Dealmaking in environmental services has been extremely active in 2021. Much of the uptick in mergers and acquisitions (M&A) activity can be attributed to broadly applicable macro factors—such as the low interest rate environment, excess cash on corporate balance sheets and dry powder overhang for financial sponsors—which together create a high level of cash available for deals. But additional and perhaps more interesting forces are at play as well.
Unprecedented deal spree
It is unlikely news to anyone reading this article that the environmental services industry has been extremely active from an M&A perspective in 2021, especially for those companies operating within waste and recycling. Global environmental services deal volume has surged to a total of $57 billion year-to-date as of Sept. 30, 2021, up 117 percent versus full-year data for 2020, according to Seattle-based PitchBook Data [see chart]. This already represents an all-time annual high for M&A volume in the sector, overtaking the previous record that was set in 2007.
The robust level of deal activity highlights the strong appetite of strategic buyers and financial sponsors, including the growing list of infrastructure and impact funds, all of which don’t appear to be slowing down anytime soon.
When will consolidation peak in solid waste?
Within solid waste, major strategic buyers—which estimates show already make up the majority of industry revenue—have been largely leading the rush for deals. Many smaller, family-owned haulers have found 2021 to be a good year to sell, due to expected generational transitions, changes in tax rates, labor issues and supply chain constraints. Larger strategic players have been happy to oblige, paying multiples of EBITDA [earnings before interest, taxes, depreciation and amortization] that are far below the multiples at which such strategic companies trade in the public markets, and enabling immediate upside for them.
Financial sponsors, including infrastructure funds, have played a key role in building the platforms that are now the major strategic players in solid waste. However, the current level of consolidation and aggressiveness of the major strategics in M&A processes have somewhat limited opportunities for funds recently.
This is certainly not for a lack of interest on the part of financial parties, including a number of funds that have dedicated environmental services investors and operating partners. Infrastructure funds, for example, have grown in number and importance in the waste and recycling industry.
Infrastructure funds have a key competitive advantage when competing for deals: their lower internal rate of return (IRR) mandates enable them to underwrite deals more aggressively relative to other financial sponsors. As an example of an infrastructure fund’s influence in the space, Macquarie Infrastructure Partners recently completed a significant equity investment in LRS. We expect infrastructure funds to continue playing an influential role in waste and recycling, especially as they see opportunities to drive waste-to-energy initiatives.
We see many financial investors seeking to repeat past success in solid waste within other environmental services subsectors, and we regularly speak with investors that are researching opportunities in other specialty waste streams (e.g., liquid waste, hazardous waste, specialty recycling and waste-to-energy), as well as other environmental services subsectors (e.g., professional services; testing, inspection, certification and compliance (TICC); and remediation and abatement).
In addition, we see opportunities with “disrupters” seeking to drive innovation in the space. These disrupters are often focused on reducing the environmental footprint of waste (or what would become waste without intervention). We expect to see continued and likely increasing venture capital, growth/crossover and impact fund investment in environmental services going forward, as these disrupters continue to raise capital to scale.
What has driven a valuation inversion?
Another unusual feature of the waste and recycling industry is the fact that valuations for pure-play solid waste companies have outpaced valuations of specialty players since 2015. This is counterintuitive—in most industries, specialty players trade at a premium to pure-play companies.
One explanation is that solid waste companies have done a better job of consolidating their industry relative to specialty players and have stayed closer to their core capabilities. The role of regulation may be a factor as well—at the very least, regulation has increased the value of existing landfills. Regulation is and will continue to be important for driving pricing power with customers and demand for recycled products.
Sustainable solutions driving the electrification of everything
Emerging subsectors are gaining in significance and will continue to see greater attention. Investors have shown particular interest in recycling companies connected to the electric vehicle (EV) and battery markets. Example companies in this space include Redwood Materials, a Nevada-based recycler of lithium-ion batteries and producer of materials for electromobility and electrical storage systems founded by a former Tesla executive, and Toronto-based Li-Cycle, a lithium-ion battery recycler focused on resource recovery that recently went public via a SPAC [specialty acquisition company].
As with many emerging subsectors in environmental services, investors are interested in recycling companies connected to the EV and battery markets for two main reasons. First, they represent both a large and growing total available market (TAM). In addition, they represent strong environmental, social and governance (ESG)-focused investment opportunities. These ESG opportunities are well-aligned with consumer sentiment and regulatory trends, such as the recently passed United States infrastructure bill.
What will the future hold?
We see strong M&A activity in the environmental services market continuing into next year, while ongoing dialogue around labor, inflation and supply chain issues may cause some disruption. We expect consolidation to continue, because “platform” investments by private equity and infrastructure funds essentially require add-ons. Innovation, especially related to sustainability, will drive expanded investor interest and growth across environmental services for the long term.