Ecolab's Case For Financial Re-engineering

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Ecolab (NYSE: ECL) is a chemical company that historically specialized in cleaning and sanitizing products and services. The company is probably not very well known but could offer an interesting investment opportunity because of a current business transformation via financial re-engineering.

Ecolab, based on mainly its cleaning & sanitizing business, had core 2011 annual revenues of around $6.6 billion. In December 2011 it started its transformation with the highly levered acquisition of Nalco Holding Company.

Nalco, a chemical company specializing in water treatment applications in the manufacturing, energy and hospitality industries, had annual sales of roughly $4.8 billion. Ecolab spent about $6.0 billion for the company using $1.6 billion in cash and issuing 68.3 million shares. The purchase also increased Ecolab's balance sheet leverage substantially by taking on an additional $5.5 billion or so of debt.

Anticipating a tougher environment for its core revenue growth, Ecolab saw that Nalco offered better opportunities. Though adding a significant debt load, the purchase did allow the company to report increased revenues on a current basis by about 76%.

The most important aspect of the acquisition's growth potential seems to be in the operations of the Global Energy Services business segment. This business segment concentrates on oilfield, well service and downstream chemicals. While other business segments showed minimal growth, Ecolab's purchased Global Energy business grew pro forma revenues at close to 20% in the last quarter.

Thanks to the widespread expansion of North American oilfield exploration using hydraulic fracturing, or "fracking," there has been stunning growth throughout the oilfield service industry.

Baker Hughes (NYSE: BHI), an industry leader, has shown revenues increase from $14.4 billion in 2010 to an expected $21.1 billion for 2012. An impressive gain of roughly 47%.

Smaller players like RPC Inc. (NYSE: RES) and C&J Energy Services (NYSE: CJES) have shown even better growth. RPC grew 2010 revenues of $1.1 billion more than 72% to an estimated $1.9 billion in 2012. C&J Energy Services more than quadrupled their sales from $244 million in 2010 to around $1.1 billion in 2012.

Ecolab took full notice of the oil service industry sales boom and furthered their business reorganization with the October 2012 announcement for the acquisition of privately held oil & gas service company Champion Technologies for $2.2 billion, recently reduced to $2.16 billion reflecting the exclusion of some downstream business. This acquisition is expected to add sales of around $1.2 billion, but is also expected to add another $1.7 billion in debt to Ecolab's balance sheet.

The company is clearly putting its growth hopes on becoming a leader in the oil service chemicals industry.

Ecolab's business transformation is a bold but risky move. The leveraged nature of the change could offer significant upside to shareholder value, but history also seems to indicate that the odds of success for these debt-laden acquisition based reorganizations aren't great over the longer term.

Over the near term, Ecolab should continue to advertise the good revenue growth provided by acquisition and management does believe that these purchases will provide financial accretion. However, some of these benefits might already be priced into the stock. The market has recently approached the high end of my somewhat generous fair value estimate, exclusive of the Champion purchase, of $66 to $75 per share.

I'm anticipating that sometime in 2013, Ecolab's case for financial re-engineering may offer an interesting investment opportunity. I'd say that right now the jury is still out on whether the company can beat the odds and build significant shareholder value from this radical transformation. But enough evidence should be disclosed over the next year to make a reasonable judgment on the merits of Ecolab's strategy.

Investors may want to check in with Ecolab periodically. If there is a successful integration with increased growth opportunities in the Energy Services business, the highly levered nature of the acquisition strategy could pay off big. The company would be able to reap the benefits of growing cash flow to fund new ventures as well as pay down the high debt level in a timely manner.

On the other hand, the company could be stuck with a lot of debt, stagnant profitability and limited revenue growth if the expected benefits from the business transformation aren't realized.

Either way, be it on the short or long side, there's a good chance that Ecolab will provide a very interesting investment opportunity over the coming months.

grahamsway (Bob Chandler) has a long position in C&J Energy Services. The Motley Fool owns shares of Ecolab. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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