GFL Environmental Inc. (GFL) Earnings Call Transcript

Good morning all and thank you for joining us for the GFL investor update. My name is Carlin. I'll be coordinating your call today. [Operator Instructions] I'd now like to hand over to your host, Patrick Dovigi, Founder and CEO of GFL Environmental. The floor is yours.

Thank you, and good morning. I'd like to welcome everyone to today's call, and thank you for joining us. This morning, we will be providing an update on the sale of our Environmental Services business. I am joined this morning by Luke Pelosi, our CFO, who will take us through our forward-looking disclaimer before we get into the details.

Thank you, Patrick. Good morning, everyone, and thank you for joining. We have filed a press release, which includes important information. This press release is available on our website. We've prepared a presentation to accompany this call that is also available on our website. During this call, we'll be making some forward-looking statements within the meaning of applicable Canadian and U.S. securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set out in our filings with the Canadian and U.S. securities regulators. Any forward-looking statement is not a guarantee of future performance, and actual results may differ materially from those expressed or implied in the forward-looking statements. These forward-looking statements speak only as of today's date and we do not assume any obligation to update these statements, whether as a result of new information, future events and developments or otherwise. This call will include a discussion of certain non-IFRS measures. A reconciliation of these non-IFRS measures can be found in our filings with the Canadian and U.S. securities regulators. I will now turn the call back over to Patrick.

Thank you, Luke. We are very pleased to announce we've entered into a definitive agreement to sell our Environmental Services business at an enterprise value of approximately $8 billion, significantly higher than our initial expectations. From the transaction, we expect to net cash proceeds of $6.2 billion, an amount that is also greater than our initial expectations. These proceeds will allow us to materially improve our capital structure and position GFL with the ultimate financial flexibility for multiple avenues of equity value creation, including through organic growth initiatives, M&A, opportunistic share repurchases and dividend increases. Additionally, GFL will retain a $1.7 billion equity interest in the ES business resulting in a tax-efficient sale and providing us with the opportunity to participate in what we expect to be continued value creation from these high-quality assets. The transaction structure also allows us to continue to grow revenue synergies between Environmental Services and GFL solid waste business. This transaction is the culmination of a robust and intense process over the past 5 months. On the back of significant inbound interest, we spent the month of August preparing and launched a formal sale process in September. We had conversations with nearly 40 parties, went through diligence with 10 of those and had deep dives with the final 4 potential buyers. After a very competitive process, we are very excited to have selected Apollo Funds and BC Partners to partner with on this transaction. We have a long-standing relationship with BC Partners to whom we have delivered significant returns on our capital. We also look forward to working with Apollo Funds, a leading alternative asset manager with deep expertise that had a demonstrated track record of value creation for its stakeholders. I will now pass the call over to Luke, who will walk us through certain financial benefits and the transaction, and then I'll have some closing remarks before we open it up for Q&A.

