Merging Ahead

The concept of “reduce, reuse and recycle” has helped keep aluminum cans, plastic and glass bottles and paper out of landfills for decades. However, as technology becomes further ingrained in our lives and the life span of electronic equipment grows shorter, the volume of cell phones, computers, televisions and other consumer and commercial electronic scrap that ends up being landfilled is growing.

While electronic scrap currently accounts for only 2 percent of the municipal solid waste stream, it is the fastest growing category of solid waste in the United States. It also can be one of the most difficult types of materials to discard, given municipal landfill restrictions and the difficulty associated with finding electronic scrap recyclers in many communities.Electronics recycling is not only a means of recovering valuable metals, such as gold and copper, it also helps keep heavy metals, such as mercury, lead, arsenic, cadmium and beryllium, from being improperly disposed and polluting groundwater.

Groundwater pollution is increasingly regulated by strict federal, state and local agencies, creating attractive demand characteristics for electronics recycling, even in an environment where secondary commodities prices are falling.

MANDATING RECOVERY
Since 2004, 19 states plus New York City have passed take-back laws, putting the economic burden on electronics manufacturers to collect and recycle electronic scrap, tasks that are typically outsourced to third-party electronics recyclers and consolidators. Another 13 states have introduced similar bills for consideration during the first half of this year.

Even where no recycling requirements exist, some retailers are proactively addressing electronic scrap disposal. For example, Best Buy allows consumers to drop off a broad range of electronics to its stores for free.
Electronics recycling is more expensive relative to other types of recycling in light of the labor intensive nature of the process. It can often involve tedious manual disassembly of the electronic devices into reusable components, scrap metals and other recyclable materials. Successful electronic recyclers, therefore, depend on low-cost labor, high utilization and a dependable supply of materials, which they could obtain through partnership with a retailer or through charity-sponsored collection events.

M&A CONSIDERATIONS
In the more developed European and Asian electronic recycling markets, consolidation activity has been stronger than in the United States. In the last two years, nine relevant transactions involved foreign targets, compared to five acquisitions of U.S. targets. U.S. firms have made only two acquisitions, neither of which were cross-border.

While we expect consolidation in the U.S. electronics recycling market to follow a similar path as that of the industry in Europe and Asia, it will not be driven primarily by domestic competitors. Instead, the U.S. market will likely be consolidated by larger-scale foreign strategic acquirers, such as Australia-based Sims Metal Management and U.K.-based Centillion Environment & Recycling, which have made three recent U.S. acquisitions (Sims acquired Global Investment Recovery, based in Tampa, Fla.,  in October 2008; Centillion acquired Computer & Electronics Recycling, Denver, in August 2008 and Metech International, Gilroy, Calif., in October 2007). Domestic participants could include companies in the traditional waste services sector looking for ways to tap into this high-growth market niche. In any case, there are several important considerations for potential acquirers, including:

• Financial Performance—As in most transactions, historical and projected financial performance will be major drivers of valuation. In developing industries like electronics recycling, sustainable financial performance is likely to draw increased scrutiny. Companies that can demonstrate the ability to process electronic scrap on a consistently profitable basis at margins in excess of traditional recycling streams will distinguish themselves as attractive acquisition targets. In addition, the ability to provide visibility of revenue growth through contractual electronic scrap streams will result in higher valuation multiples.

• Regulatory Environment—While European governments have stringent and cohesive regulations that require recycling of electronics, laws in the United States are less demanding and inconsistent. Manufacturers in the United States are facing the possibility of dealing with different regulatory frameworks in every state, which may make federal legislation imminent. Until this occurs, M&A activity will likely target states where electronics recycling legislation is longer standing and where electronics recyclers have achieved necessary scale.

• Social Responsibility—Given that the electronics recycling market is more developed in Europe, it is likely that European participants will look to the U.S. for growth in this area. To attract acquisition interest from foreign parties, a potential target company should be able to thoroughly document when items are disassembled and where the constituent raw materials are sent to be melted or otherwise disposed. Electronic scrap in the United States is often shipped to developing countries for recycling. This practice was prohibited in 1995 through an amendment to the Basel Convention, an international treaty on hazardous waste disposal that has been ratified by 65 nations, but has been opposed by the United States to date. Accordingly, this practice could deter acquisitions from foreign companies domiciled in a country that has ratified this treaty.

• Process Certification—Most clients, but especially financial institutions and government agencies, that recycle retired computers and electronics want assurance that sensitive information stored on hard drives never winds up in the wrong hands. Businesses that have earned third-party certifications ensuring that their processes are equipped to properly handle destruction of all information will have a competitive advantage, making them ideal acquisition targets. As many traditional recyclers have not achieved these certifications, those with more sophisticated business models and management teams will be much better positioned to gain market share in electronics recycling as well as interest from potential acquirers.

A flurry of acquisition activity in the electronics recycling segment has yet to be seen in the United States, but with the fragmented nature of the market and the relative maturity of the general waste services sector, consolidation is likely forthcoming.

Electronics recycling is a fast-growing sector of the overall recycling industry that should attract healthy acquisition interest from domestic and foreign acquirers once U.S. players reach sufficient size. Given the favorable long-term demand prospects driven by government regulation, there is little question on the part of Lincoln International that merger and acquisition activity will increase substantially during the next five years.