Paul Giannamore: If you look at the DXY, you'll see the US dollars at a twenty-some-odd year high. The pound is at a 47-year low versus the dollar if you looked at that, Patrick. Have you kept your pounds shorts on?
Patrick Baldwin: I’ve not.
Paul Giannamore: Ride that thing down like an escalator.
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Paul Giannamore: Mr. PB.
Patrick Baldwin: I've got some questions. You're back in Puerto Rico. All I know is it was pitch black. I'm glad you're alive and well but things are scarce down there.
Paul Giannamore: That is correct. I got in late after Hurricane Fiona as it were. It was pitch black. The island had no electricity and we still don't. We're all on generators. Here in the office, a generator. At the house, a generator. We don't even have running water. If you don't have a cistern, you're out of luck. The infrastructure down here in PR has been neglected for many moons, let's say. Fiona wasn't nearly as bad as Maria but it created some problems.
Patrick Baldwin: It hit the southern part of the island.
Paul Giannamore: It did. Most of the catastrophic images people are seeing online are at the epicenter, which is in the south end of the island, around Ponce, which is a major city in the south. Up here in the north, in San Juan, if you drive around town, you don't even see any broken branches. We're feeling the impact of the infrastructure.
Patrick Baldwin: Two questions, when I hear the word cistern, I think of medieval times. For some reason, Robin Hood comes to mind. What is a cistern?
Paul Giannamore: A cistern is nothing other than a big plastic bin full of water. At the top of homes here, there's a water storage unit. When the water goes out, you're able to get some running water. It’s not recommended for drinking but you can shower in it and operate the toilet. The water is out on the island because of the pressure system and the pumps. We got too much rain. From what I understand, at least what they're posting online, the water pumps that we have are operating correctly. It'll take some time for that to drain out and the pressure to equalize, so I read. Whatever that means, I don't know.
Patrick Baldwin: Question number two, is the Mex’s boat still intact?
Paul Giannamore: That's an interesting question. He drove out to where his boat is docked. He said there were trees down, wind, and all sorts of stuff. He made it to the boat and it was full of water. It took hours for him to get the water out. I could imagine him with buckets in the boat, rain coming down, and wind, getting out water from the boat. The Mexican’s boat stands.
Patrick Baldwin: You've got a few other people in the office there. I hope they're all okay.
Paul Giannamore: Everyone's good. Everyone's on generator power. Jessica is the only one that has natural power. She's in Old San Juan. Her power came on but everyone else is still on the generator.
Patrick Baldwin: The cost of freedom.
Paul Giannamore: Life in the tropics.
Patrick Baldwin: Paul, do we have some time for listener questions?
Paul Giannamore: Yeah, let's do it.
Patrick Baldwin: Shane asked, “What about different brand names in the same market owned by the same company?” Long ago, I learned about the Procter and Gamble model. You've got different detergents with different labeling and different color bottles. At the end of the day, it all flows up in the same parent company. Have you seen that done in the service industry?
Paul Giannamore: The big companies do it all the time. Rollins owns Orkin. They buy Western. Rentokil maybe has 300 brands. There are a lot of them.
Patrick Baldwin: Probably not by design.
Paul Giannamore: I don't think it's by choice. The Rollins organization, for years, has tried to dissemble and get rid of a lot of those brands as has Rentokil. Personally, I would look at it and say, “It costs a lot of money to develop a brand. Why not just focus on one brand? If you're going to invest in it, focus on that one brand.” That's the way I would look at it.
Patrick Baldwin: I remember, a long time ago, episode seven with Mike Givlin. The question was, What about consolidating all these brands as you're acquiring them quickly? That's on one side of the coin. Those advertising dollars can get a lot more bang for their buck in that bigger pool. What about by design having multiple brands in the same market? I think about when Terminix bought 855Bugs.
The idea was, “Let's keep these two brands running side by side.” It’s a ring fence, the 855 name. Keep that running and as long as it performs in line or better than Terminix, why consolidate it? If someone's had a bad experience with Terminix or whoever the acquirer is and they find out, “855 is part of Terminix. We roll on in Terminix.” They're going to jump ship and go somewhere else. If they own two buckets in the same market, it’s potentially a better way to get customers.
Paul Giannamore: that probably works well for a company like Terminix. I would wonder how it would work. Would you and Bobby have had 855Bugs and then another brand in that same marketplace?
Patrick Baldwin: We almost spun off a bedbug brand. I don't know if you knew that. We had Bed Bug Butler run that for a hot minute, your white glove bedbug service.
