Paul Giannamore: What we're saying here is if your reputation sucks and you got a crap culture, profitability doesn't matter because we're not doing the deal anyway.
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Patrick Baldwin: Paul, we've said time and time again that we have a face for a podcast or at least a face for radio. Are you jet lagged over there? You look like crap.
Paul Giannamore: Mr. PB, I'm on a thirteen-hour jetlag, yes, and I feel like it.
Patrick Baldwin: Do you know what day or time it is?
Paul Giannamore: I have a watch so, yes, I do know those things. I am back here in Puerto Rico after two and a half weeks on the old international road, Europe, and then off to Asia, and now back.
Patrick Baldwin: I find it ironic that you travel all the way across the globe and back, you come back to work, and you find yourself in the middle of a vacation if you will.
Paul Giannamore: I do?
Patrick Baldwin: Yeah.
Paul Giannamore: How so?
Patrick Baldwin: Because the Mexican is in Europe.
Paul Giannamore: This is very true. It is somewhat of a holiday over here, I forgot about that. Good, PB. I know we missed a week or two. I apologize to everyone. I attempted to bring a microphone on my trip but I didn't bring all the right pieces. Between timezone differences, it gets complicated. Here we are and we're back. We have some cool episodes coming down the pike here. I'm excited about what we've got.
Patrick Baldwin: It's coming. I do want to give a quick shout-out. You and Dylan have been killing it over on POTOMAC TV before we get into this episode. You didn't ask me to say this but I’m super grateful. I find I’m still constantly learning. As much as we've done The Buzz, had these interviews, talk to sellers, talk to big companies, talk to private equity, and all these people, I still get on there.
Sebastian, I was learning things, and Steve Mote. Tony came back on. We've talked about Tony. If you have not listened to or watched those, head on over to POTOMAC TV, that's my shameless plug. I'm not in them. No one has to see me pretend to smoke a cigar or anything like that. They look great. They are wonderful to listen to.
Paul Giannamore: You're learning stuff from some of those, PB. Riddle us with some of the things that you pulled out of some of these episodes.
Patrick Baldwin: Sebastian Tomassoni, you've got the head of M&A for Anticimex. If you hop in there, you'll hear some interesting key performance indicators and what right now is relevant. He's had previous M&A experience. He comes from the elevator industry if I'm not mistaken. He's done this before. In the pest control realm, what are things that Anticimex is looking for? I'm not going to give it away. Go over there and watch Sebastian.
Steve Mote has been there twice, once with his wife, Michelle, a great story there. He's a seasoned business entrepreneur in the paper industry, pool industry, janitorial, promotional construction, and pest control. He’s done a lot and just what's important from his perspective in business. He and Shawn Hollis were interesting. Do you know what I think about Shawn Hollis? There's a point where Shawn Hollis listed out some percentages up to the 100th place of decimals. It was .91. I was like, “Who is this guy?” It’s fanatical.
Paul Giannamore: Shawn is a great guy. For those of you who don't know Shawn, Shawn Hollis is the President of Waynes, an Anticimex platform based in Alabama. Patrick, do you remember the size he talked about?
Patrick Baldwin: 70 headed to 90 I think.
Paul Giannamore: It was something like that. 90 is the bogey for 2023. He’s a great guy. He came down to Puerto Rico, he brought his wife and his daughter. Unfortunately, the wife and daughter got direct exposure to the Mexican, which I thought was a dangerous proposition but they found him entertaining, at least they appeared to have found him entertaining. It was great to see Shawn and the family. We did a discussion with Shawn Hollis and Steve Mote on the same day that I interviewed Sebastian.
Later on that evening, we went back, had some drinks at my place, and then we recorded Sebastian, Shan Hollis, and myself. Sebastian runs the centralized M&A process. Of course, Shawn is a platform president. I wanted to get into some of the push and pull that goes on internally within an organization. If somebody like Shawn wants to do a deal and Sebastian stands back and says, “It's too expensive. We can't do it. What makes a good strategy?” That was an interesting discussion and it’ll probably come out sometime in December.
Patrick Baldwin: Matt and Ron, that's a funny duo there.
Paul Giannamore: Yes. Matt and Ron both sold their businesses, they were both Potomac clients. They sold their businesses to Thompson Street Capital Partners’ PestCo business. They were following acquisitions to the acquisition of Pointe, Jared Borg and Kyle's business in the Midwest. I'm trying to think here. Matt's business, that transaction closed in September 1st, 2022. Ron's deal may have closed in July or August. What's interesting is when Jared was down here, Ron was down here in Puerto Rico doing due diligence. The Thompson Street guys were down here. When we had Jay Keating and Jared on, Ron was down here doing DD beachside.
Patrick Baldwin: Was it back in May?