Thanks, Patrick. Pro forma for the planned use of proceeds towards debt repayment and share repurchases, net leverage is expected to be approximately 3x. Across our revolver, term loan and 2025 bonds, we have over $2.25 billion of debt that is readily repayable. The amounts outstanding under each of these facilities would be the first debt to be repaid. The remaining $1.25 billion to $1.5 billion of intended debt repayment would be achieved through a tender process targeting some of the higher coupon bonds in our debt stack. Based on conservative assumptions regarding tender participation rates across our various bonds, we estimate the annualized cash interest reduction associated with the $3.75 billion debt repayment to be approximately $200 million. As part of our capital allocation strategy post the ES sale, we also plan to opportunistically pursue up to approximately $2.25 billion of repurchases of GFL shares with a view to reducing the current overhang as well as reducing our current diluted share count. Adjusted EBITDA margin pro forma for the exclusion of Environmental Services will increase, approaching 29%. Reported corporate costs will reduce by $10 million to $15 million post the transaction. But the corporate segment as a percentage of revenue will temporarily increase on the lower revenue base. We expect to go forward operating leverage on our corporate costs as we grow our top line, both organically and through M&A. The expanded adjusted EBITDA margins and lower cash interest costs will be immediately accretive to adjusted free cash flow margin and conversion. As we've previously indicated, we expect that as we transition to investment-grade credit quality, our cash interest expense as a percentage of revenue will reduce by over 300 basis points, which represents a 1,000 basis points improvement in free cash flow conversion. We expect the debt reduction from the transaction to reduce cash interest as a percentage of revenue by approximately 100 basis points reflecting less than 1/3 of what we see as the longer-term opportunity in this area. Bottom line, when you couple execution on the various self-help levers in our portfolio with reduced cash interest costs going forward, we expect free cash flow conversion to improve at an accelerated rate. As Patrick mentioned, the delevered balance sheet provides GFL the financial position to allow for incremental growth investments including reigniting our M&A strategies that have been tempered over the past 18 months. Recall, the power of the financial model is such that the business organically delevers each year through adjusted EBITDA growth and free cash flow generation offsetting any potential leverage impact from M&A. So this 3x starting point of net leverage will allow us to comfortably remain in the low 3s range for net leverage on a go-forward basis. As we've previously discussed, we intend on hosting an Investor Day in New York next month. The official registration details will be announced in the coming weeks. At the Investor Day, we look forward to presenting further details of the expected financial impacts of the transaction as well as our refreshed multiyear outlook for the business. I will now pass the call back to Patrick, who will provide some closing comments before Q&A.

Thanks, Luke. This transaction facilitates the acceleration of several of our key financial objectives while preserving the opportunity to participate in expected material value creation through our retained equity in the ES business. As it relates to our call option on the ES business, I want to highlight that this is solely a GFL's option and it's not an obligation of GFL to execute on. As we begin 2025, our setup has never been better. We have proven that we can execute on our strategic plan and with the ES transaction set to close in Q1 of 2025, we believe that we have laid the foundation for long-term growth and value creation for all of our shareholders. Our go-forward strategy is simple and clear: Continue to focus on generating industry-leading organic margin expansion, benefit from the ramp in earnings contribution from both EPR and RNG, execute on our robot solid waste M&A pipeline while maintaining our low 3 leverage targets and progressing towards an investment-grade credit rating. With that strategy, we believe that we are uniquely positioned for industry-leading financial performance over the near term. On behalf of GFL's management team, I want to thank our investors, our customers and our communities for your continued loyalty and support. Most importantly, I want to thank each and every one of our employees because we would not be where we are today without their hard work and dedication. I wish you all a Happy New Year and look forward to an exciting 2025. I will now turn the call over to the operator to open up the line for Q&A.

[Operator Instructions] Our first question comes from Saba Khan of RBC.

Could you maybe talk a bit about the structure of the deal, kind of the ownership interest you're maintaining. It seems like there's a tax efficiency element to it, the equity roll in and any other important aspects of this structure. And it seems like an interesting structure here that you've set up. Maybe if you can just talk about how you arrived at it and some of the puts and takes around tax and that could roll just so we understand how you thought about this deal?

