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Can Swisher Hygiene continue to clean up?

The core business at Swisher Hygiene Inc. invites bad jokes. Fortunately, Behind the Numbers never - well, practically never - indulges in potty humour. What intrigues us about this growth stock is its spectacular rise, based on the company's prowess at cleaning washrooms.

Is it really possible for a firm to add something new to the utilitarian business of swabbing toilets and peddling green soap? Investors appear to think so. Since the start of the year, Swisher's stock price has soared 76 per cent, making it one of the best performing names on the Toronto Stock Exchange.

Swisher isn't an obvious star. It sells cleaning chemicals, rents floor mats, collects waste, and cleans kitchens and washrooms. The company delivers those unromantic services to more than 30,000 customers, primarily in the United States.

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Swisher's only conspicuous claim to fame is in the executive suite. Wayne Huizenga, the brains behind Blockbuster Video, Waste Management Inc. and AutoNation, is the company's largest shareholder. In 2004, he and an associate, Steven Berrard, acquired a majority interest in Swisher International, a chain of "restroom hygiene" franchises. A couple of years later, they bought the remaining shares and took the company private. Then in November of last year, they merged Swisher with CoolBrands International, a TSX-listed company that used to peddle frozen treats, and returned to the public markets. Swisher now trades on both the TSX and Nasdaq.

The company revels in the unappealing nature of its business. Cleaning washrooms isn't glamorous, but it can deliver a recurring stream of earnings through good times and bad. In an interview, Mr. Berrard, now the CEO of Swisher, stresses that the company provides essential hygiene and sanitation services - "and the key word there is essential," he says.

He acknowledges that Swisher faces competition, notably from Ecolab, the 900-pound gorilla of the cleaning and sanitizing industry. But Mr. Berrard argues that Swisher is unique in the breadth of its offerings. Unlike Ecolab, it rents towels and floor mats. And it also offers waste collection in some markets.

To extend its reach, Swisher is snapping up smaller companies in the cleaning and sanitation sector, buying out the owners with a combination of cash and Swisher stock. Since January, it's acquired more than a dozen firms, arranged a $100-million (U.S.) credit facility and completed two private placements of equity for total proceeds of $136-million. All of this is part of its strategy to quickly build market share and construct a dense network of service providers through which it can cross-sell its services.

The question is whether Swisher can make money at this. Its recent history is not encouraging. In the three years from 2008 and 2010, it lost more than $36-million on revenue of nearly $185-million. Mr. Berrard attributes the losses to the cost of buying back many Swisher franchises and improving the company's distribution network and product line-up. Investors, though, may wonder what happened to those steady profits that washroom-cleaning is supposed to generate.

So why are people piling into Swisher stock? Perhaps because they see it as a classic roll-up play, in which a corporate acquirer buys up a string of small private players in an industry that lacks a dominant player. The math of such acquisitions is enticing, especially if, like Swisher, the acquirer can use its own stock as the primary currency in doing the deals. Assuming the market values the acquirer's stock at, say, 10 times earnings and the acquirer is buying private firms for, say, five times earnings, every purchase drives the share price higher, creating even more high-powered fuel for additional acquisitions.

The problem is that roll-ups only look good until they don't. Target companies eventually grow scarce and the price of acquisitions goes up. Or earnings hit a bump, the acquirer's stock no longer commands a premium, and the growth machine suddenly stops.

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With its recent equity offerings and credit facility, Swisher has lots of cash to finance its acquisition binge for the year ahead. But some investors appear to be taking their profits now rather than waiting around to see how things turn out. After doubling to $10.95 a share since the start of the year, Swisher stock plunged this week and closed Thursday at $8.45.

It's still trading for more than 100 times forecast earnings and has yet to prove its model can thrive in an industry without many barriers to entry. To a value investor, all those signs indicate this is one clean-up operation you may want to leave to someone else.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More

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