Paul Giannamore: That was back in May. Here at Potomac, we try to make DD as fun as possible when we try to do it beachside. I'm reminded, Patrick, of some of the things that were raised in Sebastian's episode. We've talked about this on The Buzz quite a bit over the years. We even have an episode entitled It Doesn't Matter What Acquirers Think so to speak.
At the end of the day, when you're building a business, what you're selling is a stream of cashflow. The faster you can grow that stream of cashflow and the lower the risk of that stream of cashflow, the more valuable the business is. There's a lot of common sense to it but everyone always asked those same questions. I pulled up Anticimex’s roadshow presentation. Do you remember when they were going public or attempting to go public in 2021?
Patrick Baldwin: Yeah.
Paul Giannamore: There were some European asset managers that were looking at purchasing equity in Anticimex. I did some consulting for some of those firms. I went over to the roadshow and I remember Jarl talking about key considerations in the M&A deal. Here on the roadshow presentation, I'm going to go through the top fourteen key considerations for Anticimex when it comes to M&A. This comes directly from the former CEO. Jarl is still actively involved in the business but he is on the board now. Key considerations, these are in order. Number one, continuous and stable growth rate. Patrick, let's have a little bit of fun here. Can you guess number two?
Patrick Baldwin: No. We don’t need to have fun. I'm not going to guess 2 out of 14.
Paul Giannamore: You can't guess 2 out of 14? How?
Patrick Baldwin: Do you know what we'll do? I've got Sebastian's list. I'm going to see how Sebastian did.
Paul Giannamore: I'll tell you what, you name one thing off and I'll tell you what number it is. Continuous and stable growth is number one.
Patrick Baldwin: I don't know if Sebastian's were in order but growth was on here as number six.
Paul Giannamore: That may have been the order in which we discussed it.
Patrick Baldwin: That's correct.
Paul Giannamore: You're going to list yours and I'm going to tell you what numbers they are.
Patrick Baldwin: Okay. Recurring portfolio.
Paul Giannamore: That's definitely on there and that clocks in at number three. It's the percentage of total revenue that is recurring. The higher that number is, the better.
Patrick Baldwin: Relative pricing.
Paul Giannamore: Do you not see that on the list?
Patrick Baldwin: Jarl, you're fired.
Paul Giannamore: Of course, relative pricing, profitability is a derivative of that. Profitability clocks in at number seven on the list.
Patrick Baldwin: Who's in trouble? Sebastian or Jarl?
Paul Giannamore: Profitability and cost management is what it specifically says.
Patrick Baldwin: It sounds like everything but pricing, what you just said.
Paul Giannamore: Correct. What else have you got?
Patrick Baldwin: Jarl, you can keep your job. People, this was the hard-to-measure one. People and culture came out. To me, I thought of employee retention, that's what I connected.
Paul Giannamore: There are a lot of things on people on here. Number six on the list would be cultural fit. Number nine on the list is the quality of the management team. The number ten on the list is dependence on any single individual. Those are all the people-related risks.
Patrick Baldwin: In the Shawn and Steve interview, Steve was saying, “There are about four people. You're going to make sure you want to keep those.” Revenue composition. Sebastian’s saying, “We're heavy on general pest control and we do like our termite, Sentricon.”
Paul Giannamore: That's number four. General pest control as a share of total revenue is numero quatro on the old list.
Patrick Baldwin: Customer retention, Sebastian’s saying up to five years back. It was discussed both open and closed book portfolios and monthly churn out there.
Paul Giannamore: That's number eleven on the list and it specifically says, “Customer concentration and retention.” Customer concentration, we deal with that a lot. Not only is it rare, I almost think it's borderline impossible to see a lot of customer concentration in a residential company. When you start getting the commercial businesses, we've seen this thing before. You got a $1 million in revenue business but one customer is $250,000 per year because it's like a big hospital system or something to that effect.
Customer concentration, anything above 10%, we start to look at it as a rather concentrated business. When I say 10%, it’s when a single customer is 10% or greater of total revenue. We've done a lot of deals in the past where there is some customer concentration. As a matter of fact, we did a transaction where the seller and his business were servicing my alma mater, Cornell University, and it was maybe a $400,000 or $500,000 a year contract, a multi-year contract. In that particular case, we are no longer in the days of holdbacks for the most part. We have holdbacks but non-contingent holdbacks based on customer retention.
When you see a highly concentrated customer base, sometimes you have to put in a specific contingency. If the company is doing 4,500,00 customers, you don't want to lose that customer the day after the closing. There might be some contingencies in there. Retention, of course, is a big one. With customer retention, different aspects of the business will retain differently. With Sentricon, the retention is in the 90s-plus. You guys did Sentricon down in Texas, right, Patrick?
Patrick Baldwin: We did, and then Trelona after Sentricon but yes.
