Stericycle, Inc. (Nasdaq:SRCL) – July 2016

Article Title: “Stericycle: This Is Still A Good Short”

Recommendation: Short Stericycle (Nasdaq:SRCL) equity

Current Stock Price: $104.70

Target Stock Price: $65.00 (38% return)

Timing: 6 – 12 Months

Catalysts: Disappointing earnings, failure to integrate acquired businesses, accounting re-

statements

Summary Thesis

Stericycle is a waste management roll-up which has exhausted its growth opportunities in

its core business and has expanded into lower quality businesses

The company’s core medical waste business is facing limited growth opportunities and

margin pressures from the consolidation of its customer base

The acquisition of Shred-it in 2015 will likely continue disappointing investors as it is a

low quality business and its purchase was predicated upon synergies that have proven

difficult to realize

The acquisition of PSC in 2014 has exposed the company to a cyclical earnings stream

and has resulted in Stericycle receiving an adverse opinion from its auditor for material

weakness in internal controls

Continued earnings pressure and multiple compression could result in Stericycle’s stock

failing an additional 20% - 50%

Situation Overview

Stericycle (SRCL) was founded in 1989 as a medical waste management company in response to

the introduction of more onerous laws regarding the disposal of medical waste. In 1987, a leak

from a landfill resulted in hypodermic needles washing up over a 30 mile stretch of the Jersey

Shore. This environmental disaster known as “syringe tide” resulted in the Medical Waste

Tracking Act of 1988.

Capitalization Financials Valuation

Market Cap $8,890 2015 Sales $2,986 EV/2016E Sales 3.3x

Cash $46 2016E Growth % 22.1% EV/2015 EBIT 18.2x

Debt $3,152 2015 EBIT $658 EV/2016E EBIT 15.5x

Enterprise Value (1) $12,009 2015 Margin % 22.0% Price/2016E EPS 21.0x

(1) Includes $12.1 million of minority interest.

Source: Capital IQ as of 7/8/2016.

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Today, Stericycle continues to specialize in medical waste management but has expanded to

hazardous industrial waste, document shredding, outsourced medical call centers, and product

recall management. The company doesn’t provide revenue or profitability break-outs by product,

but below is my best estimate of what the mix looks like today.

Est. Revenue Mix Est. EBITDA Mix

Stericycle has used an acquisition-led growth strategy to build scale in its waste management

business and expand into other lines of business. Since becoming a public company in 1996, the

company has made 450 acquisitions to grow at a compound annual rate of 30%. Half of this

growth has been inorganic.

The acquisition strategy is to first acquire a regional waste collection network and then focus on

making tuck-ins of competitors in order to bring on additional customers. The company’s stated

IRR hurdle rate is low-mid teens (which is quite low). The company believes that once it builds a

strong customer list it can cross-sell its services (waste management, compliance training,

document shredding, ect.) to make the acquired businesses much more profitable.

Stericycle has had a great deal of success rolling up the medical waste industry. By 2003, the

company was generating over $400 million in revenue and had a 31% EBITDA margin. In 2003,

the company entered the sharps management (hypodermic needles) and pharmaceutical returns

businesses. In 2008, the company began expanding its medical waste business abroad through

acquisitions. In 2010, Stericycle entered the outsourced medical call center business.

While the company had expanded beyond its core service of handling medical waste, it was still

focused on health care oriented services and maintained strong profitability and return on

invested capital (ROIC). However, in 2012 Charles Alutto took over as CEO and changed

strategic direction. Alutto expanded SRCL’s hazardous waste business by acquiring PSC in 2014

and expanded into document shredding by acquiring Shred-it in 2015. These recent acquisitions

were much larger and transformational in nature. These acquisitions have been extremely

disappointing and appear to be significant capital allocation mistakes which have impaired

shareholder value.

