Paul Giannamore: It is high margin, extremely sticky, you're in these houses, and 95% plus retention rate, I would go all in on that.
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Paul Giannamore: Welcome back to The Boardroom. Seth, how are you doing over there?
Seth Garber: I'm doing great. How are you, man?
Paul Giannamore: Doing well. I've had some long interviews in recent weeks and now it's just the three of us. Fat Pat, what's going on down in Texas?
Patrick Baldwin: It's hot.
Paul Giannamore: What kind of weather are you facing? What's the temperature?
Patrick Baldwin: 105. It's terrible. Twenty-five consecutive days of triple-digit heat.
Paul Giannamore: I was at a YPO meeting and somebody had come from Florida and said the water in the Keys was reaching 100 degrees Fahrenheit. Does that sound right to you, guys?
Seth Garber: It does. I got a call from Amanda and they were down with their family at the beach, and she said that the water was over 100 degrees and nobody wanted to get into it. That was a clear water beach area, which is about five hours North so it's brutal.
Paul Giannamore: This is probably one of the hottest summers on record down here in Puerto Rico. The water is super warm. Hurricane season just started and we've already had some nasty weather systems come through. This might be a brutal hurricane season.
Patrick Baldwin: Does it get in the 90s there?
Paul Giannamore: No, not really. It touches it a little bit, low 90s. It doesn't get Texas hot. We've got more humidity. For us, being in the 90s is pretty hot.
Seth Garber: Paul, since you've gotten so in shape, do you feel much hotter or do you feel cooler now that you have less insulation?
Paul Giannamore: I feel cooler. It's keeping me cooler, less insulation, for sure. Fat Pat, how are you feeling?
Patrick Baldwin: I see where this is going. Go ahead, Seth.
Seth Garber: It's okay. I'm not as fit as Paul is and I feel cooler so I can imagine you feel very cool.
Patrick Baldwin: This is like Goldilocks and the Three Bears and I'm the most insulated. I see where this is going. Fat Pat's here. It's hot.
Paul Giannamore: Do you guys have any trips planned soon?
Seth Garber: We've got business in Oklahoma City, which I'm super excited about. It's going to be incredibly hot. We're heading to Indiana the following week for AAC's big event and then we get into the whole PestWorld world. Where are you heading? You're heading out somewhere, aren't you, Paul?
Paul Giannamore: I'm off to Asia and I'll be in the Philippines and then I got to hit Europe on my way back to Puerto Rico. Probably my next trip will legitimately be to PestWorld. Fat Pat, are you going to PestWorld?
Patrick Baldwin: I’m not going to Pest World.
Paul Giannamore: No PestWorld this year.
Patrick Baldwin: I’m not skinny enough yet. I don't deserve it.
Paul Giannamore: This is true.
Patrick Baldwin: You all have fun. So far, Boston's my only PestWorld.
Paul Giannamore: You've got time. You've got over two months to get ready.
Patrick Baldwin: Have you seen my workout schedule?
Paul Giannamore: I've not.
Patrick Baldwin: I can’t get it done in two months.
Seth Garber: We've seen the results.
Paul Giannamore: Yes, we have.
Patrick Baldwin: Thank you.
Paul Giannamore: I wanted to talk to you a little bit, Seth, about one of the things that I am seeing here in the market. This isn't talk, this is actual data. Over the course of June, July, and now into August 2023, we're starting to see some softness in customer retention rates. We're starting to see some deterioration on the demand side. As you all know, folks have pushed a lot of price increases through in recent years. We're, for the first time, starting to see some pushback on that.
Now there's certain areas of the country, particularly the Boston metro area seem to be immune and I'm not sure why. When I look at other areas of the country, the Midwest, certain areas of the West Coast, even in the Southeast, to a certain degree, we're starting to see softness. Rates of growth are decelerating, customer cancellations are ticking up, folks are getting complaints about pricing, and so on and so forth. I'm wondering in your consulting business if you're seeing the same thing.
Seth Garber: There's a little bit of insulation in the consulting business a little bit. Now we see data from companies that are non-consulting clients because we get focused on these as changes happen. I would agree with you. The one thing that I'm seeing that's been interesting is some of the markets that would tend to have higher churn tend to be slowing down and coming more within a lot of the averages that we see in different parts of the country and I'm not sure why.
If we look out in the Vegas markets and places that historically have these high churn numbers, they're getting nice and flattened out, which I find interesting. I think about Vegas specifically, now they're back, and everything's up and working after COVID. There's a lot of comfort level there. I'm wondering if people are buying a little bit more and the consumers are being a little more educated, I'm not sure. The one thing I will tell you is that throughout COVID and even up until recently, we were able to press any price increases we wanted.
We were able to do multiple price increases. I would almost even argue at a level of somewhat recklessness to where we could throw prices out there and people would accept it. We are much more careful now when we're applying pricing pressures based on different cohorts of services and how we're doing it and being more measured, which we've talked about before on different episodes. When we went with more of a broader stroke, for the first time, we were getting pretty big pushback from some of the consumers on the price increases we were pushing through for the first time in years.
Patrick Baldwin: Does a lot of demand come from new home ownership? If interest rates are high, people are buying less. They could sell but they have nowhere to go and afford it except for coming out of California and they can cash out. That pushes prices up here in Texas, let's say. In Vegas, if there are not a lot of people necessarily selling because there are not a lot of people moving, in general, is that what's pushing down demand?
Paul Giannamore: Are you talking about demand for pest control services, for example?
Patrick Baldwin: Correct. Could you look at those being directly related?
Paul Giannamore: We did a study years ago that was probably more anecdotal than anything. I wouldn't call it a sophisticated statistical analysis. However, it did point to the fact that there's not as much relationship to new housing starts or even the secondary market in relation to pest control service demand as people seem to think. We didn't see any sort of correlation in those sorts of markets. Conventional wisdom is that as people move into new houses, they get pest control services.