Paul Giannamore: You guys saw Sentricon retention in the 92% to 95% and that's probably pretty consistent, it’s definitely above 90 but probably in the 92% to 95% range. General pest, we've talked about this on The Buzz before, there are a couple of different ways to look at it. From a monthly churn perspective, Orkin’s always used 2% as a bright-line test. It's binary. If you're turning 2% per month or greater, your customer churn is too high. If it's less than that, you're okay. It's binary, you’re good or you’re bad.
We tend to look at things here at Potomac differently and not necessarily based on a monthly churn. We've talked about this, the opening-closing portfolio method where you will bifurcate your customers into cohorts and say, “This cohort that came on in 2020, for example, let's move it forward to the beginning of the year 2021.” Of the 2020 customers, how many do we have on the books on January 1st, ‘21? How many do we have on the books on the 31st of December? We can calculate how many you have retained.
Clearly, we like to see a bright-line test push it around 80%. We want to see retention of at least 80%. We’d love to see it in the mid to high 80s. In general residential pest, it's hard to get higher than 85%, 86%, or 87% but it does happen. That's customer retention. That's number eleven on this list and it's an important analysis.
Patrick Baldwin: I know we’re on the Anticimex roadshow for a second, especially talking about Sebastian. In that open and closed book portfolio, which of the acquirers are not looking at the open and closed book portfolio? They measure customer retention differently.
Paul Giannamore: It’s consistent across. They have their own internal metrics from a management perspective of what they look at. Sometimes it's easy to measure customer churn but every one of them is taking customers and separating them by cohorts. What year did they come on? They're tracking that particular cohort over time.
It doesn't have to be from January 1st to December 31st, it could be June 1st. You want to get a full year. A calendar year is a natural way to do it. Almost all private equity firms would use that analysis methodology. Private equity firms tend to be more focused on customer retention because they don't know nearly as much about the pest control industry as the strategics so they focus very heavily on that. I've always said it's important for people to understand how that's done and to measure retention.
Patrick, if you can increase your retention rate by 200 basis points or 2% and when that compounds over a five-year period, you can add substantial value to your business. Let's say 2023 comes out and you say, “I'm going to do one thing. The only thing I'm going to do this year is to increase my customer retention rate by 2% or 3%.” You then look at all of the levers that you can pull. You're trying to, historically, go back and understand what impacts your customer retention, and then try to patch those and fix those things. That's one way to build value because that additional 2% or 3% per year compounds over time. 5 or 10 years into it, you've added millions of dollars in value. We belabored that point, number eleven.
Patrick Baldwin: I do have one more on that. Is it the count of customers that’s more important or the revenue of those customers?
Paul Giannamore: There are different ways to look at it. You could do it on a revenue-weighted basis or you could look at it based on a unit basis. Pest control is based largely on unit and the reason being is that there's a lot of consistency across the customer. If you're a pest control company of 100 customers that are on residential general pest plans, there's probably a tiny delta between the low-end and the high-end customer. They're all paying $495 a year or whatever. The average is $495 and the range might be $450 to $550 or something like that, it's narrow.
When you think about customer retention in other industries, jewelry stores, for example, tend to have consistent customers. There's a huge difference between somebody who's going and spending $300,000 a year versus somebody who comes in once a year and buys a $200 bracelet or what have you. When you get into other industries doing it on a $1 weighted average basis is more important than pest control. In pest control, we go simply to unit-weighted.
Patrick Baldwin: If you say so.
Paul Giannamore: I do say so. Why? Are there contrary opinions out there?
Patrick Baldwin: I would never disagree. I like the weighted revenue because residential might be $450 a year. Sentricon might put them at $700 bucks a year. A commercial might put them at $36,000 a year. It's a horse of a different color if you know what I mean.
Paul Giannamore: I agree with you. For the general audience out there, most guys are running residential businesses with probably 70% to 80% residential. I do get your point about spending more time retaining the customers that are paying you more money. You could even get it on a revenue basis but is it more important to save revenue or save profit? In analysis, you peel back another layer. Now it's on a gross margin or a contribution margin basis. At the end of the day, instead of getting mired in the particular details, you can Moneyball this sort of stuff all you want. 99.9% of people out there aren't even doing basic unit retention. If you start with that, you're a hell of a lot better than most other folks.
Patrick Baldwin: I'm back to agreeing with you. Thank you.
Paul Giannamore: What else have you got?
Patrick Baldwin: The seventh thing I have on the list. I don't know if you're marking off what you've got on your fourteen-list over there but I've got subscription billing.
Paul Giannamore: No, it is not on the old list and I know why it's not on the list.
Patrick Baldwin: Tell me why.
Paul Giannamore: It’s because Anticimex is a large international player and in a lot of the countries they operate in, residential subscription billing doesn't even exist, it's commercial on terms. This is a broad base for the Anticimes group globally. It's not on the list. I had a call with somebody about the importance of not only auto-pay because they have auto-pay. When they go and do a service, it automatically charges the card. I made a strong suggestion to them that they should get on the monthly billing.
