse, not to mention the difficulty to execute given the low liquidity of the stock.  Hence, while replacing the sponsors may sound appealing, it likely limits the company’s future options.

When I invest, I want to let a company compound its earnings for a long time after I buy in.  It would be great to be invested in GFL’s municipal waste business for a long time.  The sale of ES seems like the best approach as it immediately de-levers the company, partially solves the sponsor overhang issue, increases the concentration of business in high quality assets, and allows investors to remain part of the growth of GFL’s municipal waste business.