[SPECIAL REPORT: M&A UPDATE] Shopping Spree

2010 closed in a frenzy of merger and acquisition activity.

There was a “massive push like I’ve never seen before,” said The Potomac Company M&A Director Paul Giannamore. He had more transactions of $5 million-plus companies wrap up in 2010 than in the last six or seven years.

National players reported as much. Terminix, always busier in the fall, saw an increase in the fourth quarter, said Fred Murray, director of business development.

Orkin also had a “very active year,” reported Rollins Inc. Corporate Administration Vice President Gene Iarocci.

Arrow Exterminators had a “significant upswing” in M&A activity, said Chief Development Officer Kevin Burns. In December, the company acquired Ponte Vedra, Fla.-based Nader’s Pest Raiders — ranked 79th on PCT’s Top 100 list with $6.2 million in revenue.

A Buyer’s Market.
For the first time in 15 years, it was a “fantastic buyers’ market,” explained Joey Edwards, president of J. Edwards Services in Atlanta.

Owners were motivated: Many feared Congress wouldn’t renew Bush-era tax cuts expiring at the end of 2010. This would have pushed capital gains and personal income tax rates significantly higher in 2011.

The slow pace of economic recovery also played a role. In 2008 and 2009, pest management professionals sat on the sidelines and waited for the economy to improve. But “there comes a point where it just doesn’t make sense to wait any more,” said Giannamore.

Some professionals changed their price expectations and sold while their business had value, said Lance Tullius, a partner at Tullius Partners in Portland, Ore.

Five years ago, buyers paid $1.50 to $2 on annual revenue, said Edwards. Now, they’re paying at annual revenue or a little less depending on the recurring revenue ratio.

Big industry players had cash-rich balance sheets to make deals happen. They focused on “expansion and growth as opposed to preservation,” said Tullius. “Cash is like inventory. They have to deploy it.”

This allowed national companies, in particular, to expand their footprints and customer bases, and acquire “some really experienced talent,” Edwards said.
 

Shopping Should Continue.
Tullius expects M&A activity will “accelerate and heighten.” The extension of the Bush tax cuts could, in fact, “perpetuate accelerated activity.”

Rentokil North American Pest Control Acquisitions Director Alexander Nigh said activity may dip early this year because most owners considering a sale probably did so by year end, but he expects activity to bounce back. “This is an industry with thousands of companies moving slowly toward more consolidation, and we expect that trend to continue.”

Economic conditions will be a big factor. A good economy will motivate sellers who held back during the recession to move while the company’s value is better, explained Arrow’s Burns. He’s “cautiously optimistic” about the economy, though unemployment and the housing market remain wild cards.

Murray doesn’t see the economy improving any time soon, and said this will continue to create more activity.

Edwards said each year that goes by without the economy bouncing back makes it more enticing for owners to sell and perhaps finish out their careers at a large company. “I think that trend is going to continue,” he said.

The industry continues to get older, reminded Giannamore. “You’re going to start to see a lot of old-timers who’ve been hanging in there say, ‘enough’s enough.’”

According to PCT’s 2010 State of the Industry Report, 5 percent of owners said they plan to sell their pest control companies in the next one to three years, and 25 percent are undecided. On the flip side, 15 percent plan to purchase another pest control company, with 23 percent undecided.

Strategy for Growth.
Acquisitions help big players grow revenue. “If you listen to their earnings calls, there’s a real big push to buy sales,” said Giannamore.

Acquisitions played a major role in Rentokil’s growth in North America, said Nigh. When he joined the company five years ago, it had $26 million in revenue originating from 16 offices on the East Coast. Since then, Rentokil has made nearly 30 acquisitions, including regional anchors J.C. Ehrlich, Presto-X and Watch All, and has grown to $228 million in revenue with nearly 80 offices in 35 states and Canada.

In 2011, the company will “remain active in seeking out quality acquisition opportunities” that help it “strategically and thoughtfully expand our geographic footprint and service offerings” coast to coast, said Nigh.

Strong management teams at branch and regional levels will help it accomplish this. “We are always looking for good people to join our team, and acquisitions of good companies are a great way to find those people,” said Nigh.

Terminix generally targets “large, strategic regional companies” that average $2 million in revenue, but will consider larger and smaller operations, said Murray. About 95 percent of acquired accounts are tucked into the company’s branches. “The customer list is primarily what is being purchased.”

Terminix acquires 25 to 50 companies a year. Last August, it bought Antimite/SOS Exterminating, which will continue to operate as its own brand. “There’s a value there,” said Murray of the company’s long history, solid customer base and brand image in California and Arizona.

Rollins tucks in small acquisitions, transitions others over a period of three to five years, and operates larger acquisitions — Home-Team Pest Defense, PCO Services, Western Pest Services, The Industrial Fumigant Company, Crane Pest Control and its largest acquisition of 2010, Waltham Services — as separate brands. The company acquired 23 companies last year.

Plan Now for Later.
Tullius, who advised former Waltham Services owner Clark Keenan, said selling a business is an art, not a science. It’s the biggest piece of one’s financial life and it’s never too early to plan an exit strategy.

“Always be prepared to sell but run the business as if you’re never going to sell,” he said. Being prepared doesn’t detract from day-to-day operations, but enhances it. And, you’ll be in a position of strength should you receive an inquiry.

Many owners of small and mid-size companies “don’t have a clue” when it comes to exit strategies, cautioned Edwards. Likewise, those buying firms give little thought to the due diligence process and contract negotiation. “You can really get burned if you’re not careful,” he said.

