[Special Report: Mergers & Acquisitions] Let's Make a Deal

Recent mega mergers and acquisitions get big attention. But among small and mid-size pest control companies, hundreds of M&A transactions have taken place this past year. In a recent PCT e-mail survey more than 37 percent of pest control operators said current M&A activity is above average. What’s driving the action? And should you be getting on the buy-up/sell-out bandwagon?

FOLLOW THE MONEY. Money drives mergers and acquisitions: the potential to make it and the means to fund it. The structural pest control industry generated an estimated $6.76 billion in 2005, up 4 percent from 2004, representing a five-year annualized growth rate of 5.3 percent, according to Gary Curl of research firm Specialty Products Consultants. And, PCOs are optimistic. Three-fourths of those surveyed for PCT’s 2005 "State of the Industry Report" said they expected 2005 sales to increase an average of 17 percent.

This profit potential is attractive to outsiders — the private equity firms that dance with the industry every five years or so, says Joseph Edwards, corporate vice president, Arrow Exterminators, Atlanta. Although PCOs cite an increase in blind solicitations from these entities, most equity firms are prudently searching — unlike the late 80s/early 90s frenzy — for companies with solid sales and management platforms on which to build, says Lance Tullius of Tullius Partners, Portland, Ore., which brokers deals in the industry. The 2005 Sunair-Middleton transaction, he says, is a perfect example.

The pest control industry generally has good growth prospects, conforms to M&A strategy, and is profitable if managed right, says Tullius. Its low capital investment requirements, sustainable cash flow, and repeatable, routed business make the industry very appealing to outside investors, adds Pamela Jordan, president, Acquisition Strategies, Tampa, Fla. The caveat, they agree, is execution. Running a successful pest control business is not as easy as it looks on paper.

The bulk of acquisition activity, however, comes from inside the industry, and access to ready capital is making it easier for all players, regardless of size, to merge and acquire. Tullius sees the majority of transactions occurring among companies with between $100,000 and $500,000 in gross sales. He regularly hears PCOs say, "I just bought a route" or "I just bought 1,000 accounts." Nearly 50 percent of operators surveyed online by PCT have been approached to sell in the past three years. Cash-heavy coffers, low interest rates, and lenders’ willingness to finance 50 percent to 75 percent of an acquisition have made pest control a seller’s market.

And many potential sellers exist. "There’s always the opportunity for consolidation in the industry," says Jordan. That’s because pest control is a mom-and-pop, fragmented industry that’s relatively easy to enter, she explains.

Curl notes that last year, 19,150 pest control companies were operating in the U.S. More than 24,000 are expected to be in the business in 2020. As a general rule, explains Al Woodward, president, A+ Business Brokers, High Springs, Fla., 10 percent of businesses are for sale at all times. Because pest control is a tight industry, he estimates the number is closer to 7 percent. Meanwhile, 17 percent of PCOs surveyed by PCT online say they’re likely or very likely to sell out within three to five years.

AVENUE FOR GROWTH. Mergers and acquisitions can make good business sense. "Acquisitions can exponentially expand growth," says Jordan. Because a finite number of consumers use professional pest services — 16 percent according to a 2005 study by consumer research firm Mintel International (Editor’s note: PPMA’s estimate is higher) — the quickest, most economical way to get them on-board is through an acquisition. In comparison, organic growth adds new customers through internal marketing and sales efforts, and new service offerings. It’s generally the least expensive type of growth but the hardest to come by, says Tullius. A 10-percent organic growth rate is good, he says, but it will take a $1 million company about seven years to double its business at that rate.

When healthy internal growth is combined with growth through acquisition, PCOs can see a 50 percent to 100 percent increase if a solid growth and transition strategy is in place, says Jordan. "Taking into account the amount of time invested and the efficiencies of scale, acquisitions make good sense," adds Tullius. "It’s often more advantageous to acquire a business," agrees Clarke Keenan, president, Waltham Services, Waltham, Mass., who has acquired 10 companies in the past 15 years. "The risk is really minimal," he says, if you know how to blend the companies together. Consultants can coach PCOs through this process.

The tax breaks aren’t bad, either, says Woodward. The government allows companies to amortize acquisition expenses for significant tax savings. Acquisitions are a "good way of putting money in the business and putting [the money] to work," says Keenan, especially for PCOs sitting on capital in rainy day or portfolio funds.

Perhaps even more important, says Woodward, is the opportunity to acquire trained, experienced employees. Mike Rottler, president, Rottler Pest & Lawn Solutions, St. Louis, Mo., agrees. His acquisition of a $180,000 company was a "no brainer." "We bought it for the talent. It was a good fit for us."

Acquisitions can provide new leverage with suppliers, eliminate competitors, open up new geography, and consolidate share in an existing market. Atlanta’s Arrow Exterminators, with 80 acquisitions under its belt since 1964, started in its "own backyard," where it had considerable knowledge and contacts, says Edwards. The company soon expanded into the Southeast and now reaches into Texas and Arizona. "There’s a tremendous opportunity to consolidate and acquire new companies and expand into new regions," he says.

Companies with similar culture and pricing models are attractive to buyers in the same market, says Jordan. Most of the operational overhead goes away, and the revenue carries on for a "really wonderful, incremental improvement in operating profit." PCOs don’t always consider pricing as part of their exit strategy, adds Rottler. If a company’s services are under-priced, he says, it won’t get as much interest from buyers, as there are "more obstacles to overcome." Yet companies with low prices, good service and stable customers are worth a second look, says Keenan, as they may be cheaper to buy.