US Medical Waste37.0%

Intl. Medical Waste16.9%

Shred-it20.6%

Haz. Waste17.3%

Call Centers

5.5%

Recall2.7%

US Medical Waste56.6%

Intl. Medical Waste9.7%

Shred-it18.9%

Haz. Waste8.6%

Call Centers

2.9%

Recall3.4%

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As a separate capital allocation issue, the company has spent over $300 million buying back

share above its current stock price over the past 2 years. This includes recent share repurchases at

average prices in the $120 - $140 price range; the stock currently trades at $104. The company

still has a large share repurchase authorization which it is likely using to purchase shares as the

stock price continues to collapse.

Stericycle believes its competitive advantage is its ability to build business density through its

acquisition machine. This business density works 2 ways:

1) SRCL is primarily a logistics company transporting waste and by having a dense

customer base it can more efficiently serve its customers.

2) By cross selling other waste and business management services, SRCL creates

more sticky and profitable customer relationships.

Outside of the company’s ability to build business density, SRCL recognizes that its business has

low barriers to entry because anyone can pick up and deliver waste to a processing facility.

Despite the low barriers to entry, Stericycle has managed to create a very strong customer

ecosystem within healthcare waste management and compliance.

However, I believe that Stericycle has lost it way with its recent expansions into hazardous waste

and document shredding. The company has entered businesses outside of its core competency

that are more competitive, more cyclical, more capital intensive, and less profitable. As a

result, the company is facing margin compression and declining ROIC. Margins peaked in

2009 before Stericycle expanded into call centers (2010), hazardous waste (2014), and

document shredding (2015).

Stericycle’s Medical Waste Business Faces Headwinds to Profitability

With ~54% of total sales of ~66% of EBITDA, medical waste is SRCL’s most important

business and crown jewel asset.

Stericycle has multi-year contracts with physicians, clinics, and hospitals to collect and dispose

their regulated medical waste. Regulated medical waste is defined by the EPA as “any solid

waste that is generated in the diagnosis, treatment, or immunization of human beings or animals,

in research pertaining thereto or in the production or testing of biologicals”; examples include

needles, blood, surgical specimens, pharmaceuticals, ect. Stericycle provides its clients with

Historical Financials

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 LTM

Revenue $609 $790 $933 $1,084 $1,178 $1,439 $1,676 $1,913 $2,143 $2,556 $2,986 $3,197

Growth % 18.1% 29.6% 18.1% 16.2% 8.7% 22.2% 16.4% 14.1% 12.0% 19.3% 16.8% 20.7%

Gross Profit $268 $350 $418 $510 $582 $706 $802 $902 $1,017 $1,151 $1,328 $1,424

Margin % 44.0% 44.3% 44.8% 47.1% 49.4% 49.0% 47.8% 47.1% 47.4% 45.0% 44.5% 44.5%

EBITDA $191 $233 $272 $316 $365 $447 $510 $553 $645 $717 $786 $816

Margin % 31.4% 29.4% 29.2% 29.2% 31.0% 31.1% 30.5% 28.9% 30.1% 28.1% 26.3% 25.5%

EBIT $170 $206 $241 $282 $325 $394 $444 $477 $556 $612 $658 $667

Margin % 27.9% 26.0% 25.9% 26.0% 27.6% 27.3% 26.5% 24.9% 26.0% 24.0% 22.0% 20.9%

Adj. EPS $1.07 $1.22 $1.44 $1.74 $2.07 $2.52 $2.78 $3.03 $3.54 $3.92 $4.21 $4.23

Growth % 16.9% 13.9% 18.4% 21.1% 18.4% 22.0% 10.2% 9.1% 17.0% 10.6% 7.3%

ROIC % 11.8% 11.3% 10.7% 11.5% 10.6% 10.7% 9.9% 9.5% 10.1% 9.9% 6.5% 6.5%

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special containers for the various types of waste and has scheduled pick-ups (generally once a

month).

Stericycle operates a nationwide fleet of trucks which pick up waste and transports the waste to

company-owned facilities where the waste is treated either by autoclave (hot steam) or

incineration. Once the waste has been processed, it is then transferred to third-party landfills.