When there's a lot of turnover in the housing market, it should stimulate demand for pest control services. That's not evident when you look at the growth rates in the industry as well as if you benchmark the large players in the industry and try to attempt to correlate that in some way, shape, or form to a variety of different housing data. It doesn't tell a story. We weren't particularly granular but there's a lot more that goes on behind the scenes there than housing starts and turnover in the secondary market.
Seth Garber: We deal in a lot of working with home builders, pre-treatment, installations of bait systems, and all kinds of different things. One of the things that I did see, which I was surprised by, is we are having a more difficult time in different markets, getting the first-year renewals on the termite warranties than we have ever had. Typically, we would renew them easily. We had good processes around it. This is at scale too for some of the markets.
Right now, it's been more difficult to get that first-year renewal than it's ever been. We're seeing a lot more churn on the first-year renewals than I've ever seen before. These are in the metro markets. The tertiary markets haven’t been as big of an issue. For installing a few thousand systems in a certain market, a year later, those systems were not getting the same type of renewal rates that we were getting years ago, which probably correlates to what you're saying, Paul.
Patrick Baldwin: To clarify, you're talking about bait stations as pre-treats or liquid pre-treats.
Seth Garber: Bait stations for pre-treats. It could be a combination. The data that I care about is if our clients are doing a ton of liquid pre-treats, honestly, I don't love that business to begin with, and it's not super scalable. The ones that I focus on are the bait systems that are easier and we can sell at scale and those are the ones we're not seeing the renewal rates nearly what they were years ago, which is interesting to me because that's never been a problem before.
Patrick Baldwin: Your consulting clients, are they repoing for lack of a better term? Are they pulling stations after a year?
Seth Garber: It depends. Everyone's got their own opinion on this. As you relate to Sentricon, Sentricon regulates that pretty heavily. For the companies that use Sentricon, I would tell you that they're fairly obligated to do it. For the other systems, for a Trelona system, or there are several other ones out there, it depends on the business model.
If these guys are charging the bigger dollars for install, they tend to leave them. If they're doing some type of a lease or monthly subscription model, they're pulling them out. The reality is a lot of people leave them there. People are going to probably think this is crazy but in some instances, it's cheaper to leave them there than it is to go pick them up depending on how far they are down the road.
Patrick Baldwin: I was wondering if you had a general rule of thumb, Paul, or if you even see this where repo has better retention than letting it go.
Paul Giannamore: You're saying when people come out and take the base stations out?
Patrick Baldwin: Yeah.
Paul Giannamore: I don't know. I've never looked at the data. There's been a handful of companies over the years. When they do a residential program, they'll make their own bait stations, even though they don't do anything. They put the company logo on it and they put it at the house. When the guys cancel service, they have to come out and take the bait stations and say, “The stations have to come out. You're not paying us anymore.” They think twice about it. I don't know that there are any studies as to the effectiveness of that. It sounds like an interesting gimmick and maybe it works.
Seth Garber: If I think about the repo, is my ego so big as a pest control owner that I'm like, “If I go pull my stations, I'm going to show you.” Is my ego that big? When I built my company, we were a massive purchaser of rodent stations and we had them custom made for us. I remember having the ego sitting there with my business partner and my business partner was like, “They canceled. We got to go and get our stations.”
Meanwhile, we're driving a truck, loading up twenty bait stations at this commercial property, driving them back to the office, and stacking them all up. We ultimately decided that if someone canceled, we'd leave them. It was such a pain in the ass. There are probably still thousands of rodent stations all over Florida in buildings that we don't service that we probably installed that had our company logo on it. I've heard operators say, “We're going to get our stations off to buy them again.” Honestly, the next company is going to give it to them probably. It's an ego thing.
Patrick Baldwin: It's definitely humbling to go pick up stations. What we did and I would do it differently but we let them stay in the ground. In fact, we'd have people switch over to us because their other company was threatening to pull them. They would pick up the phone and figure out that we were also the bait station calling, “We don't pull stations. If they pull them, we'll go put new ones in the ground. Let them pull them. Let it go. We'll fill them back in.”
There was an exception to the rule. I could probably count on two hands the number of times we got clients that way. If we focused on the repo and doing that well, we would have retained a lot more baiting clients. I've had a conversation. If you cancel within the first three years, there’s a $300 cancellation fee for bait stations. They're doing that to combat the door-to-door that's going through the area and almost giving away Sentricon.
If they're locked in, they remind their client, “If you cancel, it is $300 to cancel.” That's helping them also but they almost swore by repos is the way. I've come more and more to love the whole termite baiting. We looked at Bora-Care and Borathor and borates for pretreats, it did a lot of liquid for commercial. More and more, technologies come a long way. The subscription model and what you can do with the termite systems and both, you pay a little bit more for the cost of goods sold. You end up getting your $20, $25, or $30 a month after an install and you could start month two, I love it.
Paul Giannamore: There is something to be said. I've often thought if I wasn't busy doing a lot of other things, I would go to the Southeastern United States and start a Sentricon baiting-only company. I wouldn't even do pest control. I would just do Sentricon baiting and I'd get door-to-door sales guys to go out into those neighborhoods.
I would install Sentricon, I would monitor it, and that would be it. I would just collect those coupons and then I wouldn't dick around with wasp nests and all sorts of other stuff. By the way, if another firm needs to come out and handle that, so be it. I wouldn't even worry about losing the customer because that stuff is sticky. You could probably go out there and build a $20 million business in two years if you did this right. That's what I would do.