Paul Giannamore: That didn't gain traction?
Patrick Baldwin: No. “Unfortunately”, Bed Bugs didn't take off in Waco like in other metro markets. We did bedbug work but not a critical mass to where it made sense to cover the extra brand cost. Shane's asking by design, “Would you go in the same market and add an additional brand line? The same frequency, virtually the same service offering, a little bit different pricing, and a different brand.” I don't know how you handle the back office as far as shared CSRs. I don't know.
Paul Giannamore: In Texas parlance, I don't think the juice is worth the squeeze doing that. I don't see a lot of benefit in it. I see it as a distraction. That’s me. What about you?
Patrick Baldwin: This is marketing 101, the class I took in college that had to do with Procter and Gamble and that this was a working business model. That is the one instance where I can call, by recollection, by design, this is what we're choosing to do. It's funny though. The flip side of the coin is all these acquirers are trying to get to one brand, a unified brand. Here it is, a smaller market and multiple brands. I don't know if the brands are about the same size and same brand offerings.
Paul Giannamore: I too, many moons ago, read the Procter and Gamble case studies. When I think about Procter and Gamble, there was an interesting case study on the Oil of Olay many moons ago. It's now known as Olay. They used to joke about it becoming the Oil of Old Lady. Procter and Gamble are trying to try to position that. It's a skincare product.
With Procter and Gamble, their distribution arm is drugstores and supermarkets. A lot of their products would go out in those mass market type distribution. They weren't necessarily competing in Saks Fifth Avenue with extremely high-end products. With the Oil of Olay, they wanted it to be a prosumer product. Better than just consumer but still not too good where you weren't going to find it at your local supermarket.
A lot of that had to do with positioning the various products. In this particular case, they rebranded Olay. They charged twice as much as your standard supermarket brand but it was still like $8 per ounce or package less than the higher-end stuff. That effectively turned the brand around. In pest control, would you have a service that's like the Walmart of pest control? Would you have a higher-end pest control that you would serve yourself for more? I don't know that you would do that.
Patrick Baldwin: Is the theory that the customer or consumer is going to contact three companies and they're going to get a low price, a medium price, and a high price by the nature of calling three people, and then you've got possibly two dogs?
Paul Giannamore: On bigger ticket items like wildlife exclusion. Let's say that you have a job that's going to be $2,000, they might call around a couple of different companies and get quotes. Your wife is moaning because there are ants in the kitchen. I don't know how many people call around and price quote. At the end of the day, they either know a company that they see around town, they're referred by a neighbor, or they ultimately get on Google and find somebody to call it up if it sounds reasonable. I'm making this up, that's the way I did it. I would imagine that's the way a lot of people do it.
Patrick Baldwin: It might be hard if you share CSRs or use air technicians. Those names keep coming up in the Google reviews or if they're calling around, like, “I spoke to Kadian and another company. You sound Kadi. That is interesting.”
Paul Giannamore: I don't see the benefit of doing that because it takes a lot of time, money, and effort to build a brand. I would say you probably want to focus there. I do see where it could potentially be interesting if you were a commercial-only operation to have a specific brand for commercial-only enterprises. You're building out different capabilities. You branded it differently. It's different than the residential. I could see that being the case but I don't see why you would do two residential general pest brands in one market.
Patrick Baldwin: This is similar. As I was asking this question, this other listener question comes up. Roy asked about too much outsourcing. You've had clients that have outsourced different functions over the years and even in recent history. What if CSRs are outsourced? Recruiting can get outsourced. Marketing. Paid ads, SEO, all this advertising, email, newsletters, and all that marketing component. Sales. Slingshot is a big name out there. They're going to answer the phone. They're going to schedule cell service, schedule service, and the nine yards as far as sales the goes. The question is when it comes time to sell the business, is there a point at which too much outsourcing becomes a weakness?
Paul Giannamore: Yeah, I think so. In pest control, you're out there, and you're killing bugs. At the end of the day, as we talked about with David Dunning, a lot of times, the consumer has a hard time differentiating between the expertise of one company versus another company. At the end of the day, what are you selling? You're selling a relationship. I look at it in all aspects whereby the company can build a relationship. Those should be internally developed capabilities, customer service.