Stericycle serves over 1 million customers worldwide and no single customer accounts for more

than 1.5% of total revenue. Customer retention is over 90%. The company primarily serves small

business accounts (SQ) and over time has focused on growing its customer base of these small

businesses because they are significantly more profitable than SRCL’s institutional accounts

(LQ) such as hospital systems. Over the past 20 years, the customer mix has shifted from 33% of

sales coming from small businesses to over 60%.

Source: SRCL Q1 2016 Earnings Presentation.

Note: The above chart depicts the customer base for the entire company, not just medical waste.

The profit margin differential in serving small accounts vs. large accounts is quite large. Small

accounts generate an average gross margin over 50% vs. low 20% range for large accounts. The reason there is such a wide gap is because small medical practices are less equip to manage

regulatory requirements and SRCL can effectively sell additional services such as compliance

training/consulting, document shredding, and outsourced phone services. Larger accounts are

also better at negotiating lower prices for waste management.

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Source: SRCL Q1 2016 Earnings Presentation.

The medical waste management business is benefiting from secular tailwinds in the US from the

expansion of the healthcare system due to an aging demographic and universal health insurance

coverage. There is also pressure in the US healthcare system to reduce costs which has resulted

in more outsourced contracts awarded to companies like SRCL. As a result of these tailwinds,

Stericycle has managed to organically grow at a mid to high single digit rate over the past 25

years.

However the same cost pressures and regulatory trends that have encouraged outsourcing

have also led to a trend of consolidation among hospitals and private practices which

represents a significant profitability headwind to Stericycle. According to KaufmanHall

(http://www.kaufmanhall.com/about/news/hospital-merger-and-acquisition-activity-up-sharply-

in-2015-according-to-kaufman-hall-analysis), hospital M&A is up 70% since 2010. Small

physician practices have also been selling to hospital systems to mitigate regulatory costs.

(http://www.startribune.com/why-local-doctors-are-selling-their-practices-to-national-

companies/383334071/).

As the trend of industry consolidation continues, Stericycle will see its margins compress as it

moves from high margin small accounts to low margin big accounts. Stericycle is already well-

penetrated with small practice healthcare businesses leaving little room for the company to

generate growth to offset the structurally declining margins. The trend of lower margins is

observable: SRCL’s margins peaked in 2009/2010 and have been steadily compressing each

year.

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CEO Charles Alutto acknowledged the headwinds from customer consolidation on the Q1 2016

earnings calls: “We are starting to observe some longer sales cycle at these hospital-affiliated SQ

customers. Remember the decision-maker changes a little bit when the hospital acquires a

doctor's practice, where we normally deal with an office administrator or office manager. We are

now dealing with more personnel from the hospital. So we believe we'll see some pricing

pressure on hospital-affiliated SQ account as these contracts come up for renewal.”

In recent years the company has de-emphasized the domestic healthcare waste management

business by acquiring international assets and expanding to other products. This capital

allocation focus sends a clear signal that the company doesn’t see a bright future in the domestic

healthcare waste management business and is working very hard to diversify away from the

segment.

Stericycle’s foray into expanding internationally hasn’t proven to be very valuable. Despite over

200 acquisitions made internationally since 2001, SRCL has not developed a very profitable

business outside of the US. Currently, ~75% of the company’s international sales are medical

waste related. Prior to 2013, virtually all of the company’s international sales were medical waste

related.

Today, the domestic medical waste business generates ~40% EBITDA margin vs. ~16%

EBITDA margin for the International business. The margin differential is likely structural given

the persistency of the difference over time. The company has stated that it has a greater mix of

large accounts in its international business and offers less services that can be cross-sold.

In summary, the medical waste management business has historically been a strong business for

Stericycle. While I expect continued mid to high single digit growth from the segment, margin

compression driven by customer consolidation will hurt the business over time. The company’s

policy of prioritizing international growth will also lead to margin compression and declining

return on invested capital.