Sure. So I think from the company's perspective, at least from my perspective, obviously, in life, there's no such thing as perfect, but this is about as close to a perfect of a deal as I think anyone could sort of architect. I think we went into this back in the summer, the expectation is that we would sell the business for approximately $6.5 billion potentially. And there would have been, at that time, a $700 million to $800 million tax bill, netting us about $5.7 billion to $5.8 billion of cash proceeds. I think we got into it, the objective from my perspective, was pretty simple. We wanted to sort of manage short-term needs of the business, but we didn't want to forego any long-term shareholder value creation. That's most important to me being sort of the largest individual shareholder, wanted to make sure we didn't give any of that up. So with that sort of in vain, we basically said, how do we deal with the balance sheet to expedite IG status and then potentially buy back stock at what we believe to be a very attractive value when we look at what the opportunities are over the next sort of 3 to 5 years. So with that, we went back and sort of looked at it and we have a lot of smart people here, and a lot of smart people that are smarter than me and truthfully the rest of the team here and looked at how we could do this efficiently. And as we got into the process, the value of the business ended up being more than probably we could have even imagined we went into the process. And we looked at how we could continue on owning equity in the business given what we saw as again, still significant opportunity with the business. And now you look at it, I think the tax bill will be somewhere between $20 million and $25 million as an estimate, not $600 million to $700 million, and we've been able to roll those assets on a very tax-efficient basis into the new entity, which has allowed us to continue owning 44% of the business today. So I think for the RemainCo of GFL, it solved all the short-term needs, as well as for our existing shareholders, we'll continue owning 44% of ES. And then when you look at the private equity style case that you have here, that ES will continue on and which is a world we grew up in the first sort of 14 years of GFL's existence, which is a world we know well. Again, we get to use a private equity style balance sheet leverage profile. And if you think about equity returns in the private equity world, in their base case is underwriting to 2x their equity in 5 years. And in their upside in better cases, you're underwriting to 3x their equity. So if you put that into context for the $1.7 billion we're rolling, in private equity base case, that's a $3.4 billion equity check in 5 years. And if we execute on the plan like we think we can, that number grows to somewhere around $5.1 billion. So again, from my perspective, satisfying the long-term objectives of what we're doing. In addition to that, we have the option to buy back solely at our discretion in the business. So if we get into a position like we think we're going to do with the cash flow generation, et cetera, and a different leverage profile where we're going to be in 3 or 4 years, and we want to continue growing in other business segments, we have that option solely at our discretion. So I think it was just a perfect transaction. And one thing I should mention -- should have mentioned first, none of this would have been possible without the team, both on the ES side and sort of corporately. And I should really thank them from Ed, Brad, John, Kevin, Amid, Gian, Jordan, Michael on the ES side and all of their respective teams as well as on the corporate side. Again, what was pulled off here from the team under Mindy, Luke, Craig, Sean, Nina, Yusuf, Pino and Julie and sort of the integration side. Everybody worked tirelessly over the last 4 to 5 months and particularly over the Christmas break to get this transaction across the line for all shareholders. So I'm extremely proud of the team, extremely proud of the outcome. And I think it's the best of all worlds for all of us as shareholders for the long term.

Great. And then just on the option that you have to purchase the ES business, the comment around 5 years, are there any terms, conditions or anything we should know about? Or how are you thinking about that option?

It's generally solely in our option. So we have the ability to trigger that repurchase. So again, we can explore that 3.5 or 4 years from now whether that made sense or not given what is going to be in front of us over the next 3.5 or 4 years.

And just 1 last quick 1 and I'll pass the line. Just the $2.25 billion earmarked for opportunistic share purchases, how are you thinking about that? Or do you have specific parameters? Should we expect announcements on the front, or anything just kind of a share buyback program? Just maybe you can just lay out the thought process there.

So obviously, we'll refile our certain normal course issuer bid again. So that will be one avenue. And we will apply to the OSC to be able to buy back stock from certain of the larger shareholders with GFL sort of off of a perspective. So that is coming. We have a plan. We intend to execute on that sort of plan now that the transaction -- we signed a definitive agreement, so we'll turn to that. But from our perspective, listen, it gives us the ability to buy back stock, and we believe to be a very attractive value today given what we know we have in the pipeline between RNG, EPR and all the organic margin expansion opportunities as well as the M&A pipeline. So we've set this up very well, and it was always part of the plan and we're going to kick that into motion now. But it will be a combination of, again, both buying in the market and buying back from certain shareholders over time.

Our next question comes from Kevin Chiang of CIBC Wood Gundy.

