Pest Control M&A Weekly Commentary – July 30, 2018 – Where to Stash Your Cash When You Sell

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In this week’s commentary, we’ll be exploring:

  • Driving Value: The Importance of Route Density
  • Potomac Announces the Sale of Banks Pest Control to Rollins, Inc.
  • Where to Stash Your Cash When You Sell (or Even if you Don’t Sell)
  • Meetings in Singapore & Malaysia
  • Western Governments are Totally and Completely Broke … and They Want Your Money
  • A Highly Recommended Deal Attorney

Driving Value: The Importance of Route Density

Two of the most powerful levers you have to drive profitability in your business, and therefore value, is pricing and route density. We’ll save pricing for another day.

Where I see more than half of pest control companies not really thinking through things is on the density side. Sure, it feels good to cover an entire region. “I service from NYC to Baltimore, I’m YUUUGGGEEE!” 

However, pest control is a network business and route density is one of the most important aspects of driving profitability.

If you think about it, once a branch has been opened, trucks acquired, office folks hired, etc., the fixed costs are already in the books. The greater the volume that can be run through that fixed cost base, the more profitable it will be. In fact, with density, profitability grows exponentially, at least up to a point.

While it’s basic arithmetic, and everyone gets it, it’s sometimes hard to put into practice because in order to build high route denisity while growing your business, you have to say no, a lot. When that potential customer right outside your service area calls you up because your competitor shit the bed, you, and your people, have to be willing to say, “Sorry Mr. Smith, we’d love to be able to help you but we don’t service that area just yet.”

As you build route density, your business will start kicking off more cash, that can be reinvested in the business and you’ll grow that much quicker.  

The higher your market share in any given market, the higher your operating margin will be, to a point. If you look at the chart below, you’ll see that at around 20% market share, you’ll see contribution margins north of 20%. Offices in very dense areas with adequate pricing will realize contribution margins of 30% to 35%.

To illustrate how this works in real life, if you take a look at the chart below, you’ll see Rentokil’s route operations in Melbourne (on the left) and Victoria (on the right). The average customer in Melbourne is less than 1 km from the next and very easy to route, whereas in Victoria, it’s rural and spread out, average 29 km between customers.

The gross margin of the Melbourne service center is a full 1500 basis points (15 percentage points) higher than that of Victoria.

If you’re operating in a rural area, I am not suggesting that you pick up and move to the big city. What I am saying is this:

  • First, recognize that route density is massively important
  • Second, understand that it can have a dramatic impact on the profitability (and therefore the growth rate, if invested correctly) of your business
  • Third, embrace tight and dense routes and build an incentive structure in your business to support the increase in density
  • Finally, resist the urge to grow geographically and focus on doing more in less geographic space

In the United States, Rentokil has focused on building national scale over the last five years. The name of the game was national accounts so that they could compete with Rollins, and to a lesser degree Terminix.

Now that Rentokil North American covers 90%+ of the US population, they are focused on margin improvement. And guess how they are doing that…According to Chris Hunt, Rentokil-Initial’s Global Head of M&A, they’re making acquisitions in “new cities and towns with good long-term growth prospects” and “bolt-ons for density in areas where we are already present.”

Anticimex North America is playing the density game as well. They’ve now acquired five platforms from Maine to Florida: Modern, Viking, American, Killingsworth, and Turner. Instead of buying additional platforms around the country (I am not necessarily saying that they won’t), they are doing tuck-in acquisitions in order to increase density in their current footprint.

I’ve got a lot more to say on route density in our upcoming valuation report, but for now, I’ll leave you with this final thought.

The president of a Big 3 once told me over dinner, “Paul, I would rather buy a $10 million in revenue business that owns a small market than a $10 million in revenue business with operations in a region… and I’d probably pay a lot more for it.”

 

Potomac Announces the Sale of Banks Pest Control to Rollins, Inc, the Parent of Orkin

Potomac is pleased to announce its thirteenth transaction thus far in 2018 — the sale of our client, Banks Pest Control, of Bakersfield, CA, to Rollins, Inc., the parent company of Orkin.

Banks Pest Control was founded by Orland Banks in 1969. What began as a one-man shop grew to a company of over 40 employees and one of the largest privately held pest control companies in the southern region of the San Joaquin Valley.

 

Where to Stash Your Cash When You Sell

Selling your business is a very stressful event and you’ll breathe a sigh of relief once you get to the closing table. However, you’ll quickly be greeted by another issue that can be even more stressful than the sale process. What to do with the cash in an environment of very low returns and very high risk.

Without fail, every single owner asks me what I would do with the windfall. Since I am in the process of moving into short positions on sovereign and corporate debt as well as equity, most sellers won’t have the stomach to do the types of things that I do. However, I do know what to do with money that’s: (1) far safer than banks, (2) provides returns in excess of 50x of what banks will pay, and (3) can provide cash on cash returns of 5% to 10%, fully collateralized.

Today I am only going to talk about one of those… the other ones, well, those are just for clients.

Over the last 12 months, we’ve had individual owners walk away with as little as $700,000 to well over $100 million in cash.

The more money you walk away with, the more the financial advisors will come out of the woodwork with all sorts of bright ideas as to what to do with. Unfortunately, a lot of those recommendations (e.g., annuities, which, by the way, are completely moronic things to buy) tend to lead to the greatest fees for those advisors.

In this brief post I am not going to get into the extreme importance of US and international trusts and asset protection vehicles (which are very important and each of you should explore them), I am going to instead mention something that is quick, easy, and in the immediate near term is probably one of the best places to park some cash while you’re trying to figure out what to do next — especially if you need immediate liquidity to pounce on other opportunities.