Stericycle’s Hazardous Waste Business Is Low Quality And Has Accounting Issues

Stericycle significantly expanded its hazardous waste management business when it acquired

PSC in April 2014 for $275 million. The company did not disclose the valuation paid. PSC

roughly doubled SRCL’s hazardous waste business and provided significant infrastructure which

could be used for additional growth.

Domestic vs. International Profitability

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Revenue

US $616 $721 $831 $913 $1,084 $1,212 $1,371 $1,498 $1,788 $2,165

International $173 $211 $253 $265 $356 $464 $542 $644 $767 $821

EBIT Margin

US 32.2% 30.5% 31.2% 32.2% 31.5% 32.3% N/A 32.8% 29.5% 22.8%

International 17.6% 17.4% 18.5% 21.0% 18.5% 17.5% N/A 15.3% 12.3% 8.7%

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Stericycle intended to use the company’s enhanced hazardous waste platform post-PSC to

accelerate growth through customer acquisitions. However, SRCL has had significant difficulty

integrating PSC. The biggest issue is accounting related. As a result of poor internal

organization, Stericycle received an adverse opinion from its auditor, Ernst & Young, for

having material weaknesses in its internal controls. The acquisition of PSC was specifically

called out as a key contributor to the material weakness.

Page 40 of Stericycle’s 2015 10K: “The Company’s risk assessment process did not operate

effectively, resulting in a material weakness pertaining to this component of the COSO

Framework. Specifically, the Company did not sufficiently identify risks associated with certain

routine processes and related information systems, including revenue, and certain non-routine

transactions. In addition, the Company did not properly design and implement appropriate

process-level internal controls at the Environmental Solutions component of the Domestic

Regulated and Compliance Services segment. The Environmental Solutions component primarily

consists of the PSC Environmental Services, LLC component acquired on April 22, 2014, which

was excluded from management assessment of internal controls over financial reporting as of

December 31, 2014. The material weakness relating to the risk assessment component of the

internal control framework contributed to the other material weaknesses described below.”

Separately, Stericycle’s auditor noted a weakness in the company’s ability to account for

revenue. This may result in the company restating some of its historical financials.

Page 41 of Stericycle’s 2015 10K: “Management concluded that there is a reasonable possibility

that a material misstatement could occur in the consolidated financial statements if the control

deficiencies were not remediated. Accordingly, management concluded that the matters

described above are material weaknesses in the Company’s internal control over financial

reporting and that the Company did not maintain effective internal control over financial

reporting as of December 31, 2015.”

As of the most recent quarter, the internal accounting issues still have not been fixed.

Page 24 of Stericycle’s 2016 Q1 10Q: “Although we have taken steps toward our planned

remediation of material weaknesses as described above, there were no changes implemented in

our internal control over financial reporting during the quarter ended March 31, 2016 that have

materially affected, or are reasonably likely to materially affect, our internal control over

financial reporting.”

The hazardous waste business is also structurally less profitable because the customer base

primarily consists of large accounts with better pricing power. Unlike its medical waste business,

Stericycle does not own any hazardous waste treatment facilities and must also pay for the waste

to be treated and disposed by third parties.

Finally, the hazardous waste business is cyclical because its customer base is primarily made up

of industrial companies. The energy and manufacturing downturn of the past 2 years has led to

lower volumes of hazardous waste to be picked up; Stericycle is paid by volume. Much of the

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softness in revenue which has led to earnings misses over the past year has been blamed on

lower hazardous waste volumes.

Stericycle’s Document Shredding Businesses Has Also Been Disappointing

In October 2015, Stericycle closed its $2.3 billion acquisition of Shred-it. Stericycle paid 9.3x

EBITDA and financed the transaction with $1.7 billion in debt and $700 million of convertible

preferred shares (convertible to shares representing ~5% of current outstanding). Shred-it is the

leading document destruction company and was set to IPO in Canada when SRCL acquired it.

This is Stericycle’s largest acquisition by a factor of 7x and is a totally new product category

for the company.

