[M&A Supplement] Acquiring Minds

Pest control isn’t the sexiest industry. The work is technical, the purpose is practical, the demand is driven by infestation — not pretty, let’s face it. Clients who buy the service want you to come over because they’ve got the creepy crawlies. They want nothing to do with those bugs, whatever kind they are. So they call you.

In good times and bad, those clients keep calling because pest control isn’t a luxury — it’s a must-have. And this makes pest control an industry that’s highly attractive — sexy, even — to suitors from the outside who are looking to buy a business, and pest control veterans who want to expand their operations.

Pest control looks hot even when Wall Street looks like a deserted alley. And, in the mergers and acquisitions (M&A) world, pest control is a solid, proven investment.

“Yes, the recession is occurring, but we are basically recession-resistant — we really are,” says Norm Cooper of Cooper Associates in Rye, N.Y. “Pest management companies have maintained strong and even growth.” In fact, Cooper reports more M&A activity in the last few years.

M&A activity did not drop much the past few years, in spite of the economy and banks’ white-knuckled grip on financing. “From 2008 to 2011, we did see somewhat of a dip, but current market activity is probably pretty close to the long-term average now,” says Paul Giannamore, director of M&A at The Potomac Co. in Philadelphia, Pa.

One reason M&A didn’t completely slow down is because acquisitions are part of the growth plan for strong companies. “They need new customers to fuel that growth and one way to get them is through acquisition,” says Rand Hollon, Preferred Business Brokers, Ocala, Fla.

So there was never a sharp drop-off of M&A activity. But lately, there’s a palpable uptick, Hollon and others notice.

Why? Factors like access to capital and taxes that never really affected pest control M&A are possibly driving more sellers to the table these days. Money is cheap. Interest rates have reached historical lows.

Also, it’s an election year and the Bush tax cuts are due to expire at the end of 2012. This is prompting uncertainty — “If I wait, will I make as much money on my sale?” Meanwhile, the pest control industry is having a great year so far according to Kevin Burns, chief development officer for Arrow Exterminators. “I think that this is one of the best years in the industry in many years, at least from the distribution side — I hear nothing but good things,” he says. “When numbers start to [trend] up, anyone that is on the border of whether now is the time to sell may begin thinking about it.”

The pest control industry has thousands of companies moving slowly toward more consolidation, adds Alexander Nigh, Rentokil’s North American acquisitions director. “Qualified buyers are going to continue to seek out acquisition opportunities to increase market share, improve efficiency and add experienced management,” he says.

Moving on M&A. Terminix aims to close deals every month. The company has 3 million customers in 46 states and 14 countries. It acquires about 25 to 50 companies per year. “The number depends on the size of the acquisitions we are doing,” says Fred Murray, director of business development for Terminix, Memphis, Tenn.

Rentokil has geared up acquisition activity since Nigh joined the company seven years ago. Then, Rentokil had $26 million in revenue operating out of 16 offices, mostly on the East Coast. During that time, the company made 40 acquisitions, including important regional anchors such as J.C. Ehrlich, Presto-X and Watch All. Rentokil’s revenues are close to $250 million today, with 105 offices and customers in 35 states, plus Canada and Mexico.

“We are quite selective regarding our acquisition partnerships, and we find that the single most important criteria for Rentokil is cultural fit — whether the company is $500,000 or $50 million,” Nigh says.

Terminix looks to acquire companies of all sizes, though those with a larger, “older” (long-term) customer base are more appealing. It looks for firms with a mix of pest and termite services, and of residential and commercial customers. And it focuses on recurring revenue, or service contracts with customers who commit to several visits per year or warranties on services like termite control. For acquirers, recurring revenues represent a sort of guarantee that the money will keep flowing in after the deal is done.

“Regularly recurring revenue is probably the single most important factor,” Cooper says. Also critical is company culture pricing structure, reputation, track record, steady growth and earnings.

Really, Terminix’s acquisition strategy, aside from the sheer volume, is similar to that of any size company looking to buy another company. Their priorities are similar. And regardless of the economy, or its apparent climb out of the doldrums, these key factors in evaluating a business for purchase are consistent.

Ian Robinson, vice president of business development at Massey Services, says the company’s prequalifiers for a solid acquisition have remained constant. “Our strategy has always been to find the right businesses that have the right cultural setup, that have the right approach to the business that would allow us to have an almost seamless transition/integration with team members, management and customers,” Robinson says.