Let’s face it, putting any money in the US equity markets right now is a horrible idea. With equities trading at an all time high, it feels like 2007 again. Instead of putting $50 million in equities, you’re probably much better off having that cash liquid so that you can pounce on opportunities that aren’t likely to be too far off (i.e., being a buyer in 2009).

When someone sells his or her business, the proceeds are wired into their bank account. There are a lot of things that they can do with that money (e.g., invest it immediately, let it sit in the bank account, go to Vegas!, etc.); however, what they are often best served in doing is the same thing companies like Microsoft, Facebook and Coca-Cola do with the “cash” on their balance sheets — put it in very short-dated Treasury securities.

Big companies don’t leave their cash in a bank account. Not only does it not earn any yield in this environment, but it’s also at significant risk because their cash becomes a liability on an under-capalalized bank’s balance sheet.

Although I am long-term bearish on the US dollar, in the immediate near-term, I am actually a dollar bull. Now, although I’m a dollar bull, I wouldn’t put any money in Treasury Notes or Bonds, but I would park some money in Treasury Bills (or “T-Bills”).

T-bills mature in 28 days and are currently yielding about 1.9%. Although they’re underwritten by a bankrupt government, that government still prints the world’s
reserve currency and unlike putting your money in a bank, the default risk, at least in the near term, is zero.

It’s super easy, you can open an account yourself with Treasury Direct and you’re on your way to parking cash in T-bills that will yield literally 20x to 50x what most banks are paying right now in interest. And since the yield curve is flattening rapidly, it’s much better to be in short-dated Treasurys like T-Bills than in any of the longer dated notes and bonds.

Finally, I am always shocked and amazed that that one simple suggestion is oftentimes cheaper, more liquid, safer and higher yielding than what many business owners hear from their financial advisors. And for you, dear reader, it’s free.

Meetings in Singapore & Malaysia

As pest control M&A heats up around the globe, we’ll be in Malaysia, Singapore and Vietnam next week. A recent transaction we closed in Singapore was Anticimex’s acquisition of Clean-Environ Pest Management, but now that Rollins is in the SE Asian market, you’ll see things heat up.  I would expect to see ServiceMaster operating in Asian / Australia within the next six months.

For our readers in the region who would like to meet with us while we’re in town, please send contact Ericka Andes here.

 

Western Governments are Totally and Completely Broke… and They Want Your Money

At Paris Charles de Gualle airport last Thursday, my fellow passengers and I were greeted by seven armed customs agents (les douanes) on the jet bridge while boarding our flight to Geneva, Switzerland.

I travel through CDG about 30 times per year — and I’ve done that for years — however, this was the first time I’d ever seen this strange display. I am used to customs agents asking questions upon entering France, but never when departing.

What were they looking for? Drugs? Weapons of mass destruction? Cheese and fruit? Guess again.

“Passport please,” an agent asked me.

“Do you have the equivalent of greater than 10,000 Euros in any currency in your possession?”

“No, unfortunately I don’t,” I answered.

“Thank you, you may board,” he replied.

Unfortunately, there was an old man behind me that didn’t appear to be as lucky. He looked to be about 80 years old and after a brief search he was found to have.… wait for it… yep, money. I don’t know what happened to him, but for his sake, let’s hope the French don’t have the same civil asset forfeiture regime as the United States.

Around the Western world, citizens are more and more becoming property of the State. As I watched people board a flight from one of the most economically unfree nations in Europe (France) to arguably one of the freest nations on the planet (Switzerland), while the regime searched bodies for cash, I couldn’t help but think of a story I once heard hedge fund manager Simon Mikhailovich tell about leaving the Soviet Union for the USA.

When Mikhailovich and his family left the Soviet Union, the government stripped them of their citizenship and all of their money except $100 per person — that was their exit tax. They were traitors for leaving.

In the United States, there is now an exit tax for expatriates (IRC Sections 877 and 877A). Further, Congress has recently turned the US into the largest debtor prison in the world. According to a July 6, 2018 article by the Wall Street Journal, “At least 362,000 Americans with overdue tax debts will be denied new or renewed passports if they don’t settle these debts, the Internal Revenue Service says.” You can read more about that here.

So, in France, they’re checking your pockets on the way out the door and in the US, if you make a booboo on your tax return, hand over your passport.

The French are owned by their government, and I expect to see that kind of nonsense from them. But in the US, what we’re seeing is inconsistent with free people and another example of a truly sad slide from freedom to government servitude.

A Highly Recommended Deal Attorney

A few weeks ago I published the name of a tax advisor, Cory Vargo, who I have a ton of respect for. He’s phenomenal advisor and I wouldn’t hesitate to recommend him for even the most complicated situations.

More so than a tax advisor, in just about every deal I am asked for attorney referrals. I have a full rolodex of some of the best transaction attorneys but one that I always find myself going back to is Mike Stanczyk. Mike and I have worked together for years and he has advised sellers on transactions with all of the major players (Rollins, Rentokil, Anticimex, Arrow, etc). He’s young, he’s aggressive and he’s a great value. If you need a transaction attorney, reach out to him.

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About Paul Giannamore

Managing Director at The Potomac Company where I head the firm's strategy consulting and investment banking practice focused on the structural pest control and integrated facilities services industries. I write the Pest Control M&A Weekly Commentary and The Potomac Pest Control Executive, newsletters read by thousands pest control professionals in scores of countries (you can subscribe to it below). In a nutshell, I do two things: (1) advise shareholders and senior management of pest management firms on creating value in their businesses, (2) advise sellers on the sale of their businesses. Based in Geneva, Switzerland, I'm a graduate of Cornell University, and I speak Italian, Spanish, Arabic and broken French. Join me on LinkedIn