Patrick Baldwin: It is the way.
Paul Giannamore: We covered a lot of things that are on this list. I'll go back to this. Number one, continuous and stable growth. This is the list that Jarl provided on the M&A segment on the Anticimex roadshow when they were attempting to go public. We had Q&A sessions with all the institutions that were looking at buying into this at the time of the IPO.
In the presentation and as they went over it, number one was continuous and stable growth. Number two, we look at affirmed reputation. We're looking at the reputation. Of course, I have my notes here as well but the bullet point says reputation and that was the reputation of the owners in the community, the reputation of the firm, taking a look at reviews, and trying to understand, does the firm have a good reputation or not?
Number three is the share of recurring revenue. Of course, that's the percentage of recurring revenue over total revenue. Number four is the share of pest control, that's the percentage of pest control. General pests versus things like termites, for example, mosquitos, and others. Anticimex has a unique one for number five, smart potential. They have their smart devices. The ability for them to take smart technology and implement that in the business is number five so it's important.
Patrick Baldwin: How do you measure that?
Paul Giannamore: It comes down to the percentage of commercials one way to say it. At the time, Anticimex SMART on the residential side, they were talking about it but it wasn't even out on the market yet so it was largely commercial. Number six is the cultural fit, we talked a little bit about it. Cultural fit is sometimes when I see it type of thing.
You can tell a lot about a culture of a business when you go in and if the trucks are a mess and there's crap all over the place and no one seems to care. Get the feel from a cultural perspective. Acquires like Anticimex isn't meeting the people so most of what's determined about cultural fit, at least during M&A meetings, is determined based upon the owner. If the owner seems like some sort of a scumbag, the assumption will be made that it's going to be a bad cultural fit.
Acquirers are always looking at sellers and how they conduct themselves and whether they seem like they have honesty and integrity and those things. That directly informs them whether or not the business will be a cultural fit. I have, in my years, seen acquirers sit down with owners, come out of the meeting, and say, “Thanks for setting that up. This is not going to be a good cultural fit.” It does happen.
Patrick Baldwin: Is that the nice way of saying that guy is a real jerk?
Paul Giannamore: That's the nice way of saying it. I have seen it happen. We've talked about this, you and I Patrick. We've discussed how to conduct yourself in meetings. Maybe we talked about cultural fit and those meetings internally, which are on some of the Potomac internal videos. Sorry, guys, only internal.
Profitability and Cost Management is number seven. It's one thing to look at a business and try to understand profitability and whether there's the ability to create some improvements and so on and so forth. These are key considerations in acquisition. If your profitability is low, it's going to impact your valuation. We're not talking about valuation here, we're talking about specifically the types of things or key considerations that Anticimex looks set at targets.
Why I bring that up is because people might say, “I got a good culture. I got decent recurring revenue. I got a good reputation so I should get a lot of money for my business because profitability is only number seven.” That's not what that means. That has a large impact. What we're saying here is if your reputation sucks and you got a crap culture, profitability doesn't matter because we're not doing the deal anyway. Number eight is seasonality. You did mention monthly billing. This whole monthly billing thing comes in seasonality.
The one way to stave off the impacts or effects of seasonality, of course, is monthly billing and we see that in the northern states where there are three feet of snow on the ground in December. If you're not on monthly billing and you're doing service charges, it's easy for the homeowner to say, “Three feet of snow. I got no pest, don't come out.” Fine, we won't come out. Why did you charge me for that service? You didn't come out. We're selling a pest-free environment. We've got you on auto-pay. You call us anytime, 365 days of the year. That's the importance of the monthly billing structure. Seasonality would be number eight.
Number nine is quality of management. The bigger the business, the more important this becomes for a variety of reasons. The bigger the business as you become more of a platform, having quality management that can scale the business, is a huge thing. Everyone out there should know that every time I sit down in one of these meetings, every one of these acquires is trying to size up management. It's extremely important.
You want the management of tenure but at the end of the day, you want management with skills and capabilities and a defensible track record of growing the business. The proof, as they say, is in the pudding. If your business is growing at 2% per year and you think you're knocking the ball out of the park, that's not going to bode very well for your management team. Quite frankly, some of the indicators of having a good management team are all of these other numbers we're going through are where they should be.
You've got a business that's growing recurring revenue. You've staved off the impacts of seasonality. You're managing your profitability and your cost and so on and so forth. Number nine is quality management. Number ten is dependence on single individuals. Similar to number nine, this sometimes is a big problem and sometimes it is not. Oftentimes people think about this being the owner and it's not always the owner.
Patrick, in one of the first episodes we ever, did you remember we talked about extortion at closing? Do you remember there were a couple of individuals, particularly one, on a transaction? One of my first deals in the pest control space a long time ago, the owner ran the business and there were maybe 40, or 50 technicians but there was one guy.