The company should have its own vernacular. It should have its own Chick-fil-A way or Ritz Carlton way or whatever they want to be and how they communicate with the customer. At each specific touchpoint, the company is able to differentiate that experience and build that relationship. Outsourcing that stuff can potentially be complicated. There are things like payroll in almost these commoditized processes. Those are good to outsource. Anytime that customers touch directly related to service, that starts to complicate things when you outsource it.
Patrick Baldwin: We can pick on Westco Shane for a minute. In that case, if I remember right, the CSRs were outsourced. I see that tied operators from time to time. It's like, “I'm here on the East Coast like Georgia, Florida. The girls answering my phone are back in Utah.” I don't know where Shane had his extra CSRs outsourced but they weren't there on the West Coast. What came with that?
Paul Giannamore: That was a different scenario. He didn't outsource those. Those were employees of his business. He hired customer service representatives in the Philippines. He had a manager there. Those CSRS were not outsourced. There's a distinction between having CSRs in another state or country but that you own those resources versus having XYZ company do it. I don't view that as outsourcing.
That was complicated because when that business was acquired, the acquirer didn't want to have the dozen or so CSRs that were employees in a foreign country, which gave rise to a lot of other international employment-type laws that they had to deal with. They said, in Texas parlance once again, the juice isn't worth the squeeze. We can't keep these people because it's hard enough in the United States to hire somebody in a different state, let alone hire somebody from a different country. That was the problem with that.
Patrick Baldwin: That's crazy. You make an important point again. A remote worker is different than an outsource company. Outsource like Slingshot, you're paying some kind of contract or service agreement relationship. It could be 100 different people answering the phone or the next phone call, round robin that thing.
Paul Giannamore: I'm not sure what slingshot does now as I knew Slingshot before. You're running your business and everyone goes home at 4:00, 5:00, or 6:00. You would tie your phones into Slingshot and they would answer the phones pre and post-business hours. That way, you weren't missing customers. A lot of people would call at 7:00 at night and they're at home eating dinner and see a bug. It was otherwise going to your voicemail. You would bring in Slingshot.
You had your core team answering stuff during the business day and sometimes it doesn't make sense to hire full-time people to work at night. I get that. That's probably an appropriate use of outsourcing. When you're talking about communication and service directly to the customers at some point, it's counterproductive to bring in outsourced service providers to do that.
Patrick Baldwin: Is it created complications? Have you had deals where there is a hole that they've got to fill and say, “Before we buy this business, this has got to go away.”
Paul Giannamore: People outsource some back office functions. Especially related to payroll and HR administration, those functions are often outsourced. That's typically not a problem. Slingshot-style, phone answering after hours, that's outsourced. IT, I've seen that outsource to companies, fleet management. There are these core functions that are not complicated to transition those outsource relationships. It's not a big deal. The big companies outsource some of that stuff too. I don't view that as an issue.
Patrick Baldwin: What about marketing advertising? We've got a company that does our social media, our paid ads, our email marketing, our website, and the whole nine yards.
Paul Giannamore: Usually, when those companies are acquired, those relationships will ultimately disappear. Usually, 9 times out of the 10, the acquirer is not going to continue to use those services, at least they won't use them for a very long period of time. If it's a big company that has that in-house like Rentokil or Orkin, it’s not going to continue to use that. They've got their own house people to do that. I would expect a pest control company to not necessarily have the capability of doing online marketing and those things. It's pretty expected that they wouldn't necessarily have that homegrown and that they would outsource that. It's not unreasonable to see that. It's pretty common, as a matter of fact.
Patrick Baldwin: This all makes sense. Here's one, in videos on The Boardroom Nuzz, we hear EBIT, EBITA, and EBITDA. Can you break down, at least from the acquirer standpoint, what they're looking at and what all that means between those?
Paul Giannamore: Between EBIT and EBITDA.
Patrick Baldwin: Even EBIT, EBITA, and EBITDA.
Paul Giannamore: You have EBIT, EBITA, and then you have EBITDA. Those are proxies for cashflow. Oftentimes, in my line of business, we talk about cashflow. Cashflow, of course, doesn't show up on a P&L. There's no metric for cashflow, per se. We have to use various different proxies for cashflow. Acquirers tend to look at earnings before interest, taxes, and amortization. They're not looking at EBITDa, they're looking at EBITA.
When we put together sell-side materials, we exclusively always use EBITDA. It tends to overstate profitability. Acquirers are looking at earnings before interest, taxes, and amortization as a proxy for cashflow. That's the cashflow metric they're looking at. The thing about businesses that run fleets, a pest control company, for example.