He advised buyers to verify recurring revenue sources, ensure signed service agreements are in place, and carefully evaluate liabilities.

When negotiating the purchase agreement, protect your investment with a performance or charge-back provision, which allows you to offset the purchase price should revenue drop after the transaction, Edwards said. Sellers must carefully consider these provisions before signing, as they could impact their payout.

Keenan hired Tullius two years before he sold Waltham Services to fine-tune and execute his exit strategy. He’s the “poster child for how to do it right,” said Tullius.

-Anne Nagro

Private Equity is Good for the Industry
Private equity firms continue to set their sights on the industry and that’s a good thing, experts say.

“I think we could have some newer players in the industry in the next few years,” said Joey Edwards, president of J. Edwards Services. He’s working with private investment groups to possibly build a larger entity from three or five smaller pest management firms.

Paul Giannamore, M&A director at The Potomac Company, worked on a deal last year that received three bids from private equity firms.

They like the long-term contractual, stable revenue of the industry, he explained. “Compared to some other industries, it’s relatively resilient in poor economic times. And it’s very fragmented, so it’s a way for them to create value by consolidating,” he said.
Private equity’s biggest challenge is coming into the industry from scratch, said Lance Tullius of Tullius Partners.

They often can’t always pay owners top price like big industry players, which can justify paying more because they have the infrastructure to cut costs or accelerate growth, Tullius explained.

Private equity generally needs an owner who will sell a majority share but stay on for five or more years to grow the business with help from outside capital and expertise, said Tullius. Owners have the potential to maximize their value even further. It’s a “great opportunity for the right person.”

But not many are willing to engage in this type of deal, mainly due to the added risk and because entrepreneurs like the autonomy of working for themselves, said Tullius. Plus, private equity traditionally has targeted companies with $10 million-plus in revenue, and there aren’t many companies that size in the industry.

Wind Point Partners invested in Wilson Pest Control in 1998, and Prometheus Partners acquired Baco Exterminating in 2008. Last year, former Terminix President Albert Cantu joined Waud Capital Partners, which has aggressively targeted the pest management industry but has yet to announce a deal.

Private equity’s interest validates the industry’s health and long-term prospects, said Tullius. “Not every industry offers that type of exit alternative.”

-Anne Nagro

Thinking of Selling?
Here’s what buyers want and how you can make your business attractive.

WHEN IT COMES TO ACQUIRING PEST MANAGEMENT FIRMS, NATIONAL PLAYERS HAVE SPECIFIC REQUIREMENTS:

Recurring Revenue.
Arrow Exterminators likes companies with 75 to 80 percent recurring revenue, said Chief Development Officer Kevin Burns. “It’s a very important number to us” and is an indicator of the health of the business.

Terminix seeks a mix of termite renewals and contracted pest control with assigned service frequency, said Business Development Director Fred Murray.

“Your company’s not going to have the value if you don’t have signed service agreements,” cautioned Joey Edwards, president of J. Edwards Services.

Buyers like diversified services such as insulation, wildlife control and gutter protection, which help eliminate “revenue peaks and valleys,” he added.

Sustainable profit also is important, reminded Rentokil North American Pest Control Acquisitions Director Alexander Nigh. It’s “largely the basis of the valuations we make and thus the consideration we can pay any potential seller.”

Long Employee Tenure.
Rollins Inc. wants companies with an “outstanding reputation,” continuity of management and long employee tenure, said Corporate Administration vice president Gene Iarocci. A service business is built on employees, he said. “We want to keep those employees. If they have good tenure, that’s a plus to us.”

Some of Terminix’s top executives have come through acquisitions, said Murray.

Arrow wants employees “we can add to our staff and make us better,” said Burns. “We’re not buying revenue just to build our numbers.”

Rollins builds relationships with companies “we know have an outstanding reputation in the marketplace, and that we admire their leadership,” said Iarocci.

Similar Cultures.
Cultural fit is the “single most important criteria” for Rentokil, whether the company has revenue of $500,000 or $50 million, said Nigh. “We must share the same fundamental values,” such as the commitment to quality service and strong personal relationships with coworkers and customers.

Iarocci agreed. Similar cultures also help the transition occur without disrupting the operation.

A culture built on quality, reputation and relationships takes “the lifetime of the company to build,” Nigh reminded.
Other criteria include mature customer lists, good standing with state and local agencies, and similar pricing.

Get Prepared.
Terminix does not take a “cookie cutter” approach to mergers and acquisitions, said Terminix Finance Vice President Ted Schultz. “We look at each deal, and each deal is slightly different.

Some buyers will help owners resolve issues, though this can delay the transaction process. Arrow offers owners a third-party perspective after signing a non-disclosure agreement. “We’re happy to do it,” said Burns.

Murray encouraged owners to organize computer and hard copy files so they can detail their revenue stream going back three years. Be able to present a clean, active customer list, and identify customers by service frequency and types of treatment. Buyers also want to examine retention rates and pricing structures.

Owners also need a realistic expectation of their company’s value, said Iarocci. Although they’ve spent a lifetime building the company, they must “separate emotions from reality” when it comes to pricing.

Rollins lets owners continue to work after the transition period or nominate managers to lead the company. “We feel as though we’re easy to deal with when it comes to these transactions, because we’re not just interested in the customer list,” said Iarocci.

Arrow emphasizes the “merger” in M&A activity, said Burns, who insists on having discussions with owners in person. “We make that sure the people are taken care of first.”

- Anne Nagro

The author is a frequent contributor to PCT magazine. She can be reached at anagro@giemedia.com.