Growth through acquisition also can help overcome challenges of a successful industry. More effective chemicals, improved treatment techniques, shorter-term guarantees, quality assurance initiatives, and historically low service pricing satisfy customers but can pinch the bottom line. "It’s interesting to me to see the price per account is not substantially more today than it was in 1989," Jordan says.

MOTIVATION TO SELL. Although 51 percent of PCOs surveyed by PCT online say price is the most important factor in their decision to sell, it’s not the only one. Shared business values (23 percent) and employee retention (10 percent) also are considerations.

"Rarely will money alone cause someone to sell their business," says Jordan, unless there’s a compelling, personal reason involved. Burn-out, skill and resource limitations, divorce, looming retirement, lack of a succession plan, and health and partnership issues, among others, influence a PCO’s decision.

Some operators may have started their own business to create a job, and now have significant revenues. Managing a business, however, may not be what they had in mind, nor was working seven days a week. The industry also is coming of age. PCT’s 2005 "State of the Industry Report" found the average age of survey respondents — 73 percent of whom are company owners or presidents — was 50 years. Baby-boomer owners are nearing retirement, and many have no succession plans in place. Some wait too long to bring their children into management or discuss a succession game plan, only to find the kids have no interest in the company.

For a PCO not yet ready to retire, selling a majority interest offers a way to balance the personal portfolio, reduce risk of ownership, and stay engaged in the business, which now has bigger resources to fund aggressive growth.

MAKING THE MOST OF M&As. PCOs who’ve had success with acquisitions have no plans of stopping. Arrow Exterminators, which expects $81 million in revenue this fiscal year, has aggressive plans to reach $250 million by 2016 through 8 to 10 percent annual organic growth and 4 percent acquisition rates. Rottler has acquired two companies in recent history and is on the look-out for the next good fit, as is Keenan, who regularly courts 10 to 15 area firms.

"I think we’d all be shocked by the number of deals going on among smaller operations," says Jordan. Global acquisitions will continue and big deals get the attention, "but there’s a lot of smaller buyer activity, and interest in learning how to do it well."

The mergers and acquisitions market definitely has heated up, says Tullius. "I don’t see it going away, but I don’t think it’s going to get any better than this."

The author is a contributing writer to PCT and can be reached at anagro@giemedia.com.

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Evaluating Sellers

Are you looking to buy another pest control company? If so, Robin Bryer of The BlueSky Group, Powell, Ohio, suggests reviewing sellers (target companies) in the following areas:

1) Revenues. The larger the target company, the greater the opportunity for success is by the acquirer. Revenue makes up for many operational miscues and presents the foundation for further expansion into the market.

2) Recurring vs. non-recurring revenue. Recurring revenue-dependent businesses generally are valued greater, as the assumption is that the revenue is more predictable in the future, thereby creating a greater lifetime value of the customer. Also, minimal additional investments in selling expenses are required to generate revenue. Revenue from monthly, bi-monthly or quarterly GHP, as well as termite warranty renewals, imply recurring revenue by their very nature.

3) Service delivery model. Acquiring companies often will target companies whose revenue streams are higher, consistent and similar to their own revenue mix. For instance, certain companies may value quarterly GHP higher because their own revenue mix may be comprised of a greater percentage of GHP. That is not always the case, however; a revenue stream may represent a horizontal expansion or new service initiative — therefore an acquirer may ascribe a "strategic" premium to that piece of business.

4) Adjusted cash flows. Adjustments are made to the target company’s net income to reflect the expected cash flow to be generated by the target after acquisition. These include adjustments for owner’s compensation and other expenses of a personal nature. One-time expenses can be part of an adjustment as well. A potential seller should specifically list these types of expenses. The owner’s salary will typically be added back if the acquirer does not have to replace the owner with a general manager or to the extent that the owner’s compensation is above that of the required replacement salary. Adjusted cash flow typically determines and drives valuation. The acquirer typically is not willing to pay for synergies realized as part of the value they create after acquisition.

5) Customer retention. Customer retention is important in forecasting the lifetime value of a customer acquired and a terminal value. This ties back to the discussion of a recurring- vs. a non-recurring-based business. Historical retention rates are looked at closely during due diligence.

6) Asset value. Oftentimes this becomes a negotiating point. Recognize that accounts receivable is discounted if the acquirer collects any outstanding balance after acquisition. Vehicles and equipment are valued at fair market value if they are to be utilized for service delivery after acquisition. Oftentimes a target may be better off selling equipment on their own rather than forcing the acquirer to buy it. Target vehicles may not support the image that the acquirer wishes to project. If this is the case, the target may not receive fair market value if they force the purchase of these assets.

7) Management capabilities. When expanding into a new market, an acquirer needs a management team that can marry its corporate philosophy to the target company’s way of doing business. If there are employees in place that can accomplish this task, outside management does not have to be transferred from another company site. This is less critical if this is an expansion in a given market.

8) Quality of employees. Companies that have long-tenured employees and little turnover are worth more than those with high turnover. Employees stay at one place for a reason. They are treated well and work for solid organizations. These employees typically stay with the new company after the acquisition.