Seth Garber: I want to tell you, Paul, I appreciate it because now we have to build models and processes and procedures for all the people that are about to move to the Southeast and start a door-to-door Sentricon baiting-only company. I appreciate it, thank you.
Paul Giannamore: Does anyone have any pushback on that thesis?
Patrick Baldwin: I had a phone call, I said, “It would be awesome to start a Sentricon business.” It's funny you said this.
Paul Giannamore: Fat Pat wants to take credit for it.
Patrick Baldwin: I've got a witness.
Paul Giannamore: Let's get that witness on the phone.
Seth Garber: I imagine the discussion when Sentricon comes and they meet with you and they tell you that you have to have certain amounts of termite work and you tell them that this is all you're going to do. I wonder if they would go and back it and if they would give you a Sentricon or if they're going to say, “How many do you have? How many do you do per year?” There are a lot of companies out there that have incredibly simplified programs and we work with some of them.
If the model is to keep it super simple and do the same service and that's all you do is, frankly, when you look at the books of these companies and you've probably seen some of them, they look incredible compared to a do-everything company, they do. We have a couple of clients that do it, that do limited services, 1 or 2 services, they don't deviate at all, they have it sorted out. Honestly, their P&L looks great.
Paul Giannamore: If you got sophisticated about it and you thought about the customer acquisition costs, not only could you do it through door to door, but you can go out and get channel partners. You can go out and find a lawn care company. I know personally a lawn care company in the state of Georgia that does $25 million per year and they don't do any pest control.
You can go out and put together an offer the customers of that lawn care company cannot refuse and forget a way to incentivize those technicians. Sell those Sentricon baiting stations all day. Have your people come out. You're a termite expert. You've got an effectively 95% retention rate in termite country for a Sentricon baiting station. Especially if you can target neighborhoods tightly, you're effectively building yourself a long-duration bond that pays a high coupon. It's abundantly sellable at some point in the future.
Instead of focusing on lawn, pests, wasps, bees, and this and that, “That's all we do. We are the experts in termite control here in termite country. This is what we do. Here's how we're on top of it and we'll give you a great program.” You can do neighborhood sales where you can say, “You've got fifteen people in this neighborhood. If 10 of the 15 of you sign up for this, you're all going to get a free installation,” or what have you?
All of a sudden, fifteen houses, one guy went out there and talked to all the neighbors and gave them a deal. There are a lot of things that you can do to get creative and build a sticky, extremely recurring high-margin business and not dick around with a lot of other stuff. Who knows? Should I go up to a termite country, Seth, and get this done?
Seth Garber: The more important question is what would you name it? Would you call it Pauly G's Sentricon E's or something? What would you name it?
Paul Giannamore: I would focus on termites because termites scare everyone. The cockroach might scare your wife every once in a while but it's the termite that scares the homeowner. I would certainly have termite in the name in some way, shape, or form. Patrick, you're wincing over there. You don't like that?
Patrick Baldwin: I thought you were going to say Fit Jacked Paul's Pest.
Paul Giannamore: No. It reminds me of ugly nightclothes that women wear and you can call it the termite because it destroys wood. I don't know where I would ultimately go with it. I've thought about this. Where'd you go, Fat Pat?
Patrick Baldwin: I'm back.
Paul Giannamore: I think about a lot of things but I don't do it. I've been having a hard time debunking that as a thesis in my mind. In the big companies, you would talk to an Orkin or Terminix, “You can't do that. That's not worth that much. That's BS.” It is high-margin, it is extremely sticky, you're in these houses, and 95% plus retention rate, I would go all in on that. I would come up with a good name. I would have termite in the name, Patrick.
Patrick Baldwin: Paul checks for wood once a year.
Paul Giannamore: I would call it Paul Checks Wood Once A Year, that's a great name. I would want the customer to understand that it's termite-related, Patrick. That's what I would do. Channel partners, probably get some door-to-door guys going at it. I would do the opposite of what everyone else is doing. I'd maybe have postcards and I'd probably do some neighborhood routines. There are new folks moving into the neighborhood, you got a gift basket, and you bring that out, “Welcome to the neighborhood. Here's a plumber. Here's this and that.” Let them all fund it and then ultimately, “Here's what we're going to do, we're going to put Sentricon in here.”
Patrick Baldwin: Your spiel rolled out earlier, “If you get ten of your buddies to sign up, we'll give it to you for free.” It sounds like you've been knocking on the doors. You've been around 1 or 2.
Paul Giannamore: I've knocked on a door every day.
Seth Garber: Would you guys want me to pull the camera guys out and watch me go out with a box of Sentricon and see how fast I could sell one to somebody in my neighborhood?
Patrick Baldwin: Yes, if it's authorized.
Paul Giannamore: Maybe I should go out and try to sell Sentricon.
Seth Garber: In Puerto Rico or are you going to come to Tampa?
Paul Giannamore: No, we don't have much termite pressure down here.
Seth Garber: That's even better.
Paul Giannamore: That's true but no one concerns themselves. When I think about different areas of the country, you need enough activity where it exists in people's minds and they talk about it and they're like, “Do you remember old Jim before he passed away? His house was a real shit show from the termite.” You need that. In certain areas of the country, they just don't exist. It's hard to sell preventative.
Seth Garber: Are you saying, Paul, that you don't think you can build enough value in a place that doesn't have termites to sell Sentricon?
Paul Giannamore: What I'm saying is I got to first look for the pain point. I got to tend to a problem. If there's no problem and no one believes it's a problem, I'm wasting my time. Sure, probably I can't build enough value but only the fool would attempt to build value where pain doesn't exist.
Patrick Baldwin: I got one. We all go to Tampa, we each get our box of Sentricon, we pick three different parallel blocks, and the first one to sell wins.
Seth Garber: If we're going to do it, we have to pick someplace that's fair. I don't think Tampa is legitimately a fair place to do it.