Source: Shred-it IPO prospectus.

The business model is similar to SRCL’s medical waste business. Customers deposit sensitive

documents in containers. Shred-it trucks pick up the containers and documents are destroyed at

processing facilities. Shred-it primarily serves small business accounts with multi-year contracts

and high customer retention rates. The business has benefited from increased regulations

regarding handling sensitive documents. Shred-is even has a similar acquisition-led growth

model. Great fit, right?

Where the Shred-it model differs is that 16% of revenue is generated from the re-sale of recycled

paper. Because margins on the pick-up and transport business are low, paper re-sale represents

~35% of the earnings mix. Although paper re-sale is highly profitable, it is also highly cyclical

and depends on the commodity price for recycled paper which fluctuates widely on

macroeconomic factors.

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Source: Shred-it IPO prospectus.

Another issue is that due to regulatory issues and current fleet constraints, the combined

company will still need to use different trucks for transporting medical waste and shredded paper

waste. There are limited cost synergies from the deal. Management is primarily betting on

revenue synergies from the ability to cross-sell additional services to existing/acquired

customers. Revenue synergies are very difficult to underwrite because they are much harder to

lock-in.

There is significant execution risk in the transaction because in addition to this being a new

business line for Stericycle, Shred-it was in the middle of a major merger with Cintas Document

Destruction when it was acquired. In 2014, Shred-it and Cintas merged in a transaction that

doubled the company’s size. When Stericycle acquired Shred-it, it paid a multiple based on

expected synergies from the Cintas merger that had not yet been materialized. Stericycle stated

that the management team carefully studied the expected synergies and expressed confidence in

realization.

Upon announcement of the Shred-it acquisition, management stated that there were $71 million

in synergies from the Shred-it/Cintas merger that were only 1/3 of the way done. Management

estimated that they could capture an addition $20 - $30 million in synergies from the

Stericycle/Shred-it deal. 9 Months later during the Q1 2016, management pushed back the

timeline on the realization of $20 million of the Cintas synergies to 2017/2018 and still has not

provided a timeline for the synergies between Stericycle and Shred-it. Remember, the Cintas

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deal closed in April 2014 and Stericycle assumed those synergies were a sure thing and paid up

for them. The unrealized synergies represented 22% of Shred-it’s Adj. EBITDA. Backing out

these unrealized synergies implies that Stericycle actually paid 12.0x EBITDA for the deal.

The delayed synergies involve re-routing trucks to improve efficiency and closing document

shredding facilities due to low utilization. Once these company-owned facilities are closed,

shred-it plans to use third-party shredding facilities. The incremental synergies from the

Stericycle/Shred-it deal will likely be focused on headcount reduction. These are all fairly

disruptive changes to the business and it is not a good sign that the timeline on these synergies

has been extended for another 2-3 years because they will likely hurt fundamental performance

of the Shred-it business until they are completed.

This acquisition has proven to be quite the mess. Despite M&A being a core competency and

competitive advantage of the company, Management’s recent acquisition track record is quite

poor when also considering the PSC deal. This is a troubling sign that the company’s

acquisition based business model has exhausted itself as the company needs to do larger deals

to maintain its expected growth rate but has proven unsuccessful in execution after large deals

have been made.

Recent Financial Performance

Over the last 2 years organic growth has slowed from 7% - 8% to 5% - 6%. During this same

period, the company made its acquisitions of PSC (Q2 2014) and Shred-it (Q4 2015) to boost

overall growth. Margins have also compressed as these new businesses are less profitable. EPS

growth has slowed and ROIC has also declined.

