Will Change Do Them Good?

Since November, the “$10,000 question” throughout the pest control industry has been “What is going to happen with ServiceMaster?”

November was when ServiceMaster Chairman and CEO J. Patrick Spainhour announced that the company was exploring “strategic alternatives” — including the possible sale of the company.

Rumors swirled about just who was courting ServiceMaster, parent company of Terminix, TruGreen ChemLawn, TruGreen LandCare and other home maintenance services. Was it another big business already involved in service industries, a large corporation not involved in service industries, or perhaps a private investment equity firm looking to take the publicly traded company private?

On March 19, those rumors were put to rest with the announcement that ServiceMaster had entered into a definitive merger agreement to be acquired by an investment group led by Clayton, Dubilier & Rice (CD&R) for a total value of approximately $5.5 billion, which includes the assumption of about $800 million in debt.

THE NEEDED FIX? News of the ServiceMaster sale did not come as a surprise to those following the company, which had been facing challenges in recent years, including a falling stock price and higher operating costs.

“I know that they’ve had some issues for some time now. They’ve had some turnover with their very top management, including their chairman (Jonathan Ward, who resigned in March 2006),” said Harvey Massey, CEO of Massey Services, Maitland, Fla., and a former Terminix executive. “Their stock wasn’t performing well and what I think was happening was their stockholders were getting a bit uneasy and asking difficult questions. That’s when I think they started marketing the business to be sold.”

Bob Wanzer, president and COO of HomeTeam Pest Defense, Dallas, Texas, said ServiceMaster was under tremendous stockholder pressure to “get the stock to move.” Wanzer said he thinks that stockholder pressure picked up after Ward was ousted and provided with a sizable severance package. “After that, from what I’ve heard, two of the bigger investors had been pushing for radical change of the status quo.”

Also in November, Spainhour announced that ServiceMaster had appointed Morgan Stanley and Goldman Sachs Group to advise it on strategic alternatives. However, many in the pest control industry believe that talks with CD&R were well underway when this announcement was made.

“My guess is that announcement was more of a warning notice to investors that a deal was close,” said Pam Jordan, president of Acquisition Strategies, Tampa, Fla. “With a public entity you’ve got to do all the security law requirements. It is a complicated and time-consuming process. I can’t imagine that they just started exploring things in November and it already is a done deal.”

GOING PRIVATE. So what does the sale mean for ServiceMaster? Only time will tell, but ServiceMaster Group President Katrina Helmkamp told PCT that the company will be able to focus more on long-term investments by going private, as opposed to being a publicly traded company, where investments need to be reasonable within any quarter.

ServiceMaster’s TruGreen divisions, for example, always were hampered by the seasonality of their businesses, Helmkamp said. “TruGreen is a great example where revenue drops off in the fourth and first quarters, and as a result we have not historically made large investments in those time periods because it would hurt the quarter’s result,” she said. “Going private allows you to make those kinds of investments if they are the right thing for the long term; for example, doing additional direct mail campaigns in the fourth quarter that would help the business grow. When you are publicly traded you might hold back on doing those types of things.”

Massey, who also has a history with publicly traded companies Orkin and Terminix, acknowledged that it can be challenging having to answer to stockholders when business takes a downturn. “When you are privately owned, you can do certain things and have certain things occur that you can retain the privacy of — that’s not so with public companies,” Massey said.“Speaking from personal experience, once you understand that clearly and if you are working towards doing the right thing for your people, your industry, your customer and your community, there is nothing to hide.”

WHO IS CD&R? The key, of course, to the success of the “new ServiceMaster” will be how it is managed, supported and funded by Clayton, Dubilier & Rice. A look at CD&R’s history might provide some answers. CD&R specializes in turnaround situations. Targeting underachieving units of large corporations, CD&R typically structures a leveraged buyout (LBO) and works to improve operations.

CD&R has a breadth of experience with branded businesses operating in multi-location formats such as Hertz, Culligan and Kinko’s that CD&R Partner Thomas C. Franco believes is “directly relevant to ServiceMaster.”

“We believe that ServiceMaster, similar to the previous multi-location businesses that we have acquired, has outstanding investment characteristics,” Franco said. “In particular, operating in highly fragmented markets provides attractive upside opportunities and significant downside protection.

ServiceMaster has a No. 1 market position in all of its primary businesses and that’s a real plus. In addition, its large number of locations and customer base of approximately 9 million create a very diversified operational base from which to build.”

ServiceMaster’s Helmkamp said that her team is looking forward to working with the CD&R group. “CD&R said it is interested in making the strategic investments behind each one of the business units. I would expect they will help us take a look at those, prioritize even further and decide where we can move even faster,” she said. “I think we are all looking forward to those longer-term investments. Those are the ones we think are going to be easier to make in a private environment.”

At the same time, CD&R’s history also suggests its short-term goal might be to turn around ServiceMaster, with a long-term goal of selling it to another buyer. For example, CD&R purchased Kinko’s in 1996 and then sold its interest in Kinko’s to FedEx for $2.4 billion in a 2004 cash transaction.

“I think ServiceMaster’s success really depends on how patient their ‘new masters’ are,” said Wanzer. “If they are in it for the long-term they will support them and give them the finances they need to succeed. But they have to service an awful lot of debt, and as they continue to grow through acquisitions, cash is going to become an issue.”

The $800 million debt assumed by CD&R has many speculating that CD&R may look to sell off some of the ServiceMaster divisions to recoup some of that cash. During an audiocast that followed the March announcement, CD&R Partner Richard Schnall said the company has no immediate plans to sell any of ServiceMaster’s companies. “We think there are some opportunities for synergies among the businesses,” said Schnall. “Obviously, particularly in the smaller businesses, there are some strategic opportunities which we will explore over time, but our current intent is to keep the businesses together.”

While questions still remain about ServiceMaster’s long-term plans, the consensus among those in the industry seems to be that CD&R’s track record in turning around companies, combined with inherent benefits of “going private,” could be the cure for an ailing company.

Editor’s note: At press time, the transaction had not been approved by the ServiceMaster Board of Directors. The next step will be for ServiceMaster to issue a proxy statement, followed by a special shareholders meeting (which is targeted for late in second quarter or early third quarter) at which shareholders will vote on the sale. A majority of shareholders must approve the sale.

The author is managing editor of PCT.