Paul Giannamore: In theory, you could look at a place like Ohio and Illinois where there is termite pressure but it's not nearly as ridiculous as the Southeast. It’s pretty easy to look at termite pressure maps and experiment. I know that if you take a neighborhood in Georgia, a lot of those people are using baiting. If you take a neighborhood in Illinois, not so much. That's like a liquid treatment zone because it's like, “I got a termite problem. Go out and do it. Liquid treatment and some are renewal.” I don't know. None of this is tested. I'm surprised I haven't seen this yet and maybe we will see it.
Seth Garber: From a financial standpoint, it's tested. You could take a P&L, pull out everything that's not a Sentricon system, and see what the performance looks like.
Paul Giannamore: We should run a test on this. Maybe one of our readers might want to run out there and do this.
Seth Garber: If anybody wants to do it, they can use my team's resources to build all the marketing around it. We'll do it for him, whoever wants to do it.
Patrick Baldwin: I thought someone would fly the three stooges out. The three of us would go out there and sell door to door.
Paul Giannamore: I'm not going to do that, Patrick.
Patrick Baldwin: I know that.
Paul Giannamore: I'm way too lazy to do any sort of real work.
Seth Garber: I would do it.
Paul Giannamore: There you go. I like your work ethic, Seth. Ehy don't the two of you guys go out and do this?
Patrick Baldwin: What about this discounted install, especially in the door-to-door world where it's almost next to nothing and they're almost giving the stations away? Is that a replica model where you can almost give away Sentricon to get it installed in the ground?
Paul Giannamore: You can because that stuff lasts a decade plus. You get that out there and you get good pricing for it.
Seth Garber: I'm completely agnostic to the different products.
Paul Giannamore: To your point, Seth, I don't know that it necessarily has to be Sentricon. There are a lot of great products out there. We're talking about termite baiting. It doesn't have to be Sentricon, it could be whatever. Anyway, I do think that there is something to a termite-baiting-only company. In theory, you might have to have a division that does liquid treatments when you've got intensive stuff. The goal here is to become a company that's focused on preventative as opposed to curative because that's where the money's at.
A couple of the actual studies that we did over here is we looked at companies in different markets. There's a company we're taking out to market here in Q3 this 2023. We did a valuation form in 2022. They're probably north of $15 million in revenue and they needed to increase pricing but it's a company that's been around forever and they didn't need to do it across the board, they needed to do it in buckets.
We exported their entire customer list and we looked at the duration of each customer. When was the start date? How many price increases have they had? What are they paying right now? How many recalls have there been? We put together a variety of different charts and tableau and we looked through this stuff and then we said, “This subsection of the company or the customer base needs a price increase on the order of X amount.” It could have been 5%, 10%, or 12%.
We have done this for a variety of companies that are clients of ours across the United States. Interestingly enough, with some price increases that we did at the real beginning of the season, end of March and early April, customers have pushed back in the summer here with regard to, “It's way too expensive. I can get this cheaper.” One company, for example, has different plans. For everyone looking at it, it's a standard residential protection plan.
It could be an all-inclusive, tri-annual, or quarterly. It's the full year, everything's kind of covered. We looked at some of the numbers. The median price on this most recent basket was $638 per annum. Every part of the country is going to be different. Atlanta Metro is going to have way more pricing pressure than the Midwest, for example. We see some guys charging $640 a year, some $550, some $850, and some $900, it's across the board.
In these most recent price increases, we got pushback and we're starting to hear, “We can get it cheaper.” Even now, as we get into July 2023, we're noticing certain door-to-door companies have been offering discounts. Door-to-door companies, one of their benefits is they are typically high priced vis a vis the local player. These guys aren't scared to sell a $1,000 or $1,200 per annum contract.
We're starting to notice that they're discounting on the doors. They roll up, “I pay $640 a year and you guys are trying to sell me something for $850. Why am I going to pay you that?” “If you sign up with us, here's what we're going to do. We'll do this at $500.” This is the first time I get direct reports as well as seeing it in the numbers of this discounting. Since pre-COVID, I haven't dug in deeper to understand the cause and effect behind that. Needless to say, it does appear that consumers are starting to push back.
Seth Garber: I would agree. We're seeing it in the mid-Atlantic. In the Northeast, not so much, but mid-Atlantic, we're seeing it a lot all the way down through the Southeast. We're seeing the same thing you're describing where it's a lot of discounting. We're seeing a lot of that right now. The Middle Atlantic and the East Coast have been crazy with some of the different prices. If you look back a year ago, we were celebrating some of the door-to-door companies because they were selling at incredible value.
One of the companies was consistently selling it north of $200 per service, which I loved. It helped our clients a lot. We were able to raise prices pretty easily and all the door-to-door companies were about the same and I liked it a lot. That same company today is now offering a $59 initial and it's $60 or $59 a month, something like that. They've come down. The other component that I also think could be happening is the door-to-door talent, they're getting these guys out into the field with, I would arguably say, different training or a different level of sales rep than was there before.
One of the internal drivers to that is a lot of the better sales reps. We've got some resources in the door-to-door space. A lot of the better sales reps have all moved to Solar. The guys that were in the industry killing it have now jumped over to Solar and things that are paying more, which I found interesting. It could be a mix of talent plus economics to where they're bringing in a little bit lower-level talent, honestly.
I had a guy at my house from one of the national companies and they knock on my door here all the time. He immediately walks up to the door and offers me a discount. The same company a year ago was an incredible sales team. The guys that were hitting my doors were incredible. These guys were entry-level and green, the ones that were here. It might be a little bit of a feeling there versus data but it’s interesting.
Patrick Baldwin: Did you help train them?
Seth Garber: No, I didn't train those guys.