Maybe if I just look at, again, the option value. If I look at ES, I guess, immediately post the transaction, the new co is going to have like about $4 billion-ish of debt. And if my math is correct, you're kind of running about mid $400 million of EBITDA. I guess when you think of potential exercising an option value, is there a way to think about maybe how you foresee ES growing over the next 5 years, both from an earnings perspective and maybe how that capital structure might change over the next half decade as you think about exercising the option or maybe pursuing another liquidity event?

Yes. So it will be roughly -- Kevin, sort of roughly $3 billion of OpCo debt. I mean the rest is sort of financial engineering up at sort of HoldCo, but roughly $3 billion of OpCo debt. The business, when you sort of look at 2025, be north of $500 million sort of EBITDA. We're thinking about leveraging that business somewhere between sort of 5.5 and 6x. That's what we ran the business privately for a long period of time. I think if you look at a base case model, I think over the next 5 years, you grow the business to somewhere between $875 million and $950 million of EBITDA with the combination of sort of M&A and organic growth opportunities. So I think the case we laid out on equity value creation is pretty simple. I think when you sort of layer that out and obviously, who knows where multiples go over the next 5 years, but that's an assumption you have to make. But I think very conservatively that the equity is -- grows to 2x. Potentially, if we hit sort of the plan that we think we will, the equity will grow to 3x. So somewhere between the $3.4 billion to $5.1 billion equity check coming over the next 5 years if you decide sort of not to buy it back. If you decided to buy it back, I mean, if you ran that math, I think you can potentially buy back net of your role for probably somewhere between 9 and 10x, 4 to 5 years from now. So both options are very compelling, and we've been able to keep the optionality for both of those.

Okay. That's helpful. And maybe just a clarification question. For your 3x pro forma leverage number you put out in the press release, it looks like it doesn't include any equity pickup from your proportional ownership of the ES. Am I right on that? Or are you adding that back when you get your pro forma [indiscernible] on it?

Fully carved out, no pickup from ES.

Yes. Kevin, it's Luke here. We'll treat it similar to as what we've done with GIP and we'll just exclude it from the adjusted EBITDA calculation, not just really the sort of stand-alone GFL RemainCo, really the operation profitability of the solid waste business offset by the corporate cost.

Okay. That's great. And then maybe just last 1 here. I'm not sure if this maybe changes how you think about the monetization opportunity for GIP. I mean, obviously, this is a pretty significant transaction and to get your leverage to your target, which pretty quickly here. Does that have any implications on how you think about your investment in GIP?

I mean, no. I mean, we're going to look for -- to do it at the right time when we can maximize value. As we said, there was a couple of headwinds in that business with, I would say, increase sort of cost inflation but that has certainly moderated. 2024 was a great year, which again, we'll provide an update at the Investor Day on. And we have a lot of great opportunities in that business, but I think we'll maximize value when we think the value is there to be sort of maximized. And obviously, with this transaction, that would just give us incrementally more proceeds. But from our perspective, we're just going to do it when the timing is right.

[Operator Instructions] Our next question comes from Konark Gupta of Scotiabank.

Congrats on the deal. Just wanted to understand the minority interest that you would retain in Environmental Services, $1.7 billion. In terms of attributing that $1.7 billion equity value to GFL for GFL investors, how should we think about that number, $1.7 billion? It seems like 44% represents $1.7 billion. So a lot of tax might be attributed to this number here. Is there anything we should net out from $1.7 billion perhaps, Luke, to answer this question to attribute to GFL? Or should we take the $1.7 billion as is and as Patrick said, that $1.7 billion could multiply over the years?

Yes, Konark, it's Luke speaking. I mean, as Patrick alluded to, by virtue of the equity roll, we were unable to defer sort of taxes otherwise sort of payable. And so if you were just looking at that stand-alone basis, you'd probably have the tax effect that you want to think about what it would be worth to the GFL sort of today. Obviously, as we go forward and we grow the ES business and we grow sort of GFL and ever-changing tax landscape, what the ultimate tax liability is will only be known at that time. But I think if you wanted to present value it today, you would just tax affect that number, and that would reflect the value store that we have today.