Stericycle has missed estimates in 3 of its last 5 earnings reports. On recent earnings calls the

company has blamed earnings misses on its hazardous waste segment failing to grow due to the

slowdown in energy and manufacturing. However, in Q1 2016, the company disclosed deeper

issues regarding the acquisition of Shred-it and has lowered earnings guidance. The stock market

Recent Financial Performance

Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016

Revenue $570 $641 $668 $677 $663 $716 $719 $888 $874

Total Growth % 10.9% 21.7% 24.9% 19.2% 16.4% 11.7% 7.6% 31.2% 31.8%

Organic Growth % 6.3% 7.2% 7.9% 8.0% 6.8% 7.7% 6.3% 5.2% 5.6%

Gross Profit $268 $290 $294 $298 $296 $319 $314 $399 $392

Margin % 47.1% 45.3% 44.0% 44.1% 44.6% 44.6% 43.7% 44.9% 44.8%

EBITDA $168 $181 $181 $187 $181 $196 $189 $220 $210

Margin % 29.5% 28.3% 27.0% 27.7% 27.2% 27.4% 26.3% 24.8% 24.1%

EBIT $145 $154 $152 $162 $153 $169 $162 $175 $162

Margin % 25.4% 24.0% 22.7% 24.0% 23.1% 23.6% 22.5% 19.7% 18.5%

Norml. Diluted EPS $0.92 $0.99 $0.98 $1.04 $0.96 $1.09 $1.03 $1.13 $0.99

Growth % 8.6% 12.3% 10.0% 18.3% 4.3% 10.2% 5.5% 9.0% 2.3%

Earnings Hit / Miss Hit Hit Hit Hit Miss Hit Miss Hit Miss

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has responded to the recent disappointments by punishing the stock from a high of ~$150 to the

current price of $104.7.

Source: Finviz.com as of July 8, 2016.

In Q3 2015, the company announced that it would change the way it calculates EPS to exclude

amortization. The company noted that amortization primarily results from non-recurring charges

associated with acquisitions and excluding amortization provides a more meaningful gauge on

earnings. Acquisitions are a core aspect of SRCL’s strategy. The company makes dozens of

acquisitions per year and the related charges associated with these acquisitions are constantly

recurring. This change in guidance is a red flag as it appears the company is aware that EPS

growth is declining and the company is trying to find a way to prop it up.

Valuation

Stericycle is not an easy company to value because the company does not have any good

publicly traded peers and the company does not provide segment financial detail. Significant

estimates and judgments are required, making the company’s valuation more on the art side of

the valuation continuum.

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Today Stericycle trades for 14.6x forward EBIT vs. a peer range of 15x – 20x. SRCL trades for

12.1x forward EBITDA vs. a peer range of 9x – 12x. The peer set isn’t great because SRCL is a

medical waste company which primarily transports and cleans waste before dropping it off at a

landfill. WM, RSG, and WCN are in the business of operating traditional waste management

businesses which include pick-up, transport, and landfill. CVA, CLH, ECOL, CWST, and HCCI

are more on the industrial / hazardous waste management side. Sharps Compliance (SMED) is

actually a medical waste management company similar to SRCL, but is a sub-scale business and

a microcap stock making it a less relevant comparison. Stericycle is generally less capital

intensive than the peer set which explains why the company looks more expensive on an

EBITDA basis vs. using an EBIT multiple.

Historically, the company has traded around 15x forward EIBTDA, making today’s 12x level

appear attractive. However, I would argue that Stericycle today is a lower quality company

because its growth prospects are lower and it has expanded into lower margin businesses.

Stericycle’s Historical Trading Multiples

Ideally a sum-of-the-parts (“SOTP”) approach is best because Stericycle’s businesses have such

diverse business profiles and profitability. However, the SOTP is limited because the actual sales

mix and margins are unknown. I have taken my best shot at making these estimates and applying

relevant valuation multiples. Note: the total sales and EBITDA figures tie out to consensus

analyst estimates for 2016E.