Patrick Baldwin: After he crashed a burned, did you help him?
Seth Garber: I walked him through a little bit different strategy and I hope it helped him so we'll see. I did help him.
Patrick Baldwin: Do you have theories on why demand is soft?
Paul Giannamore: It's largely related to the health of the consumer in general. You look at credit card delinquencies are up and you look at foreclosures on automobiles are up. It's purely related to consumers tightening the belt. The PPI came out, the producer price index came out, and we had an upside surprise to inflationary pressure. Inflation is still there and there's a lot of inflation in the services space. It's the overall health of the consumer.
Patrick Baldwin: In addition, would you also say there were a lot of price increases during 2022 and those companies probably did not do a lot of price increases leading up to 2022? Now they're going back in 2023 trying to do another price increase because it's needed and then their clients are like, “One was enough. I put up with you last year but now, again? I'm not used to this.”
Paul Giannamore: You want to raise prices when price inelasticity is highest. You wanted to do this early on and the guys that are doing it now, it's perhaps a little bit late, but you want to do price increases every year, but it's timing, that could have something to do with it, Patrick. That's a good point. It might also be the magnitude of price increases. You can't charge $5,000 a year for a residential pest. At some point, the consumer starts to substitute or do without and we don't know what to point is per se. We're starting to see some pushback.
Patrick Baldwin: You're seeing it across your universe of clients and it sounds like, Seth.
Paul Giannamore: We're seeing it across everything from traditional door-to-door across the country. On the door-to-door side, some of the concerns that I have in the door-to-door space is, let's face it, door-to-door commissions have gotten unbelievably out of control. If you look at the 20-year history of this industry, it has gotten ridiculous.
A lot of that has been a direct result of hot money flowing into pest control and other resi services businesses. When you have debt capital and equity capital coming in, when you've got an acquisition market that heats up, these guys are rewarded for having built that customer base and can afford to pay more for door-to-door sales reps. I do think that competition among sales reps has pushed commission rates up.
On top of that, it's been way more expensive to get people apartments. We've had occupancy inflation. You’re paying more for food, you're paying more for housing, and you're paying more for commissions. When I start to look at some of the economic fundamentals for some of the door-to-door companies, not all of them, I'm making a generalization here, but a larger proportion now is forced to compete and pay higher commissions, which has a detrimental impact on cashflow, and impact valuation.
We've gotten into this cycle. I know all the owners and managers of these companies, they're all aware of it and they're not particularly happy about it. Some are doing better counteracting that than others. It is going to become consequential and that will typically start to rear its ugly head as attrition rates kick up.
Seth Garber: Paul went through 25 different items, which makes perfect sense. We're a little bit insulated when it relates to softening demand, the data sets that we look at. Because these are highly aggressive companies, we have to manage them because we have certain growth rates we want to hit. The one component, which I find interesting, and this shifts over to the marketing a little bit, is that we're generating a tremendous amount more leads than we've ever had to generate in order to get to where we want to go.
The interesting thing is that we're also generating leads much cheaper than we've ever been able to generate them before. The agencies are doing a good job now. What that says to me is that there is a softening demand. However, from an economic standpoint, at least it relates to cost, is that our customer acquisition cost is staying similar or coming down a little bit, which has been beneficial. For our insulated group of clients across the US, it hasn't been impacted as much as the entire market. I'm not going to say that's work that we're doing, it's the work that the agencies are doing, and it's the CEOs that are focused on hitting specific metrics that we want to get to.
By looking at, “Where do we want to grow the company? How do we want to grow the company and stay laser-focused on those things?” It has insulated a lot of these guys in markets that we typically would have high demand, we’re having lower demand, except we're able to generate a lot more leads through bigger marketing efforts to counteract that. If we needed 1,000 leads to hit our goals and we would pay X amount of dollars, now we may be able to generate 1,500 leads for the same exact cost in order to get to where we want to go. We've hedged against it is the best way to say it in most of the markets because we're pretty insulated.
Patrick Baldwin: I heard you say you're the top consultant in the industry and that your clients are immune from soft demand.
Seth Garber: No.
Patrick Baldwin: That's what I heard.
Seth Garber: I'm not saying that.
Patrick Baldwin: Paul, I know you've got Asia in front of you. New York is a couple of weeks in the rear-view window there. You're out shaking hands and kissing babies. Any common questions that you're hearing out there?
Paul Giannamore: It's universally questions about private equity transactions. We closed three in New York, yet to be announced, and I don't know when they'll announce these. Private equity firms tend to take some time while they get their act together. A lot of operators are interested in understanding how the equity role works in a private equity model and how the funds work and the distinction between a family office and a private equity firm and how that works.
In my opinion, in general, and I'll say the same thing on the air that I said in person is that a lot of guys will get contacted by private equity firms. One of the things that excites me is most private equity firms will say, “Do not use Potomac.” If I think about private equity transactions, especially the platform deals, both in Asia, Europe, and the United States, in this industry, we've done most of them. A lot of these deals were 5X revenue plus 20 times EBITDA.
There are a lot of distinctions between each of these different private equity firms. Some of these are going to be phenomenal successes and other ones are going to be unmitigated disasters. When you have the better part of 100 financial sponsors trying to get into an industry, they're not all created equal. A private equity firm is betting on a company and it's betting on a management team. It's partnering with you, the manager of a business, especially if you're rolling equity and co-investing along with them.
You're betting on the sophistication of an investor. Their track record of being able to invest in harvest returns over a long cycle. What people don't realize is that after investment banking, I was in private equity years ago, it was a different environment than it is today. I always tell people over the last 12, 13, or 14 years, we've lived in an environment of suppressed yields, and ever-increasing equity valuations. More than half of the private equity professionals that you're meeting with today have never worked professionally in an environment that wasn't of declining yields and increasing equity valuations.