It was in the mid-Atlantic where there are a lot of homeowners associations and he was the key sales/relationship manager with regard to a huge chunk of the company's revenue. He was paid well. It wasn't dependent on the owner. Most people think, “If you're the owner, you've got to remove yourself from the org chart.”
A lot of times that is true. Oftentimes, companies where one of your employees becomes overwhelmingly important. If you were to lose that team member, you might lose relationships with scores of property managers and lose millions of dollars in revenue. Sometimes it's important to take a step back and look at your own organization and say, “Am I overly dependent? Can I put bullets in this guy and that guy? What happens to the business?” that's an important thing to ask and try to diversify away from that single individual risk.
Patrick Baldwin: Sounds violent, putting bullets in people.
Paul Giannamore: I'm just trying to keep it colorful.
Patrick Baldwin: Thank you. I don't know if we've talked about this before but when we got into a place where customers were asking for a certain technician, we would do anything but put that technician on that account to help save us from issues like that.
Paul Giannamore: It's interesting because in this industry, when you hear the Rollins guys talk on earnings calls, for example, there's a lot of discussion about retention, especially the residential market is largely based upon the relationship that the residential customer has with the technician. I know that's important but I'm hearing more and more in the last couple of years where folks have been doing similar things to what you guys were doing, which is rotating these technicians, getting them used to working with the company, and putting more emphasis on office reaching out. Let's use Fat Pat’s Pest Control as an example. We haven't used that for a while.
Patrick Baldwin: It’s after Thanksgiving now.
Paul Giannamore: If you use Fat Pat’s Pest, Skinny Pete comes out. For 9 or 10 years, your only interaction with Fat Pat's Pest is Skinny Pete. It's not a good position to be in.
Patrick Baldwin: Do I need to do sound effects? That's Thanksgiving.
Paul Giannamore: Patrick, is it true that after we said Fat Pat's on one of the recordings in May that you started to hit the gym hard?
Patrick Baldwin: July 27th.
Paul Giannamore: Did it have anything to do with the fact that everyone in the industry now refers to you as Fat Pat?
Patrick Baldwin: I love being called Fat Pat.
Paul Giannamore: I know you do.
Patrick Baldwin: I showed up in Pest World and they’re like, “You're not fat.” I was but I'm not anymore. Keep calling me Fat Pat.
Paul Giannamore: When I called you Fat Pat, it wasn't because you were fat. You got Fat Jim and Fat Jeff. We got all kinds of fats.
Patrick Baldwin: I love it.
Paul Giannamore: We talked about eleven, which is customer concentration.
Patrick Baldwin: Real quick on that too, that came up on a call speaking with Shane. He was looking for a system as the technicians are reaching out to the clients and confirming appointments. If a client calls and wants to reschedule, do a callback, or retreat, he wants that client to go back to the office to schedule. They've already lowered the barrier of entry and set that standard of communication to be between the technician and the client.
I refer to him to assist them that would then take that. He can at least monitor and he can own those phone numbers. He needs to be able to track all those callbacks and break that client technician communication at least when it comes to retreats. I do love the idea of rotating technicians. I have heard that a time or two, “We're going to rotate, put it in the pool, and sort it out.” I do like that more and more.
Paul Giannamore: I don't know if it's happening more or if I have noticed it more in recent years. Maybe a lot of folks have been doing it for a long time but I more recently noticed it.
Patrick Baldwin: Every time you say a number, I feel like I should have been repeating it. Go for it.
Paul Giannamore: Number twelve, back office infrastructure. At the end of the day, it's hard to grow a pest control company and, at the same time, build the infrastructure. In a perfect world, you would build back-office infrastructure ahead of field operations. That's not always the way it works in real life. In fact, it's often the exact opposite. Your phones are ringing off the hook, you're hiring technicians because those are the guys that are doing production, and then the back office is a train wreck.
This is a spectrum. You've got small, medium-sized, and big businesses. If you start to get $10 million or above, you're expected to have a pretty sophisticated back office. It's the guys that are doing between $100,000 a year and $10 million. You get various flavors of back office sophistication. It's relatively low on this list, this is number twelve but it's still important.
Thirteen and fourteen are interesting. Thirteen is the ability to further execute M&A. This is for a platform acquisition. The question is if we buy this platform, do we have the ability to further execute M&A from it? I have sat across the table from Anticimex. Do you remember Scott Stevenson, a former client whom you know? He came out.
Patrick Baldwin: I ran at the senator at Pest World.
Paul Giannamore: That's right.
Patrick Baldwin: Good old time.
Paul Giannamore: The senator came out with the M&A team and with the president of Anticimex North America at the time, who was Mikael Vijnje, who’s no longer with us. He's alive but he's no longer with Anticimex. They all came out and we had a meeting on a business that was clearly of platform size. The senator had known the owners for many moons. I'm not going to say which company this is but you've interviewed one of the owners on a prior Buzz episode.
