Quick Pitch: Heritage-Crystal Clean (HCCI)

Heritage-Crystal Clean (HCCI) – Potential Higher Offer – TBD Upside

This is a short note on a speculative but low-risk bet that a competing bidder will emerge during the go-shop period.

Heritage-Crystal Clean is a $1.1bn market cap company with two businesses – environmental services and used engine oil re-refining. The company has signed a definitive agreement to be acquired by a PE firm J.F. Lehman at $45.50/share. Currently, the company trades at the offer price. The merger includes a 35-day go-shop period that expires on August 23. Approval from 75% of outstanding shares will be needed. Company’s founders, who hold a 30% stake, are already in support. The deal is expected to close in Q4. The buyer, J.F. Lehman, has a track record of acquisitions in the environmental services space. Overall, even if a higher bid doesn’t materialize, I expect HCCI to trade at a minimal spread to the offer price, thus the downside is well protected. There are several nuances, a combination of which suggests a non-zero likelihood of an improved offer.

• From the merger background in the proxy, it’s evident that HCCI’s management had actively advocated for the inclusion of the go-shop period in the merger terms during the buyout negotiations. J.F. Lehman had initially pushed for the exclusion of the go-shop provision, yet HCCI’s management has eventually secured not only a 35-day period but also has negotiated a reduction in the termination fee from 4% to 1.9% during the go-shop period and 3.5% thereafter.
• Management didn’t run a proper sale process and simply agreed to J.F. Lehman’s final offer following several months of negotiations and two bid raises. Aside from J.F. Lehman there was only one other bidder mentioned in the proxy but this party was interested only in HCCI’s oil refinery business for which it made two undisclosed offers.
• Two years ago, back in 2021, HCCI conducted a strategic review and attracted 2 undisclosed buyers with bids ranging from $32 to $39/share. One of the parties eventually withdrew the bid, whereas another one was rejected by HCCI management due to valuation concerns and a lack of strategic fit.
• The current offer seems cheap. It came at just an 8.5% premium to the pre-announcement prices. The buyout values HCCI at 7.1x TTM adjusted EBITDA versus the only relatively comparable peer CLH trading at 10.8x. Some of the discount might be warranted given that CLH is a much larger company and is also a dominant player in both environmental services and used-oil re-refining markets in the US. CLH sports c. 50% market share each of its segments compared to c. 20% for HCCI. It also has slightly lower exposure to oil re-refining. However, both companies have delivered comparable revenue growth rates during 2017-2022 (14% CAGR for HCCI vs 12% for CLH) with similar adjusted EBITDA margins (21% for HCCI vs 20% for CLH in FY22).
• For the most part after the offer announcement, HCCI was trading above the offer price, which indicates that the market also sees a possibility of a higher bid.

A potential problem here is that it’s difficult to pinpoint any strategic buyers for HCCI. CLH is unlikely to be a bidder here given that the combination would likely face strict scrutiny from antitrust regulators. Last year, CLH terminated its acquisition of Vertex’s used motor oil collection and re-refinery assets due to pushback from antitrust regulators. Meanwhile, analysts have stated that larger solid waste firms (such as WM, WCN and RSG) probably won’t be interested in HCCI given its exposure to used oil re-refining as well as the lack of proprietary landfills.