The jury's out as to what can happen but I do think active management rather than passive management is going to become an increasingly important aspect of getting risk-adjusted returns in your portfolio, whether private or public. A lot of these guys are relatively inexperienced in navigating a difficult financial environment. As yields rise, both in nominal as well as in real terms, the rollout model gets more complicated.
The sophistication and experience of private equity managers can become more and more important. My position with all of these guys is, first off, don't just do a deal with the guy that contacts you. The private equity firm sends you an email, there's a hundred of them. We talked about that with Jonathan. He went through a formal process and he's like, “You're an idiot if you don't run a formal process.” This isn't a pitch to use Potomac, although you should.
At the end of the day, you need to use somebody who knows what the hell he's doing. At the end of the day, you've got one asset and it's finite and it's relatively scarce. There are 100 bidders for your business. Do you think that the guy who happened to write you the email is going to be the one who’s putting the best offer on the table?
Do you think that not running a process will ultimately allow you to extract the most value? Furthermore, have you done your homework? A lot of these guys who do deals will talk to individuals who partnered with private equity in the past. Let's say, Fat Pat, you run Fat Pat's private equity, white shoe, Wall Street, a private equity firm, transplanted down to Waco, Texas.
Patrick Baldwin: I don't know what that means but I'm sure it was an insult. Keep going.
Paul Giannamore: You're running this thing and you're a private equity manager. You've got a private equity fund, which is a ten-year limited partnership term, limited duration fund. You've raised $500 million and you're investing it. You've done, let's call it, 3 or 4 other deals that you own in your portfolio and now you're talking to pest control companies. Let's say prior to that you raised $200 million, you got some exits in fund 1, and you're in fund 2 now.
What most sellers will do is they'll say, “I want to talk to somebody who's done business with you, Fat Pat.” You'll say, “Talk to Skinny Pete, he owned a plumbing business, and we did a deal with him. You should talk to him.” You call Skinny Pete up and Skinny Pete's like, “These guys are great. I made some money. They're good to work with.” You're feeling all good.
My real question though is you're not partnering with skinny Pete, you're partnering with the private equity, the management firm, and the professionals who are charged with making the decision. You're partnering up with the investment committee that's making those decisions. The real people that I want to talk to are the limited partners who have invested in these funds because those are the guys who have done diligence.
They're the ones who've gone out and looked at 2, 3, or 500 different private equity firms. They're the ones that have compared returns on a risk-adjusted basis. They're the ones who have vetted these people, as both individuals and as well as professionals. Anytime I am involved in that, I want to talk to the LPs. I want to talk to the guys who are smarter than me and are investing billions of dollars who've done diligence.
Skinny Pete's an idiot. He's like you or me. He's a businessman who has no idea what he's doing talking to another guy. I say that jokingly but let's be honest, he's as ignorant as everyone else. You don't want to talk to Skinny Pete. You want to talk to the fat cats in the suits that have a lot of money and spend a lot of money on DD. One of my discussions with pest control operators who are thinking about private equity is always run a process.
Don't be the idiot to take the email. Are you the same guy that gets the Viagra email and you're like, “I could use some Viagra. I'm going to order that online and it'll come from Pakistan.” You don't do that. There are all these things that you don't do in normal life. Why would you sell your company to some search fund or random private equity firm that emails you? It's an easy thing to do and always think price is objective and they think there's no distinction between private equity firms A, B, and C.
The reality is private equity firms don't do a great job. Anyone who sat down with a couple of dozen of them realizes that it's difficult for them to draw distinctions and differentiation among themselves. They all sound the same, “We've got very patient capital. We're doing this. We're value creation levers.” It's like they took the HBS book of buzzwords and threw it around and they all dressed the same, the blue shirt, and the khakis.
At the end of the day, it's on you if you're going to roll equity. If you're selling out 100% and you don't care what happens, who cares? If you're going to invest alongside these guys, if you're going to sell a business for $30 million, if you're going to roll $10 million and try to exit in the future, and you think, “I should get five X my money because that's what they do.” As we know, the past is not indicative of future performance so we're in a different environment right now.
At some point, all of these returns in a difficult environment are based on the financial decisions that these private equity managers will make going forward. You partner with them and they go out and do acquisitions, do you want somebody who is like, “We'll do these add-on acquisitions and we'll pay what we need to pay to get them done. We're going to consolidate and grow and turn around and sell it.” Do you want somebody who's going to say, “I'm going to go out and do deals. I'm going to make sure I have appropriate liquidation preference on my transaction whereby my fund gets paid back first.”
There's a certain lick preference on it and all sorts of sophisticated things that you can do in a deal. You also want to make sure that you're not that guy who has happened to. Some of the things I see in this industry, when I look at some of the private equity deals that have been done, what strikes me is that sellers don't have appropriate counsel and that could be legal counsel and that could be advisors, or what have you?
When I look at some of these transactions, I say to myself, “Why did you sign up for a deal where there's a ton of preferred stock on top of you where you get a 2X liquidating preference?” This means the private equity firm makes 2X its money or 2.5 times its money before you, the partners even paid anything and they don't realize what that is. A lot of times, lawyers who are not in tune with sophisticated equity participation agreements and shareholder agreements don't know what that means.
They don't understand the dynamics of in the case of a liquidation or in the case of declining valuations. Five or six years from now when somebody has to exit the business, need to get the deal done, and the private equity firm says, “I got a 2.5 times prep on mine. Let's get it done. We'll return 2.5 times our money to our LPs and we'll squeeze out all of our partners.” Now you invest $10 million and you thought you were going to get $10 million and now you get $5 million back and you lost half your money over a five-year period. It's not a good return.