After we had the meeting, which was a fantastic meeting, the company is wonderful, very well run, haa great back office infrastructure, large share of recurring revenue, a great share of pest control, the whole nine yards, and smart potential. Everything was great. That one problem was Anticimex said, “Based on the geography of this business and the research we've done, we will have significant difficulty growing this through acquisitions because we've done our research.”
It was acquired by another company and it was a great acquisition. At the end of the day, Anticimex had done their research and said, “It's going to be tough for us to do add-on acquisitions. We will buy this. This is a great business for us to have but we have to take into consideration our ability to go out and blend down our multiple.” When you're out there doing deals, when you're buying platform acquisitions, what we're seeing right now in the North American market is private equity firms are coming out and they're buying platforms, and they're paying a ton of money for them.
The reason why they're doing that is they have to pay to play. When they look at those platforms, they say, “I've got to get a platform in order to get into this space. Once I get that platform, even though I may have paid 15, 18, 20 times, or whatever EBITDA in order to get it, I can blend down my multiple. I can pay eighteen times to enter and then I can go out and do a bunch of deals at 6, 7, 8, or 9 times EBITDA. If I can do that, I blend down my entry multiple.”
When there's not a lot of ability to consolidate in a market, the entry multiple tends to remain higher because you haven't blended it down and that means you cannot pay as much. They said, “Paul, we want to do this. Here's our offer. We don't believe that we'll be competitive with others in this particular case. We’d love to win it if we can.” They didn't win it. That's thirteen.
I didn't ask this question and I've never asked this question specifically in relation to this roadshow but number 14 is hard synergies. Hard synergies would be one of the things that we've all talked about quite a bit in this industry over the last few months or over the last year since Rentokil made its tender offer for Terminex. What's a hard synergy, Mr. PB?
Patrick Baldwin: Not soft.
Paul Giannamore: It’s certainly not soft.
Patrick Baldwin: If I'm thinking right, you're going to have savings by putting together your staffing like Rentokil and Terminix. You have a lot of upper management you don't need and then that goes straight to the bottom line.
Paul Giannamore: That's exactly right. A hard synergy is something you can knock out a redundancy within the organization whether that's a person or a piece of real property.
Patrick Baldwin: Two branch offices.
Paul Giannamore: Any sort of redundancy whatsoever, equipment, people, property, plant, the whole nine yards, those are hard synergies. Those are, of course, important parts of acquisitions. In the case of Rentokil and Terminex, there are hundreds of millions of dollars in hard synergies likely. You don't need two heads of this and two heads of that, two CEOs, and two CFOs. There are hard synergies in terms of personnel. There are hard synergies in terms of offices consolidating a branch that's across the street from the other branch. You don't need two bird control teams. I'm making this up but, at the end of the day, there are hard synergies.
Patrick Baldwin: That's number fourteen? That seems low.
Paul Giannamore: I find it interesting that it's fourteen. Forgive me if I'm wrong, Anticimex, that's probably more from a cosmetic perspective because it was an investor presentation. When you buy a platform, you're not getting synergy. When Anticimex bought Modern, for example, or Viking, or American, or Killingsworth, or Clark, or Turner. You're not getting hard synergies. You might get some soft synergies where you get some back office cost savings that centralized buying and volume discounts.
Patrick Baldwin: Route density, is that soft synergy?
Paul Giannamore: I don't know that you would get route density necessarily on a platform acquisition. You need to get that from the add-on acquisitions. You start to see the hard synergies when Turner can go out and buy a business that has 4 branch offices and 2 of them are in Turner branch areas. They get rid of two of those offices. They might have a couple of AP clerks back there but they don't need that because they have centralized AP in Jacksonville. They can get rid of those folks because they don't have much to do. Those are the hard synergies.
Quite frankly, add-on acquisitions provide opportunities to get hard synergies, that's why you run a $2 million, $3 million, or $4 million pest control business if you can go out there and buy a $1 million shop and effectively get rid of the branch and get rid of a few of the folks in the office. You don't need an additional bookkeeper in there. Those are the hard synergies.
Patrick Baldwin: Wasn't it like we’re at a 19-time deal but with hard synergies, it was a 15-time deal? That was already out in the open. We can calculate these numbers.
Paul Giannamore: Everything is viewed in the context of M&A from a pre-synergy and a post-synergy basis. When a company like Rentokil or Anticimex will look at a platform acquisition, they're looking at the platform pre-synergy. What immediate synergies can I get by buying this platform? I'm probably getting a lot of soft synergies, volume discounts, centralized functions, and so on and so forth, that's what I'm getting. I’m probably not getting a lot of hard synergies though.