“I think we all look for similar pieces of the puzzle,” he adds. “We all like recurring revenue and we look for an appropriate price per service point so we know that what we are acquiring has not been sold in the past at a deep-discounted price.”

What’s different in pest control M&A today, Hollon says, is the variance in offers and deals. “We have a lot of different buyers from a lot of different places,” he says. “Some names you know from the industry, and many names you don’t know.”

Great companies are going for more money, and mediocre firms are walking away from sales with less. Hollon says six or so years ago, if there were five offers on the table for a pest control firm, the price differential would be 10 to 15 percent. The offers were relatively competitive.

Today, that variance could be 30 to 35 percent. “That represents a lot of money,” Hollon says. “So we’re seeing sellers analyze purchases more closely. They’re doing better deals for companies that really work, and they’re not really doing as good of deals for companies that don’t work from an M&A perspective.”

Giannamore says the really great companies represent about 5 percent of the bunch. “Acquirers know this and are paying a premium for quality companies,” he says. “Long-term, the trend will be downward, as acquisition multiples for the median pest control company have continued to fall over the last few years.”

Most pest control firms have been getting less. But then, there’s a sense of, “Is now the time to sell?” Given low interest rates, uncertainty as to whether Bush tax cuts will be extended and greater access to capital, is 2012 the time to enter the market? “Business is increasing,” Giannamore says. “Some could be thinking, ‘I may get a better price now than I would have a year or two ago. I’ve been sitting on the sidelines and now’s the time to do it.’”

Giannamore is watching this play out in his business. “There have been folks who have sat on the sidelines since the 2008 financial crisis, and right now I have a handful of engagements in the pest control space,” he says. “One hired us in 2007 and another in 2008. We are currently in the due diligence process for both deals—individuals who sat on the sidelines and are now looking to do something.”

Though Giannamore warns that there’s no such thing as being an opportunist in today’s M&A market. “Companies need to determine what makes sense for them, and if it does make sense to buy or sell, go out and make it happen.”

Another big difference in pest control M&A today compared to a few years ago is the number of buyers from outside the industry. Preferred Business Brokers crunched some numbers between Jan. 1, 2007, and Dec. 31, 2011, to find out more about the type of M&A activity that was occurring at the firm. Sixteen percent of transactions involved buyers that were new to the pest control industry. “That kind of blew me away,” Hollon says. “That’s pretty big. If you are selling your business, you’ve got a better than 1-in-10 chance that the guy who will buy it doesn’t know which end of the machine the product comes out of.”

Also, the size of some companies that are doing the acquiring has shrunk in recent years. Smaller guys are buying even smaller guys. Cooper saw a lot of transactions occurring among companies in the $5-million-or-less revenue block. “A surprisingly large number of M&A came from that area,” he says.

One way for smaller companies to break through revenue barriers — $100,000, $300,000, $1 million, etc. — is to buy growth by acquiring another firm and gaining economies of scale plus more customers (and recurring revenues). “A lot of people understand more than they did 20 years ago that M&A is a quick way to do that, if you do it intelligently,” Cooper says.

Uncertainty Drives Action. The issue is not finding buyers for a business, Hollon says. “It’s finding people who want to sell a business,” he relates. “Buyers have always been there.”

But there were fewer sellers after 2008 because business owners who were planning to exit for reasons other than succession (retirement, sickness, death) held on to their cards. “Over the last several years, and in any economic downturn, that seller is reticent about selling the business because that business is a paycheck he knows will be there,” Hollon says. “When times are good, people are willing to spend and be risky. When times are tough, people would much rather deal with the devil they know vs. the devil they don’t know, and their business is the devil they know.”

So pest control operators who thought about leaving their businesses because they simply wanted out probably decided to wait on selling. Hollon says after 25 years of working on M&A only in the pest control industry, the No. 1 reason those business owners sell is because they want to do something else. Prior to the recession, that something else might have been real estate, opening a restaurant, you name it. But after the financial crisis, those options didn’t look so promising, so they stayed in pest control.

