Buy or Sell? Tuesday's Winners: HEK, VRX
Heckmann looks like a perfectly-built company for the shale gas revolution. The company trucks in fresh water (and then helps handle the used water) that is used in the "fracking" process. As more and more gas wells went into service, so did demand for Heckmann, as sales shot up to more than $150 million in 2011, from $15 million in 2010. Sales are expected to surge above $350 million this year, and that's actually a disappointment: The company recently has warned of an industry slowdown (as low gas prices dampen new drilling efforts), so the current 2012 sales and profit forecasts are actually a bit lower than they were a few quarters ago.
To coax analysts to boost -- and not cut -- estimates, Heckmann has just announced a fairly bold acquisition. The company will shell out $125 million in cash and 95 million shares of stock to merge with North Dakota-based Power Fuels, which provides a wide range of environmental services to gas drillers in that region of the country.
Investors quickly applauded the deal -- with shares rising nearly 25% this morning -- as Heckmann now becomes one of the industry's largest environmental services firms, with pro forma revenue of around $700 million. Make no mistake, this combined entity will carry little cash and a significant amount of debt (which we can enumerate once the bankers line up the final financing for the deal), which means that if this business turns south, Heckmann's balance sheet would crush the equity.
Yet that doesn't look to be the case. Even with natural gas hovering near historically low prices, drilling activity across the United States appears sufficiently robust to help this company maintain solid levels of EBITDA. For shares to really take off, management will need to explain how that EBITDA will lead to a steady pay down in the debt. With reduced risk comes a higher multiple. Net/net, this looks like a very appetizing merger.
The M&A premium?
When companies announce an acquisition or merger, they often see shares initially slump as investors fear the operational indigestion that a deal can bring. So it's quite unusual to see not one but two acquirers get a bump in today's trading. In addition to Heckmann, shares of Valeant Pharma are getting a double-digit boost after the firm made a bold $2.6 billion bid to acquire dermatology-focused Medicis Pharmaceutical (NYSE: MRX), which itself is surging almost 38% this morning.
If Valeant paid a huge premium to acquire Medicis, why are its own shares surging? Because investors know that Valeant has an impressive track record when it comes to deal-making, pulling off 50 of them in the past half decade. Management tends to promise a set of post-acquisition operating targets, and invariably meets them.
The growth-through-acquisition strategy has helped push Valeant's sales to nearly $2.5 billion in 2011, from around $750 million in 2008, and EBITDA margins, thanks to savvy acquisitions that have been digested, now typically exceed 35%.
Bringing Medicis into the fold makes Valeant the premier global provider of dermatology treatments, in both medicinal and cosmetic products, in areas such as acne, keratosis and anti-wrinkling.
Yet a bit of caution is warranted. As Valeant grows ever larger, it may eventually be saddled with a "Big Pharma" style multiple. Assuming the Medicis deal leads analysts to eventually boost their pre-deal 2013 earnings-per-share (EPS) forecast (of $3.35) to around $3.70, this means shares trade for more than 15 times projected 2013 profits, after today's bump. That may not seem rich until you realize that many rivals trade for around 10 to 12 times forward profits. That doesn't mean Valeant pulled off a bad deal, nor does it mean that shares are due for a sharp drop. It only means that a significant expansion in the multiple from here may be hard to achieve.
Action to Take --> The Heckmann acquisition appears to carry pretty significant upside, once the combined entity is able to streamline costs and cross-sell various services into the respective customer bases. Still, the high level of debt means this stock brings a clear amount of risk as well. So it will pay to really sift through the numbers of the deal, especially in terms of what the finalized balance sheet will look like, before making a final purchase decision.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.