The other thing that I say is it's always important to think through these preferences and a variety of different things when you're on the front end of a process and you're going through an auction process and make sure that sort of stuff is discussed. There are aspects of the shareholder agreement. To a certain degree, you're not going to be able to change certain things that are baked in the institutional cake.
You've got to understand the difference between, for example, I invest with Fat Pat's Private Equity. I've got a company, I got Paul's Pest, a platform. Let's say I'm going to do a $50 million deal and Fat Pat comes in and says, “Paul, let's make it round numbers. You're paying me $100 million for my business.” “All right, Fat Pat, I'll take that.” You're like, “Paul, I'm going to give you $80 million in cash. I'm going to give you $20 million in rolls.”
Now you're going to roll $20 million into my business. I say, “Okay, that sounds great.” How the hell are you making money, Fat Pat? You're like, “I take a 2 and 20. I take a 2% management fee and I take 20% of the upside.” I say, “Okay, that's pretty industry standard.” Are you paying yourself 2% on your equity or just mine? How does that work? Are we Pari-Passu? Are we treated? Am I a partner with you or am I not? There are a lot of times when you're not, you're treated differently.
If you're truly partnering with somebody, you want to be Pari-Passu. Some firms just won't do that. They'll say, “Fat Pat, you're paying me 2%, I'm not charging myself.” I'm like, “2% management fee over time, that's a lot of money.” It's an illiquid asset and we got to manage it and we got to fly around and we got to do deals and we need that money. I don't know, that's a pretty big chunk compounded over a seven-year hold period on my $20 million. It doesn't make me particularly happy.
There are basic things that guys don't think about. For you guys, as buyers though, at the end of the day, one man's loss is another man's gain. I'm exclusively on the sell side. I spend my life fighting against a lot of this nonsense and I blow up a lot of deals and I scream at a lot of folks. At the end of the day, the other side of that coin is if you can pull that off, you should do it.
I'm not telling these private equity firms to not do that because if you can find people who are either ignorant or do not want to educate themselves about those facts or otherwise just negligent, then you know that's the value that you'll extract. You don't have to be a private equity firm. Being a buyer, you being a businessman out there who's growing a business and building a business, you're under no compulsion to do a “fair deal”. I don't think you should be taking advantage of widows and people who are dying. You got to do the right thing.
A lot of times, people are pricks and you don't feel bad about it. You're like, “If you're going to be an idiot and you're a prick, do you know what I'm going to do? I'm going to take a management fee. I'm going to have a liquidating preference. I'm going to do all this sort of shit. You are too cheap to hire an appropriate lawyer and other advisors who know what the heck's going on. I'm going to put that money in my pocket.” You should do that. You have my blessings. I had a lot of private equity discussions whilst in New York. I was on the road and in other areas of the country meeting with private equity firms on a variety of different transactions. Now I'm back in Puerto Rico and next week, Asia.
Patrick Baldwin: I can see why private equity companies say, “Don't use Potomac, you'll snuff it out.”
Paul Giannamore: If they try to retrade, we will just crush them. You've heard the Mexican, he's got a blacklist. There are certain private equity firms that are on his blacklist.
Patrick Baldwin: I was going to ask that. You've had firms that come in to process or at least are trying to solicit deals. What reasons would you put them on a blacklist? I didn't know there was a blacklist.
Paul Giannamore: There is a blacklist.
Patrick Baldwin: I thought it was a brownlist.
Paul Giannamore: Terminix was on that blacklist for a while. As you remember my writing from 2019, Terminix was definitely on the blacklist for a while. No, there are private equity firms on the blacklist. If you're Anticimex, Orkin, or one of these companies, you have to live in this industry. There's social pressure to do the right thing. You're always taking your shirt off, god knows why. When you go to a restaurant in Waco, you're probably not doing that. There's social pressure, like, “Fat Pat, keep your shirt on.”
When you operate in an industry, you can't be that egregious. You can't be screwing guys over left and right because no one's going to want to do a deal with you and word gets out. When you're a private equity firm and you're looking at pest control and you say, “I got to buy a platform.” There are tons of firms and you're competing with all these guys. Sometimes you say what you need to say in order to get a deal. You're going through the bidding process and you find yourself bidding up and then you overpaid in order to get this thing locked down.
Now you find yourself in exclusivity and you're like, “I got to figure out a way to get my returns.” You start the retrading and you don't care so much because you say to yourself, “I'm going to be a real dick. I'm going to try to retrade on these guys but they're already half-pregnant. They'll probably do a deal with me anyway. They're not that useful so I don't care if they're happy or not. I need to get this deal done.” You try to reprice things, you try to change terms, you try to add stuff and subtract stuff, and so on and so forth.
If the whole thing blows up, you're like, “I didn't lose anything because chances of people finding out from one deal, I can go off to another one or whatever.” As far as I'm concerned, I unleashed the fury. The Mexican does it on my behalf and he is nasty. He broadcasts that, he tells every other private equity firm and seller. He's nasty about it. At the end of the day, we all need to discipline participants in our industry. If we don't, the government will do it for us. If you've got a pest control company that's doing bullshit out there, you should stand up and say, “That's not right.” If you've got a private equity firm doing that, we'll be the first to stand up and say, “You guys go.”
Patrick Baldwin: Would you go out there and publish the blacklist in PCT magazine?
Paul Giannamore: No, I don't believe in being punitive. I don't believe in being punitive to them. There's no reason for that. Sometimes things happen in a deal and people get frustrated and deals do blow up, not out of malice. It's when it's malicious or when it's totally egregious like you knew or had reason to know you were doing this and you're trying to take advantage of this seller. You're costing this seller a variety of other opportunities that have real economic damage. You're not playing in my pond.