You might have 30 vehicles and you've acquired those vehicles in 1 or 2 ways. There are a lot of ways you can do it but you either purchased them, you went out and bought them, and you might take out a loan or finance them, or you've got them on a lease program. The lease program could be an operating lease, which shows up on your P&L as a charge or it could be a capitalized lease, which doesn't show up on your P&L, it shows up on your balance sheet.
The problem with comparing apples to apples, you could have the exact same pest control company. Let's say both of them have 35 vehicles, one is an operating lease and the other one is financed. The P&L will look different. The one that has the operating lease might have tens of thousands of dollars per month and lease charges. Their EBITDA is going to be different than the EBITDA of the company that does not have it. We're going to get complicated.
Patrick Baldwin: Let’s do it.
Paul Giannamore: I don’t know if the Buzz is a proper venue for this, Patrick. If you've purchased a vehicle and you finance it, you're going to have a lot of depreciation. If you use EBITDA, it masks the depreciation associated with that vehicle. Let's walk through this Patrick because you asked me a question that'll get complicated so we're going to be complicated with it. Black Bear, 855Bugs, refresh my memory, you guys leased or financed?
Patrick Baldwin: Financed.
Paul Giannamore: You had a good chunk of depreciation, right?
Patrick Baldwin: Yeah.
Paul Giannamore: If I looked at EBITDA versus EBITA because you finance them, what difference would I see?
Patrick Baldwin: EBITDA would be higher than EBITA.
Paul Giannamore: Correct. It would be excluding the hundreds of thousands of dollars a year that you guys had in depreciation. If we took your business and financed them and we compared your business with a company that had an operating lease, what would be the difference then in EBITA in your company versus EBITA in the other company?
Patrick Baldwin: They're going to look a lot more profitable. The leasing would look a lot more profitable.
Paul Giannamore: Why?
Patrick Baldwin: I took a guess.
Paul Giannamore: The leasing wouldn't look more profitable because you'd still have those operating leases built into the P&L. The company that has the operating lease is paying that as a P&L charge. You wouldn't have that.
Patrick Baldwin: Pure expense. There's no interest over here.
Paul Giannamore: You would have depreciation because it's not before depreciation. EBITA, you would run the depreciation charge. Usually, depreciation is a decent proxy for what an operating lease would be but not always the same. For one, if I'm an owner and I want to start to think about, “I want to be Rentokil or Anticimex. What should I do?” If you want to look at your financial metrics in a way that they would do it, you would not do EBITDA. You wouldn't care about the D. You would look at EBITA. That would be your metric. You'd be focused on EBITA margins of 20% or greater. That's exactly what you would be doing.
Patrick Baldwin: Is this across the board like publicly traded companies or is this sector specific?
Paul Giannamore: You're saying the use of EBITA versus EBITDA. Yeah, it is sector specific. US companies tend to focus far more on EBITDA than the rest of the world. If you're in Europe, you're not even looking at depreciation. You're EBITA based.
Patrick Baldwin: US, EBITDA. The rest of the world, EBITA. This is so fun. I love it.
Paul Giannamore: EBITA would be the more appropriate metric for you to look at as an owner, quite frankly. Tax laws change all the time. You can do an accelerated depreciation. It can distort things. If you want to look at apples to apples, year over year, you should look at EBITA. That's what you should focus on. If you wanted to get sophisticated about it, even if you financed vehicles as you guys did, you can impute on your P&L what an operating lease cost would be because that's where the industry is moving. That gives you better information as to where you would be in line with others.
Patrick Baldwin: Interesting. Is EBITA the closest measurement for pure cashflow?
Paul Giannamore: It's going to be more complicated to get to free cashflow. FCF or free cash flows is what's used in financial modeling. The best proxy for an operator might be what we call EBITDA less CapEx. What we're saying there is you figure out what your EBITDA is, your earnings, you subtract all your expenses, you get all the way down to EBIT da, and then you subtract your maintenance CapEx from that.
you have two forms of CapEx, you have growth CapEx and maintenance CapEx. Maintenance CapEx is what you need to invest in the business every year on a capital expenditure basis to maintain operations. Growth CapEx will naturally be more than that because it's what you need in order to grow the business. To get yourself a proxy for free cashflow, you would use EBITDA less CapEx. Less maintenance CapEx is what I would suggest that you use and that will give you an idea as to what your business's cashflow is.
Patrick Baldwin: What is maintenance CapEx then to drill into that?