Relative Trading Value Analysis

Enterprise Market Dividend EV / EBIT EV / EBITDA LTM FCF NTM Sales '16 EBIT '16 EBIT LTM

Company Name Ticker Value Cap Yield % LTM NTM LTM NTM Yield % Growth % Growth % Margin % ROC % (1)

Waste Management WM $39,549 $30,037 2.3% 18.6x 16.6x 11.4x 10.8x 4.6% 2.9% 11.7% 17.6% 9.0%

Republic Services RSG $25,605 $18,075 2.2% 17.0x 16.0x 10.0x 9.5x 3.7% 3.0% 6.6% 16.9% 6.1%

Waste Connections WCN $14,943 $12,851 0.8% 34.2x 21.3x 21.0x 12.4x 2.5% 81.8% 60.7% 18.2% 6.5%

Covanta CVA $4,534 $2,157 6.0% 32.2x 30.8x 13.2x 11.0x N/A (0.8%) 4.4% 8.9% 2.9%

Clean Harbors CLH $4,316 $3,039 N/A 20.7x 23.1x 8.9x 9.1x 2.3% (10.6%) (10.7%) 6.6% 4.9%

US Ecology ECOL $1,298 $1,021 1.5% 16.1x 14.9x 10.6x 9.8x 4.1% (3.3%) 8.0% 16.6% 8.5%

Casella Waste Systems CWST $851 $338 N/A 26.5x 22.2x 8.9x 7.4x 6.7% 1.3% 19.5% 6.8% 4.0%

Heritage-Crystal Clean HCCI $328 $280 N/A 44.9x 22.8x 13.5x 9.6x 4.0% 1.5% 96.7% 4.1% 1.7%

Sharps Compliance SMED $77 $90 N/A 54.9x 25.5x 36.6x 18.1x N/A 17.8% 115.0% 7.6% 3.7%

Mean $10,167 $7,543 2.6% 29.4x 21.5x 14.9x 10.8x 4.0% 10.4% 34.6% 11.5% 5.3%

Median $4,316 $2,157 2.2% 26.5x 22.2x 11.4x 9.8x 4.0% 1.5% 11.7% 8.9% 4.9%

Stericycle SRCL $12,009 $8,890 N/A 18.0x 14.6x 14.7x 12.1x 3.2% 16.1% 22.9% 22.1% 8.8%

Source: Capital IQ, Wall Street consensus estimates. Data as of 7/8/2016.

(1) Return on Capital = Tax-effected EBIT / (Total Debt + Total Equity)

Median EV /

NTM EBIT NTM EBITDA

1 Yr 15.3x 12.7x

5 Yr 17.6x 15.2x

10 Yr 17.5x 15.2x

Source: Capital IQ. 10.0x

12.0x

14.0x

16.0x

18.0x

20.0x

22.0x

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16

EV/ NTM EBIT EV/ NTM EBITDA

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The US medical waste multiple equates to a slight discount to Stericycle’s historical valuation

multiple where it was a pure-play medical waste company until 2010. The international waste

and Hazardous Waste businesses were estimated at 9.5x and 8.0x because they are primarily

large account oriented (low-margin) and are considerably sub-scale vs. the peer set. Arguably the

Hazardous business is worth far less due to its accounting issues; the company purchased PSC at

an ~8x multiple. The call center is valued at a premium to outsourced call center peers (CVG,

SYKE, TTEC). Shred-it is valued at roughly what SRCL paid for the business (less cash and tax

benefits). There are no good peers to the recall business so I gave it a 10x multiple because I

consider it be an average business (niche leader, high margins, unpredictable earnings).

The SOTP analysis indicates that Stericycle is valued at a slight premium to its implied value.

This strikes me as a very rich valuation given the accounting issues, execution uncertainties,

capital allocation mistakes, and headwinds in the core medical waste business. I believe

Stericycle should trade at a healthy discount to its implied fair value because earnings will be

under pressure and the valuation multiple could see continued compression as execution issues

come to light.

My first point of contention is the value of the US medical waste business which represents

~65% of the value of the whole company. I believe margins will fall over time as its customer

consolidate and renegotiate contracts. I also believe the valuation multiple should be lower than

it was historically because of lower growth prospects and the margin compression. Sensitizing

the potential impact of these adjustments to my SOTP analysis implied the overall company

could be worth 15% - 30% less.