However, Cooper and Giannamore say that market conditions are not necessarily a key driver in pest control operators’ decision to sell. The main reason pest professionals sell their businesses is because of life events. “The extreme majority of pest control operators do not ‘time the market’ to get the best possible acquisition multiple for the sales of their businesses,” Giannamore says. “Pest control operators sell their businesses for personal reasons, such as death, divorce, burnout, illness, retirement, etc.”

So those pest control firms considering retirement, feeling a little burnout and thinking about selling, might act now because of an overriding uncertainty. What will happen this election year? “The November election is certainly going to stir a lot of M&A talk,” Cooper affirms. “I think it has to be moving people forward.”

Nigh and others say the multiple reasons for the increase in M&A activity also includes uncertainty regarding whether the Bush tax cuts will be extended. “It will take action by both houses of the Congress, and the approval of the President, to extend the current reduced income tax and capital gains rates into 2013 and beyond,” Nigh says.

Nigh expects there could be pressure to extend some of the tax cuts to stimulate the economy. “However, high wage earners and those wanting to take some money off the table via the sale of their pest control businesses are rightly cautious as they still face some degree of uncertainty if they are thinking about selling in the next few years,” he says. “That very uncertainty makes potential pest control business sellers nervous and might drive some to exit now to guarantee the absolutely very lowest tax rates, leaving more money in their pockets.”

Murray says the potential reduction (up to 80 percent) of the $5 million gift tax exemption, scheduled to expire at the end of 2012, could spark serious consideration for selling. “That will definitely cause business owners to reevaluate their succession plans, including selling.”

Despite slight ebbs and flows in the M&A market, and the outliers that could be promoting more interest in deals today, the pest control industry has remained relatively stable over the years, says Bob Hines, director of acquisitions at Orkin.

“I haven’t seen a massive increase,” he says, adding that relationship building is the key to nurturing future acquisitions at Orkin. So when the time is right—and that could very well be now, before capital gains taxes potentially shoot up—companies that are thinking of selling to the Rollins family are comfortable with sealing the deal. “We’re always talking to companies and getting to know them,” Hines says. “That’s such an important part of the process. So when they’re ready, they’ll either call us. Or they won’t.”

What Buyers Want. So if now is the time to sell, what’s the best way to position your company to earn the best price possible? What do buyers really want?

Recurring revenues is No. 1 — and proof that these accounts are stable. Hollon says when his firm audits a seller, a sampling of the customer base is analyzed. He wants to see these three legs of the stool: a contract, proof of service and payment. That’s what’s called “putting legs on the revenue,” he says.

The more information a seller can provide the buyer, the fewer assumptions that buyer must make. “And the fewer assumptions he has to make, the more money he’ll bring to the table,” Hollon says. This means keeping tight financial records, from service agreements to statements prepared on a monthly basis.

Beyond the numbers, buyers today are looking for more than customers — they want resources. “They are buying long-tenured employees, high-quality management, infrastructure that has been designed appropriately with proper incentives in place,” Giannamore says. “They’re no longer looking at it as just buying a couple of million dollars in accounts. The longer the company has been around, the deeper the relationships with customers and the higher the retention the account will be post-closing.”

Culture is king for Rentokil. “The most important elements that make a company attractive to us literally take the lifetime of the company to build — a culture built on quality, a great reputation and strong relationships with coworkers and customers,” Nigh says. “We are always looking for good people to join our team, and acquisitions of good companies are a great way to find those people.”

On the buy side, Giannamore says that timing is not everything. “Buyers should not be concerned about whether now is the time to buy,” he says. “They should be concerned about whether an acquisition fits their strategic plan.”

Hollon says he notices that buyers are more nimble and decisive. Deals are closing faster, and that’s not due to harried research. Buyers are simply more sophisticated. “Because of their confidence and their ability to effectively transition the business, it has made [buyers] a lot more decisive when it comes to acting when they see a business that is a good fit,” he says. “On the surface, it may make things look like they’re fast and loose. They’re fast, but they’re not loose.”

The typical privately held acquirer should expect the seller to finance the deal, Giannamore says. “If you’ve got to go to the bank to get a deal done, you need to go back and triple-check your numbers before you sign on the dotted line,” he says. “Most privately held acquirers dramatically over-pay for acquisition targets. Buying the best pest control company in the world is still a horrible investment if you overpay for it.”

The author is a frequent contributor to PCT magazine. E-mail her at khampshire@giemedia.com.