Patrick Baldwin: Half-pregnant, you mean that you're already in exclusivity?
Paul Giannamore: Think about it. You take a business to market, you've got the materials ready, you've got the bids, you get IOIs, you go through iterative bidding rounds, and you do management meetings. A bunch of people fly out and you spend 3 or 4 days and you're meeting with all these different firms and it's all orchestrated and then you got more bidding and the next thing you know, now you're under LOI. You've done all the work and you've met with fifteen participants and now you're under an LOI. You're screwed, Fat Pat, if that deal falls apart.
Even if a private equity firm is a total dick and it's not your fault and your numbers are good, that deal falls apart. Now you got to go back to those other folks and they say, “What happened over there? What did they see that we don't see?” No matter what, even though there's nothing abundantly evident, it's clear that things are clean and good, you’ll always be under suspicion and they're going to think they found something and they're going to think they're idiots because they don't realize it. Do you still get a deal done? Yes, that happened.
We did a deal at the beginning of 2023. It was a private equity firm in this industry that tried to retrade tens of millions of dollars. It was extremely frustrating and they tried to retrade and we very quickly gave them the middle finger and we turned around and we immediately went back out to the market and we told all the other participants, “This private equity firm is a pile of shit. Here's what happened. If you act quickly, you can get this.” We were able to close it on the price and terms that we had originally gotten under at LOI. We got lucky. That doesn't always happen. That's not necessarily just because we were good. We did get lucky and I'll admit that.
Patrick Baldwin: It's scary.
Paul Giannamore: It's all private equity talk these days. I don't think a private equity deal is right for many people. Everyone seems to think, like, “Private equity, I'm going to do this. I'm going to do that.” There's a lot of investigation that people get caught up in because there are high valuations. I know it's always right and I don't think that many people think about what their role equity is going to be worth five years from now.
I've been doing life in this space for over two decades and I struggled to understand a lot of things and I know this, I know this cold. We calculate a lot of this stuff. If I have a hard time with something, I can't imagine somebody who's doing this for the first time in their life can understand how that all works. It makes me a little bit concerned for some of these guys at some point in the future.
Patrick Baldwin: Is that company still on the blacklist?
Paul Giannamore: As far as I'm concerned, the blacklist lives in perpetuity. I spend a shit ton of time talking to LPs and investors in these funds. As a matter of fact, it's not me seeking them out. I had 10 or 11 calls with PE firms and LPs. When private equity firms are interested in pest control, I never take the calls. I don't do these expert calls. I don't waste my time on all that sort of crap. I am abundantly not available for any of these guys whatsoever. The institutional investors, I quit doing that. I have slowed down on those sorts of calls.
The calls that I do take, I talk to private equity firms about others. I talk to sellers. A lot of times, I will have conversations with sellers. When I see an exit that is interesting to me, I'll talk to the sellers about how that exit went and what returns they got. When I do talk to institutions, it's the institutions and the LPs that are investors in these funds because these are guys who know what's going on. They know the professionals, they know the returns, and they know how these guys act in good environments and bad. It's helped me put our clients in the best position to succeed from a long-term perspective because I have taken a personal interest in performance and participation.
When I say that there's more than one firm on the blacklist, you get on the blacklist for being an egregious dick. However, you also can get on the blacklist and be relatively blameless if based on what I've heard doesn't necessarily line up in the sort of position that I would want to put my clients in, subpar returns, not necessarily interesting exits, poor decision-making from a timing perspective, and shooting for a 2.5X return when you could otherwise gotten a 4X return. Those professional missteps definitely go on my blacklist. I should probably say that's more of a gray list, Patrick, than a blacklist.
Seth Garber: I was thinking to myself. I laugh sometimes because when our clients are buying these small companies, I feel fortunate that, on the other side of the deal, it doesn't say, “Represented by Potomac.”
Paul Giannamore: My favorite compliment that I ever got in this industry was when Jarl left Anticimex. It was around the time Jarl left. He was in the process of leaving and new management over there in Stockholm wanted to put the KaiBosh on Anticimex buying deals from Potomac. They said, “We ran up prices across the board.”
They told all the different operators and the M&A guys to go out and send out emails, do direct outreach, and call, “Take these guys to coffee. We need to get proprietary deals. We cannot do Potomac deals any longer because they're costing us way too much money.” That was a huge compliment. As a matter of fact, if I was into advertising, I would’ve gotten that quote for a PCT ad, like, “Under no circumstances should we buy from Potomac,” and that's great.
Seth Garber: It's funny. I hear Paul talking about his blacklist and all I keep thinking about in the back of my mind is some of our clients who have their list of preferred brokers who they buy from and it's hysterical.
Paul Giannamore: You've never seen Potomac on that list.
Seth Garber: Absolutely not. It's absolutely funny because I'm sitting here processing and thinking about some of these different people. In different parts of the country, we'll see the same person, and they go, “This guy's got this,” or, “This guy's got that. We got to get on top of it immediately.” It’s hysterical. It's never you, Paul.
Paul Giannamore: I'm sure I'm on some blacklist, for sure. We have covered some good ground. I'm somewhere twelve hours ahead of you eating a lot of rice.
Seth Garber: I'm going to be in Oklahoma getting hot heat around me and probably drinking some good American beer in an odd bar somewhere in Oklahoma City.
Patrick Baldwin: We just call it North Texas. Safe travels to both of you all. I'll be here if you need me.
Paul Giannamore: Gentlemen, you guys have a great weekend.
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Dylan Seals: Thank you so much as always for supporting us at The Boardroom Buzz. We know your time is valuable and the fact that you spend 45 minutes or an hour with us means the world. All the media that we put out from Potomac is meant to honor and celebrate you, the service industry owner. As Paul would say, “Yee who toil in the pest control vineyards.”
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