Now when we move down to the bolt-on range, that's when things start to get interesting from a value creation perspective. PB, when you mentioned the Sebastian interview, I pulled up the roadshow presentation. I didn't even expect to go through this but since you started mentioning things that he was talking about, I thought it would be good to reference the answers here at the back of the book.
Patrick Baldwin: I love it. I usually was a CliffsNotes guy so you speak my language. Thanks, Paul. I don't know if you know this. I've got a question right here from a listener and this ties into Jarl’s number two of the roadshow reputation. Are you ready for this?
Paul Giannamore: Yeah.
Patrick Baldwin: Nick asks, “How much do you believe a brand name and mark matters in a transaction? What’s behind that brand, over the years, matters like reputation, services, etc. I am saying name and mark only and how investors and consumers view that brand.”
Paul Giannamore: It depends on what you have. Rentokil existed in the United States for decades and for decades, it only did about $25 million a year in revenue. No one knew who the hell Rentokil is. What is Rentokil? They brought JC Ehrlich and a variety of other companies. Those brands were important. The bigger the business gets, the less important the actual target’s brand becomes.
Rentokil in the United States will be Rentokil for national accounts. It'll be probably Terminix commercial. They announced it for light commercial. I could be wrong about that. I think that's how they're going to do it. I know it's going to be Rentokil for national accounts, that's a fact. I know, residentially, it's going to be Terminix. They're going to start to collapse all these different brands.
Rollins, over time, has started to buy more independent brands. You got Mike Prosperi at BUGHOUSE. You got Northwest. These guys are buying these businesses and these brands are important. When I look at companies like Rentokil and even Anticimex, pest control is so local it's almost silly to buy a company like Killingsworth and change the name or buy Clark's and change the name or buy American and change the name because these people have been using these companies for decades. They don't know what Anticimex is. They don’t know what’s Rentokil. No one's using the name Rollins. Those consumer focus brands are important.
We have ebbs and flows in this industry where there's been a tremendous amount of acquisitions over the last six years. Now is the digestion phase where Rentokil is going to harmonize things and rationalize brands. Rollins will do that to a certain degree. Of course, Anticimex is the prime example of, “We're buying a great brand and a market and we're leaving it.” You got JP McHale. All these brands are sticking around. I don't know how to answer that question. I don't understand the context of the question per se, Patrick. If I didn't answer it, I apologize.
Patrick Baldwin: I just read what I got here, it's my job. I thought about the integration in terms of back to Shawn and Steve. We're going to take American in Birmingham. Soon, they'll have a different uniform and they'll show up in an American truck with Waynes’ uniform. A little bit later, it'll have Waynes’ truck on it. It's intentional integration, which I love.
There are certain things about reputation though. I think about Google reviews. I look at websites and I'm like, “These websites, it's been a long time since they’ve had a refresh on it.” Certain things that I think are not consumer friendly like school, crossbones, poison, and chemical all over in their branding. There are certain things that repelled me. I'm in the industry, I don't know if it doesn't even pass the smell test with them on that.
Paul Giannamore: To be honest with you, I don't recall ever having a discussion with an acquirer about them not liking a particular brand. I've certainly seen some brands that are like, “Ugh.” Most of these companies are big companies and if they don't like it, they'll change it right. Six months later, it's gone. Especially for add-ons like bolt-on acquisitions that are tuck-ins if you got a $1 million firm, it's easy. You got a $1 million business with a high degree of recurring revenue, we can transition you out in six months. Your name is gone and you’re Terminix, Orkin, or whoever. It's a little bit more difficult, obviously, if it's a big platform company to change that name.
Patrick Baldwin: I know the best brand out there is still Killingsworth.
Paul Giannamore: That’s what they say.
Patrick Baldwin: That's what Mike told me.
Paul Giannamore: Mike says it all the time.
Patrick Baldwin: Get your Killingsworth.
Paul Giannamore: It is the end of November 2022. When I look at every single live transaction we have going on right now at Potomac, every single one of them is with a private equity firm. It’s the first Q4 in 20 years that I've been in this industry where every single transaction is with a financial sponsor. Rentokil is quiet. Rollins is sleepy. Anticimex is quiet. The strategics are quiet relative to the financial sponsors.
We've talked about this all year long and where this is going and now we're here. It's the era of private equity. Given where we are in the market from an asset price perspective and for going into the recession, we had the tens and twos invert. The yield curve inverted in June of this year, Patrick, and we all know that that is a pretty reliable indicator of a recession. Twelve months after inversion, it’s usually on average. If you look back 60 years of history, a good twelve months after inversion is when the recession is in full swing. The time we live in right now is very different than any other period I can think of.
When I looked at the ten-two spread this morning, that's the measurement of the yield curve inversion, it was -72 basis points, which is bone-chilling. It is a nasty amount of inversion. We’re seeing the housing market begin to roll over. We're seeing the PMI index begin to soften up and be in contraction territory. It looks like, Patrick, sometime between January and June, we will officially hit a recession. Given the long lead indicators, it looks like this one is going to be a doozy.