Paul Giannamore: Whatever you would typically capitalize in your business would be a capital expenditure. It could be cash payments for equipment, vehicles, or any capitalized expense. What I mean by capitalized expense would be an expense that's large enough to go on your balance sheet versus being charged through your P&L. It's your investment and then your infrastructure. That would be whatever you would need to invest year over year to maintain operations. That's maintenance CapEx.
I'll tell you what the theory is, Patrick. The theory is that EBITA is effectively the same thing as EBITDA minus maintenance CapEx. Why firms will use EBITA as a proxy for cashflow, what they're saying is that depreciation in a pest control business tends to approximate what maintenance CapEx would be. In a normal business, if you looked at John Deere, capital goods, equipment manufacturer, or go to the S&P 500 and pick business. A good proxy for cashflow would be EBITDA less maintenance CapEx.
In the pest control industry, when you look at EBITDA less maintenance CapEx, you're typically looking at EBITA. They're usually close numbers. What a lot of the acquirers will do is instead of saying EBITDA less CapEx, they'll automatically substitute EBITA. That is not free cashflow per se but it's a proxy for cashflow.
Patrick Baldwin: Drilling down at all of this, when you're talking about multiples, of course, we've had multiple expansions. We've talked about multiples left, right, and all that. After an acquisition, you're summarizing what the multiple of the maybe fill-in-the-blank future cashflow was of the deal, of the EBITDA multiple was. What's that conversation point for you when you're saying, “Here's what the range of multiples is in the industry.” Is it EBITDA?
Paul Giannamore: I tend to use EBITDA as a multiple. Over here, we tend to use EBITDA. If you're on the buy side, you want to get as close to EBITA as you possibly can. On the sell side, EBITDA overstates it. It's not that the other sides are morons and don't get that but we use EBITDA. When we talk about transaction multiples, one thing that's always confusing for people is whether you're talking about LTM multiples, last twelve months, or forward multiples. In the public markets, we're typically talking about forward multiples.
For example, if a business is growing 10% per year, and I'm talking about a valuation multiple of the business, and I'm using a forward multiple, that multiple will be lower. The forward multiples can be lower than the trailing multiple because they're going to grow ten years from now. I'm using a proxy for cashflow year out. When somebody talks about transaction multiples or valuation multiples, the first question is, are we talking about forward multiples? Are we talking about trailing multiples?
Depending on who I'm talking to, if I'm talking to a seller or business owner in the industry, I am always talking about trailing multiples because they understand that. That's easy to understand. If I'm talking to financial professionals, I'm often talking about forward multiples. Because of valuations, we're often forward-looking. It depends on the audience. Sometimes it's hard for folks to get their arms around it. One big thing is we’re talking about forward multiple or trailing multiple.
I always say you can make a purchase price into a multiple of anything, it could be revenue, cashflow, or gross margin. It could be how many pencils are on a desk. The purchase price could be multiple. How many trucks are out in the parking lot? We can create whatever we want. Only certain multiples are valuable and meaningful in the actual discussion.
When you talk about multiples, Patrick, today was the Fed decision. As you and I were on an interview, the Fed raised 75 basis points. While we were interviewing, as I mentally ducked out for a second, I got my shorts in. I am looking for companies that have a date with Dr. Zero. There are going to be quite a few of them as the Fed continues to embark on this.
Patrick Baldwin: A date with Dr. Zero, what is this?
Paul Giannamore: Companies are going to effectively go out of business. Thirteen years of free money or less than free money and all sudden, we're raising interest rates. There are going to be a lot of casualties.
Patrick Baldwin: I woke up to reading about SPACs, a billion and a half dollars worth of SPAC money getting returned.
Paul Giannamore: In 2021, we did a couple of presentations. Of course, we did Supernova. We talked about where things are going. We did Bubble Trouble. We're continuing to see what we talked about in Bubble Trouble happening in real-time in the market. Multiples are, in fact, contracting. We're seeing that across the board. I got back. I was two weeks on the road. I was in Egypt, Qatar, Italy, Switzerland, Liechtenstein, and Austria. Liechtenstein, there are 38,000 people there, Patrick. It's a little landlocked country. Have you never heard of the Principality of Liechtenstein?
Patrick Baldwin: No.
Paul Giannamore: It's a real country. It's landlocked between Austria and Switzerland. Charming little place.
Patrick Baldwin: Do they have an airport?