Stericycle Sum of the Parts Valuation

Est. Sales Sales Mix Est. EBITDA % EBITDA EBITDA Mix EBITDA multiple Value

US Medical Waste $1,350 37.0% 40% $540 56.6% 14.0x $7,560

Intl. Medical Waste $615 16.9% 15% $92 9.7% 9.5x $876

Shred-it $750 20.6% 24% $180 18.9% 9.5x $1,710

Haz. Waste $630 17.3% 13% $82 8.6% 8.0x $655

Call Centers $200 5.5% 14% $28 2.9% 9.0x $252

Recall $100 2.7% 32% $32 3.4% 10.0x $320

Total $3,645 100.0% 26% $954 100.0% 11.9x $11,374

Net Debt $3,118

Implied Enterprise Value $8,255

Shares Outstanding 84.91

Implied Share Price $97.22

Current Share Price $104.70

Implied SOTP Discount (7.1%)

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Taking a bigger picture approach to estimating the value of Stericycle I have sensitized the

current forward EBITDA multiple vs. potential EBITDA declines resulting from the accounting

issues and execution problems. This implied as much as 40% - 50% downside if the earnings

picture gets worse and investors re-rate the stock lower. This may seem like a very arbitrary and

punitive analysis, but I believe there is a high probability of earnings being revised lower.

Remember the company has a material weakness in internal controls and revenue recognition

which could result in a significant restatement. The acquisition of Shred-it is a total mess. The

company has already revised 2016 EPS guidance lower by 5% - 10%.

Sentiment is still buoyant and could lead to downgrades and wider-spread pessimism on the

stock. Wall Street still has a lukewarm buy rating on the stock. Of 17 analysts which cover

Stericycle, 9 have buy ratings, 7 have hold ratings and there is 1 sell rating. Only 5.65% of

SRCL’s traded float is currently short.

Concluding Thoughts

Despite two decades of stellar financial results and stock price gains I believe the party is over

for Stericycle. The company’s formula of making bolt-on acquisitions in the medical waste

business has exhausted itself because several hundred acquisitions later there are far fewer

attractive targets. The company’s has proven itself a poor acquirer when striking larger

transformational deals. These issues coincide with Charles Alutto taking over as CEO and the

company has not signaled that it will make any changes to its current strategy. All of these

Implied Return Sensitivity

US Medical Waste EBITDA Multiple

14.0x 13.0x 12.0x 11.0x 10.0x

40.0% (7.1%) (13.2%) (19.3%) (25.4%) (31.4%)

39.0% (9.3%) (15.2%) (21.1%) (27.0%) (33.0%)

38.0% (11.4%) (17.2%) (22.9%) (28.7%) (34.5%)

37.0% (13.5%) (19.1%) (24.8%) (30.4%) (36.0%)

36.0% (15.6%) (21.1%) (26.6%) (32.0%) (37.5%)

35.0% (17.8%) (23.1%) (28.4%) (33.7%) (39.0%)

Note: Represents implied share return.

US

Med

ical W

aste

EB

ITD

A M

arg

in

Implied Return Sensitivity

Total Company EBITDA Multiple

14.0x 13.0x 12.0x 11.0x 10.0x

0.0% 15.2% 4.4% (6.3%) (17.0%) (27.8%)

(5.0%) 7.7% (2.5%) (12.7%) (22.9%) (33.1%)

(10.0%) 0.2% (9.5%) (19.2%) (28.8%) (38.5%)

(15.0%) (7.4%) (16.5%) (25.6%) (34.7%) (43.9%)

(20.0%) (14.9%) (23.5%) (32.0%) (40.6%) (49.2%)

(25.0%) (22.4%) (30.4%) (38.5%) (46.5%) (54.6%)

Note: Represents implied share return.

EB

ITD

A Im

pact

of

execu

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n issu

es

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problems have compounded on each other and have developed a negative “lollapalooza effect”.

Given that most of the issues are unresolved, I believe the situation at Stericycle will likely get

worse before it gets better.