Ecolab Grabs For The Brass Ring

Ecolab's management seems as if it may have timed the financial markets well in order to make a very strategic acquisition of Nalco Holding Co. ECL has always carried a premium P/E and EV/EBITDA compared to its peers because, as Credit Suisse points out, it has high returns on invested capital and relative earnings stability. With its equity valuation high and corporate cost of debt low, ECL can handle paying $3.8 billion in stock, $2.7 billion of net debt, and $1.6 billion in low returning cash, for a total consideration of $8.1 billion.

Nalco's business is in three segments: Water Services, Paper Services, and Energy Services. All of these businesses are really problem solving solutions for the customers, which involve chemicals, products like filters and the like, and a high touch level of service to solve a unique, often site-specific problem. Water Services are said to be a $6.4 billion global opportunity, of which Nalco says it has a 20% share. Likewise, Energy Services are said to be a $5.6 billion global opportunity, of which Nalco says it has a 30% share. Paper Services are a $6.7 billion global opportunity, of which Nalco has an 11% share. The jewels for ECL are clearly Water and Energy.

Nalco has historically aimed at a corporate target of 5% real growth. In some years, this has been north of 7%, while in other recent years it has been 2%. Although the equity analysts talk about lack of predictability, a GDP-like real growth rate in what was once a commodity business isn't bad, provided that the acquirer can realize revenue synergies, access new customers, and take significant costs out of the combined operations.

Naclo management gave itself a target of $75 million in annual cost savings from streamlining its operations. Nalco recently embarked on a hub-and-spoke operation for its water treatment offices in the Midwest in order to squeeze smaller, local and regional competitors. This build out can probably be stopped or reversed to fit into Ecolab's structure, depending on the most efficient way to serve the new customers. Nalco also looked to enhance its sales people's offerings by partnering with companies like U.S. Filter and Johnson Diversey. These partnerships can either be scaled up, or rationalized with Ecolab's partnerships. Buying power is now substantially enhanced. ECL management is looking for $150 million in synergies, of which $30 million are said to be gained in 2012. If Nalco's targets of $75 million were real, then the $30 million should be a slam dunk.

These businesses are ALL about the sales force, the product offering, and the service culture. Whether this acquisition works or not, the rubber will meet the road in how well Ecolab's management teases out the best in both organization and about how quickly it can squeeze the obvious inefficiencies out of Nalco's sprawling organization. Both companies are global companies too, so there may be even more synergies in combining the best of the organizations in developed and emerging global markets. Like Exxon's entry into the gas markets by acquisition, this one looks like it has a lot of potential to add value for Ecolab shareholders, notwithstanding some short-term downgrades to analyst opinions.