Paul Giannamore: They use the port of Lugano, which is in Ticino in southern Switzerland. They don’t have their own airport. It's one of the countries on the planet that has more companies registered than it does people. There's a population of maybe 40,000 or so. It's one of the wealthiest places on the planet. It’s an interesting little joint.
Patrick Baldwin: What took you to Liechtenstein?
Paul Giannamore: I was in Switzerland. I had to shoot over to Austria. I never went to Liechtenstein. My wife was with me and I said, “Let's check this place out. It can't take us long to pop through.” We went there and had a drink. She hated it.
Patrick Baldwin: Was it like Monte Carlo? It's landlocked so it's not.
Paul Giannamore: It's completely landlocked. It's nothingness. You wouldn't even know you're there unless you specifically were looking for signs and asking people, “Am I in Vaduz?” It’s the capital. I don't recommend people go. There are a lot of other places that I would put on the list. My whole point is crazy stuff is happening around the world.
I was in Egypt. My wife and I have a home there in New Cairo. I hadn't been there since 2019. It was the first time back in the house. I got to see a lot of people I hadn't seen in a long time. Egypt and all of North Africa, quite frankly, all the emerging markets are under intense pressure due to dollar strength. If you look at the DXY, you'll see the US dollars at a twenty-some-odd year high. The pound is at a 47-year low versus the dollar if you looked at that, Patrick. Have you kept your pounds shorts on?
Patrick Baldwin: I’ve not.
Paul Giannamore: Ride that thing down like an escalator. It's putting a lot of pressure on emerging markets. The environment in Egypt somewhat reminds me of what it was like pre-Arab Spring. It’s beginning to show signs of unrest due to food prices. The fuel there is subsidized. The country is broke. We're seeing that across the world. You go to Europe and that place is an unmitigated disaster. The energy problem there is a total nightmare. It's always hard to predict the future. I would not be surprised if they're on the front end of what's going to turn out to be worse than 2008 and 2009 for those guys. It is bad. Factories are shutting. We were seeing shops closing early because of energy consumption costs and so on and so forth.
Patrick Baldwin: You're talking about the cost of electricity, heating, fuel, and all that is so high that commerce is being shut down.
Paul Giannamore: Decades of globalization have been based on cheap labor and cheap energy costs. You've got countries like Germany that have taken 100 billion in Russian energy per annum and turned it into 2 trillion in economic output through manufacturing. They can't do that anymore. When you look at the manufacturing in Western France, when you look at Germany, when you look at Switzerland, when you look at Northern Italy, those are big manufacturing bases. They're having a difficult time keeping up because of energy costs.
Patrick Baldwin: This is because of Russian sanctions.
Paul Giannamore: I wouldn't say it's just because of Russian sanctions. Russian sanctions accelerated that. We're getting there anyway. Due to the malinvestments, underinvestments, and the fossil fuel space, we're getting there. You're starting to see it. It's going to be particularly bad in Europe soon.
Patrick Baldwin: I know we don't directly go into politics a lot here so I'll try to ask this apolitically because I know that's how you identify it. Tapping into the oil reserves here in the US to keep oil prices down, what are going to be the long-term implications of this?
Paul Giannamore: You're talking about tapping into the strategic petroleum reserves.
Patrick Baldwin: Yes. Tell us what's happening. How bad is it going to be?
Paul Giannamore: Patrick, the SPR, that's the rainy day fund for oil. If things go to hell in a handbasket, the US needs to have those reserves. Instead, we've got an administration that wants to appease the populace by lowering fuel prices and letting it out of the strategic reserve. It's a horrible idea.
Patrick Baldwin: What happens? Fast forward 6 or 12 months or if China and Russia decide to simultaneously attack the US. What's this do as far as putting the US at risk?
Paul Giannamore: Probably we've got worse issues to deal with if they attack us. When I think about the SPR, you draw that down when there are no other options. There's a reason you have that. That's an insurance policy. We started this whole Potomac TV thing, that's where we're putting our interviews. That's where I'm doing some basic economic updates on the industry. One of the things that I was talking about is that we've seen multiples contract in the public equity markets and the private markets. We've seen the multiples go down but we haven't hit the earnings recession yet. This is coming. This is where we get the real next leg down on transaction multiples.
Patrick Baldwin: Is someone going to wake up one day and say, “We need to build our strategic reserve backup.” All of a sudden, gas prices go from what was $4 to $5 a gallon up to $10 a gallon.
Paul Giannamore: I'm not an energy expert, Patrick. You and I have talked over the years about trading crude oil futures and the like. I haven't done as much research on it as I would have liked to. The way that I look at it is that all these governments around the world have tried to get society to use less efficient forms of energy. If you go back in time, people used to burn wood.
