GFL garbage trucks collect waste in Toronto.Fred Lum/The Globe and Mail
GFL Environmental Inc. GFL-T is selling a majority stake in its environmental services division to pay down debt, but the complex transaction, which includes adding new debt, limits some benefits for the waste management giant.
GFL, based in Vaughan, Ont., is selling 56 per cent of the division, which offers services including liquid waste management and soil remediation, to private equity firms Apollo Global Management and BC Partners. The deal, announced Tuesday, delivers $6.2-billion in cash proceeds that can be used to pay down its heavy debt load.
But Apollo and BC Partners are also adding roughly $4-billion worth of debt to the business – and GFL will remain a 44-per-cent owner of it. So while GFL will be able to use the cash proceeds to pay down existing debt on its balance sheet, it will remain a significant owner of a business that will have billions of dollars of new debt.
On a GFL conference call Tuesday morning, Goldman Sachs analyst Jerry Revich referred to the deal as a “leveraged recapitalization,” which is a structure commonly used by private equity funds that involves purchasing a business and funding the deal largely with debt.
Three billion dollars of new debt will come from a loan arranged by J.P. Morgan, and an additional $1-billion comes from a PIK note that does not charge cash interest, though it is unclear who is providing this portion of the financing. (PIK stands for “payment-in-kind,” which means cash interest is not paid quarterly or semi-annually, and is instead accumulated in a single lump sum that must be repaid when the note comes due.)
GFL chief executive officer Patrick Dovigi referred to the PIK note as “equity” on the conference call, even though these notes must be repaid, and said the structure involves some “financial engineering.”
After the transaction closes, the environmental services business will have a debt load – excluding the PIK note – that amounts to 5.5-to-six times its earnings before interest, taxes, depreciation and amortization, Mr. Dovigi said. That is only slightly higher than GFL’s current debt level, as measured by debt rating agencies, and this burden is what prompted the company to sell its environmental services division to begin with.
However, GFL’s minority stake in the business will sit on its balance sheet as a single-line item, which means investors will only see the value of GFL’s equity position. All cash flow and financial details will be kept private, and any money borrowed will not be consolidated with GFL’s debt.
CIBC analyst Kevin Chiang wrote in a note to clients that even though the deal is complex, GFL is ultimately paying down a large chunk of its existing debt.
“We push back on the argument that selling environmental services is just a financial engineering exercise by GFL,” he wrote. Even after adding in GFL’s $1.8-billion portion of the new debt – 44 per cent of $4.1-billion – this sum is less than the $3.75-billion of debt GFL said it will repay.
GFL’s stock price slipped 1 per cent Tuesday on the Toronto Stock Exchange, closing at $62.45.
GFL currently has $9.5-billion in debt because it grew through debt-fuelled acquisitions. This burden spooked investors last year because interest rates are expected to remain higher for longer in the United States, and GFL borrows a lot of money in that country. The company has lost $2.5-billion since the start of 2020, in large part because of interest expenses.
Amid these concerns, The Globe and Mail reported in June that GFL hired a financial adviser to consider both a full-blown privatization of the company and the sale of its environmental services division. Two months later, in August, Mr. Dovigi ruled out a sale of the whole company but said the environmental services sale was still on the table and proceeds could be used to pay down debt.
GFL ultimately settled on a deal with Apollo and BC Partners. The transaction ascribes an $8-billion enterprise value to the environmental services divisions, and after the deal closes, Apollo and BC Partners will each own 28-per-cent stakes in it. GFL values its own equity stake in the business at $1.7-billion.
GFL will use up to $3.75-billion of the cash proceeds to pay down its $9.5-billion debt load, and will use the remaining $2.25-billion for share repurchases, and general corporate purposes. Apollo is a new business partner for GFL, while BC Partners is already GFL’s largest shareholder – and therefore already has some ownership of the division.
Under the terms of the transaction, GFL has the option, but not an obligation, to repurchase the environmental services business within five years.