I bring all this up because private equity firms are extremely anxious to get in and buy platforms, private equity firms in general. It’s not exclusively all of them but they tend to be different from strategic acquirers. You asked about post-LOI deal killers, we're going to talk about this probably at some point in December because one of the big things is that Rollins, Anticimex, Rentokil, and the big players in the industry can't afford to go and beat the shit out of sellers. They can't sign an LOI and crack somebody in the face because they've got a reputation.
That's not to say that they don't do that or haven't done it but for the most part, it is not a matter of practice. When you're a private equity firm and you're not in the industry and no one knows you and you're sending out all these emails to folks, “Jim, I noticed you've got this great pest control company and it fits our profile. We'd like to have a chat.” The seller is like, “This is interesting. Somebody thinks my little baby is super beautiful.”
You negotiate with the private equity firm, you get into the LOI, and a lot of them fall apart. Not only issues with the quality of earnings are so financial and accounting due diligence but private equity firms can afford to push you around a whole hell of a lot more than strategics because they dont’ have a reputation in the industry. If it doesn't work out, they can leave and that's fine. These are important things to keep in mind and we'll talk about them in a subsequent episode.
Overall, from a market perspective, the strategics are relatively quiet and are pushing valuations down amongst the strategics is the easiest way to say this. It's competition amongst the private equity firms that are keeping the market elevated. When you look at the financing markets, the leveraged loan market, which supports private equity valuations has continued to deteriorate at a rapid pace. By Q1, on December 12th and 13th, the Fed meeting, the FOMC, will probably raise rates again, and this time 50 basis points. We're starting to see a lot of deterioration. Did you see Walmart's earnings report, Patrick?
Patrick Baldwin: No.
Paul Giannamore: Walmart released earnings and went on a tear because Walmart's doing quite great in this environment, which, of course, isn't a great sign that Walmart is doing well. It's a sign that there's continued pressure on the consumers. Retail, overall, has been getting hurt. The early signs of recession, credit card debts increasing at a rapid pace mortgages, and loans on average are still pretty close to 700 basis points. Things are getting rough.
Patrick, when we did Bubble Trouble, I speculated that by Bubble Trouble time 2023, which was in May, valuations were going to hit head south. We're going to be on that track. We've got a few more months here before we start to see as private equity firms slowly exit the industry or get the platforms that they need. They'll further be downward pressure. Right now, there are 50 private equity firms all battling for platforms.
I'm not just talking about private equity firms that are toying around saying, “It'd be nice to get into pest control.” There are at least two dozen that are serious that have gone out and hired people from Rentokil, Terminix, and Anticimex. They've taken on operating partners. They're investing time, money, and effort. They're hiring outside advisors like Bain, for example, and a variety of consulting firms to help them build out cases and theses in the business. These guys are serious.
Platforms are scarce and few of them are far between. While the battle rages with the capital that's committed to the private equity funds right now, the competition will support valuations. As these guys get initial platforms, they're going to be looking to blend down multiples. For those of you who are not on my distribution, I have been trying every Friday. I missed last Friday.
Every Friday, I sent out a note, I have a link to POTOMAC TV, and I talked about what the heck's going on. I talked about Anticimex raising $200 million in debt capital. At a ridiculously, historically, high-interest rate, which was almost 8.25%, which is expensive, quite frankly. It’s not in absolute terms but in regard to recent history. The cost of debt is going up. That's what's going on in the market, PB.
Patrick Baldwin: Thanks.
Paul Giannamore: Good thing you sold. You guys are out. You’re done.
Patrick Baldwin: It's everyone else I'm concerned about.
Paul Giannamore: You can't worry about everyone else all the time. We've been talking about this for years. We did Aftermath and Supernova. We got everyone already. Yours is August of ‘21.
Patrick Baldwin: That's right. That's the last time you ate a good barbecue.
Paul Giannamore: That's true.
Patrick Baldwin: You have an open invitation here, by the way.
Paul Giannamore: I plan on getting down there one of these days again soon because I love the barbecue. PB, we got some great episodes coming up. You and I have to do a better job doing this every week once again. I know my travels have gotten in the way but I have gotten some hate mail, like, “What are you guys doing? Get back on the air.” Here we are.
Patrick Baldwin: I do appreciate those encouraging messages of guilt. Thank you. Awesome, man. I'm going to go and have some good old Texas barbecue for you. How's that?
Paul Giannamore: PB, it's 6:12 in Puerto Rico. For the last two days, I didn't make it past 7:00 PM so it's time for me to go home and try to work off this jetlag. Until the next episode, which I'm looking forward to next episode.
Patrick Baldwin: Go get some beauty sleep, you need it.
Paul Giannamore: I will. It sounds good. Thanks, PB. Bye.
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