Patrick Baldwin: Now they're back to burning wood, I heard.
Paul Giannamore: I can see them chopping wood in Europe. You're using wood. In Great Britain, they chopped up all the wood and they didn't have wood. Now they were importing wood, hundreds of years ago, from the United States. We’re chopping down forests over here and sending them over there. They then said, “We can use coal.” Coal is more energy efficient than wood, it packs more energy per unit of weight.
Over time, society has gone from more efficient to more efficient forms of fuel, oil to coal to petroleum and so on and so forth, and ultimately, nuclear. These government policies have tried to force people to use less efficient fuels now to move away from petrol fuels. You can't do that unless that infrastructure is built. It's certainly not built right now. There's been a tremendous amount of underinvestment in petrol fuels and fossil fuels.
My gut told me that we were going to $150 to $200 a barrel whether we liked it or not. This whole Ukraine situation has accelerated it but it was going there. Whether it's the pandemic or Ukraine, all the end results, we were ultimately going to get there. It just would have taken longer. If you think about this whole work at home from the pandemic, I was reading research when COVID first started and I was reading that 1/2 of 1% of the US workforce per annum was starting to work from home.
What did the pandemic do? It made 30 years of that progress happen in a year. We got there 30 years quicker. I don't think it's going to be changing. I don't think we're ever going to get back to pre-pandemic. It’s a different system now. The post-pandemic world will be different. A lot of the reasons we're having this inflation is because consumer preferences have changed in a post-pandemic world. People are working in different spots and enjoying different things. Whether it's Ukraine, whether it's the pandemic, it sped up changes that were ultimately happening in society.
Patrick Baldwin: I think back, what does it mean to the owner-operator? Many episodes ago, I probably guess episode sixteen but I'm going to throw it out there for a second. Jamie Clement said something to the effect of, “An operator is not going to go out there and hedge their fuel costs.” Terminix can but mom and pop or smaller regional can't. Knowing that energy cost, going where they are, what can be done?
Paul Giannamore: J-Bug is right. Your average pest control company is not going to go out into the futures market and hedge gasoline prices. The good news is gasoline is not a huge portion of the pest control P&L. In a world of $200 per barrel fuel, that changes things. I would imagine what we'll probably see in that world is service frequencies will once again change, I would think so.
Patrick Baldwin: The consumer is going to be affected. Less demand for service is what I would expect. The discretionary disposable income gets squeezed down as they're feeling the pain of the pump. I don't know. Am I just making this up?
Paul Giannamore: Tim Mulrooney and I constantly have the debate about the fact that pest control in the United States, we've had increased penetration over the last several years, no doubt. Penetration rates have increased. He's got his theories on global warming. I don't have enough information, quite frankly, to be able to form an opinion on that.
I'm interested in what our readers have to think about this because you guys are in the thick of this. I'm more of an observer. I'm a bystander to what it is that you do out there. If I look back at twenty years of history, pest control has become much more of a preventative industry than one solely of curative nature. For example, take the advent of bathing colonies. You've got Sentricon. A lot of that stuff is preventative now.
Whereas before, several years ago, if there was a termite issue, you'd have to go out and treat for termites. As the industry has moved to more of a recurring revenue model, there are a lot of people, especially on the residential side, on residential service programs. Almost by definition, that becomes one of a preventative program. You're on a preventative program. people are coming out and taking care of your home.
It's less reliance. I've got $10,000 on Rollins going back 30 or 40 years. I was reading through a lot of that stuff. Even the narrative from Rollins years ago was that pest control was way more curative than it is now today. The question is, if somebody's got a problem, they're willing to pay for it. If you get yourself in trouble, you got to pay for a lawyer. If you get sick, you got to pay for a doctor. If you've got a pest problem and your wife is screaming at you, you're going to call the pest control company.
Patrick Baldwin: It’s cheaper than a divorce attorney.
Paul Giannamore: Discretionary spending gets pinched, especially in a stagflationary environment, one in which you and I have never experienced in our natural lifetime. Everyone always looks at the fact that it's such a small dollar amount in the whole scheme of things. If you got to cut costs, we're going to find out over the next couple of years what all that means.
Patrick Baldwin: Paul, do you know what I would do? I would set up a new brand in my market, just kidding.
Paul Giannamore: I'm going to make sure I send this to Terminix, “Patrick is setting up a new brand.”