Okay. That makes sense. And just to follow up on the free cash perspective. So you mentioned about cash conversion going up. Your EBITDA is obviously your GFL EBITDA, excluding ES. But your cash flow, should that have some free cash attribution of 44% equity stake on ES?

So no, Konark. Similar to how we've accounted for GIP, right, where we have the sort of noncontrolling interest. We just exclude that from the reported results of adjusted EBITDA and adjusted free cash so that we report on just the underlying profitability or cash flow generation of the sort of GFL solid waste business today. We will have different views as to how you want to sort of value the incremental benefit of those 2 assets that we have off the side, but we will not incorporate any of their results into our ongoing reporting.

Our next question comes from Patrick T. Brown of Raymond James.

Can you remind us real quick, how much CapEx was associated with ES roughly annually?

We spent somewhere in the sort of 8% to 9% of revenue range, right? So if you think about GFL as a whole, we were benefiting and having a slightly lower capital intensity than maybe some of the pure-play peers by virtue of having 20% of your revenue track at 8% to 9% CapEx. And then you have the sort of other 75% to 80% of your revenue at the normal course 10.5% to 11.5% intensity for solid waste business. So when you back out ES on a pro forma basis, where GFL will now live, it'll probably be in that sort of 11-ish range, higher growth CapEx spend 1 year may push you up 11.5%, but you'll start being in that range commensurate with your sort of peers as you no longer have that 20% of overall revenue tied to that lower capital intensity.

Okay. Now I think as you said specifically that it would be accretive to free cash flow conversion and free cash flow margin. But will the deal be slightly dilutive to total free cash flow dollars?

Yes, I think that's right. Out the gates by virtue of -- if you just think about a free cash flow walk, pre and post, giving up the EBITDA and net of the CapEx and including the interest savings, it's a little decretive to free cash flow dollars out the gate. But when you look at the conversion percentage today, low to mid-30s and what that starts ramping up to and in addition to, if you think on a per share amount, right, post the buyback, that's where we see the opportunity to really ramp and accelerate free cash flow growth on a per share basis as you go forward.

Okay. I just want to make sure I had those mechanics. Okay, perfect. And then on the equity role, I'm again, kind of curious about the mechanics. But will we see a $1.7 billion asset that just shows up on the balance sheet as a new line? Will it be isolated?

Yes. So we currently have our carrying interest in sort of GIP and other sort of noncontrolling interest. I mean, I think with the size of this, probably there'll be some sort of note breakout. But yes, you're going to see this asset on the face of the balance sheet, they may be co-mingled with other investments, but we'll have the note disclosure. So you can see how this changes similar to what you currently see for investment in GIP.

Okay. And so that fair value will get marked every quarter? Or will you mark every year? Or how does that work?

No, it's going to be equity accounting, Tyler, so you're not going to get this sort of fair value, again, normal course sort of equity method accounting for it.

Okay. And then, Patrick, you mentioned -- just to finish here, you mentioned the M&A side, maybe reigniting some of that. Can you just talk about the pipeline there? Have you guys been active here in '24 kind of building a pipeline of deals? And how does that look into '25?

Yes. Of course, we think, again, with the balance sheet in the position that it's going to be in, we've obviously reignited the engine. Obviously, this transaction sucked up a lot of time, but we have a very robust pipeline for solid waste M&A, a lot of great opportunities that fit within our existing footprint that are going to be sort of highly accretive to us as shareholders. So I think you'll see us get back to doing what we've done for a long period of time and it's going to be an exciting 2025 and beyond.

Congrats.

Thanks, Tyler.

Our next question comes from Jerry Revich of Goldman Sachs.

Congratulations. Sounds like the team was working straight through the holidays, so well done. Can I ask in terms of the agreement with BC, is there a buyback agreement embedded in that, Patrick? I would assume that there's a tax attribute opportunity for them as well, potentially with the deal structure. I'm wondering is that part of the transaction as you laid out the buyback expectations?