Patrick Baldwin: No. That was air quotes, “my brand.” I was helping Shane with his Procter and Gamble.
Paul Giannamore: I‘m policing problems. I will say one thing. On the plane, I've been working on this 2022 valuation report. It's been taking me a long time because I've had to put a lot of thought into this. One thing that I have thought about a lot is when you think about the pest control industry in 2020, 2019, 2021, and 2022, there's been a lot of financial sponsors. Private equity firms distracted the industry. There's been an increase in investment capital in the industry. Everyone looks at it as a good thing. It’s a good thing if you own those assets and want to sell them right now. For everyone else, it's a bad thing.
At the end of the day, if you think about basic investment philosophy, when do you go out and buy assets? You go out and buy assets when they're hated, no one wants to buy them, and there's no interest in them. You want to buy low and you sell high. You want to sell assets when everyone's attracted to them. The market, like everything, is cyclical. It's a pendulum that swings back and forth.
As I think about all the capital that's been attracted to this industry, it further exasperates asset price inflation, which is great for those who want to sell. Also, attracting that additional capital ratchets up the level of competition in the space. Some of these private equity firms are bozos. Some of them, however, seem to have their act together. They're going to be formidable competitors.
In the crony capitalism society of the United States nowadays, those that get cheap money have an advantage over the smaller players. The larger players are able to get capital more so than us small guys. To me, unless you're a seller right now, all this attraction of interest in capital is not a good thing, it's a bad thing. We'll see how it plays out.
Patrick Baldwin: It makes sense. It increased competition, at least competent competition. Would you care to name some new competent competition to watch out for, the up-and-coming deep pockets?
Paul Giannamore: I'm not going to name any of those guys.
Patrick Baldwin: You had your chance.
Paul Giannamore: I don't know how competent they're going to be.
Patrick Baldwin: Place your bets, Paul. Who's it going to be?
Paul Giannamore: I’m a betting man but I won't bet on this.
Patrick Baldwin: Speaking of betting, I'll see you soon in Boston. You have committed to Boston. I've gotten more messages about you going to Boston than a lot of messages in a long time. There’s increased interest in the Mexican. There are a lot of people that want to meet the Mexican in Boston.
Paul Giannamore: Here's what's going on. There's one meeting that I got roped into. We're going to do it down here in Puerto Rico. It made more sense to do it in Boston because everyone was going to be there. I thought, “If I've got to go up there, I'm going to stick up there and stick around and see a bunch of different folks.” I am going to be there. Patrick, I don't go to Pest World very often. I do enjoy it when I go. For me, I don't go on the exhibitor floor unless I like to steal somebody else's nametag and walk around for a second.
I'm going to go up there and I'm going to have some drinks. If you and I have never met in person, I'd love to meet you. Track me down. Send me an email. I want to use this opportunity to have one serious meeting. For the rest of the time, I want to have drinks with people and get an opportunity to meet people that I haven't. Track me down. Patrick, what's our Buzz email?
Patrick Baldwin: TheBuzz@PotomacCompany.com
Paul Giannamore: Send an email because Patrick will be up there as well. Patrick, you're going to be there Monday through Friday.
Patrick Baldwin: I’ll be there early Tuesday, Wednesday, and Thursday.
Paul Giannamore: I'll be coming on Monday. I'm leaving early on Friday. Track me down. I'd love to hear from people and get an opportunity to meet people that I haven't met.
Patrick Baldwin: Is there a disclaimer or an apology for those that are going to meet the Mexican in person?
Paul Giannamore: Here's the situation, the Mexican will be going. At a closing dinner, we had the pest band closing, Patrick. You heard about that when we did the pest band closing.
Patrick Baldwin: Is that the one where you almost choked and died?
Paul Giannamore: That was a different one. He got drunk and dropped a gin and tonic on the CFO of Anticimex. The Mexican is an interesting character. He'll be up there if you want to see him.
Patrick Baldwin: Do you want to apologize now?
Paul Giannamore: I can't wait to see what he’s going to do. I know he's going to create all sorts of problems, 100%.
Patrick Baldwin: I'm looking forward to it. Paul, have a great week. I hope things get better down there in Puerto Rico for you and your island colleagues.
Paul Giannamore: Mr. PB, I look forward to seeing everyone in Boston.
Patrick Baldwin: See you, Paul.
Paul Giannamore: Talk to you.
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Mike Givlin – past episode
episode sixteen – past episode
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