Patrick Baldwin: Knock knock.
Paul Giannamore: Who's there?
Patrick Baldwin: Fat Pat.
Paul Giannamore: Fat Pat who?
Patrick Baldwin: That's all I got. I'm still working on it.
Patrick Baldwin: You confused me as a delivery driver? Do I look fat?
Paul Giannamore: It really has stuck, hasn't it, Patrick? Everyone loves calling you Fat Pat now.
Patrick Baldwin: I'm first in the phonebook and in Cassie’s heart.
Paul Giannamore: That's great, Fat Pat.
Patrick Baldwin: She said it.
Paul Giannamore: We'll have her back. At some point, we'll do Cassie on video.
Patrick Baldwin: To be the face of Terminix, it does make sense to put that in a video format and not audio. Play the cards we’re dealt. No handlers on video though.
Paul Giannamore: After the Terminix-Rentokil deal was done, we'll probably have fewer handlers. Rentokil will probably do less handling but that remains to be seen.
Patrick Baldwin: We haven't caught up in a minute. Do you travel much?
Paul Giannamore: PB, I have kept it PR-centric here. I've had some trips but not nearly as many. We've had everyone come down here. This has been fantastic. The majority of our meetings have been down here in Puerto Rico. I do have to go to Cairo so I'm going to take a quick trip over.
Patrick Baldwin: Have to? You want to.
Paul Giannamore: I do not want to go to Cairo, I have to. I've got to go to Cairo and then I've got to go to Italy. These are not pleasure trips, unfortunately. These are required attendance for me.
Patrick Baldwin: They're a pleasure but not for you.
Paul Giannamore: Somebody will be pleased and not me.
Patrick Baldwin: Your better half.
Paul Giannamore: Patrick, it is the end of August 2022 here. We're recording this on August 30th, 2022. The end of the month is the closing time. It's a pretty busy August as it usually ticks up towards the end of the year. One transaction we closed was the Viking’s acquisition of Cavanaugh in New Jersey. Viking is owned by Anticimex, it’s their platform. You don't know this, Patrick, so you'll find this interesting. We signed an engagement letter with Ralph Cavanaugh years ago. It's our longest client. Ralph passed in September 2020. He was up in years.
Ed Bradbury, who used to own Viking and the founder of Viking, and Ralph Cavanaugh came up together. They both had small firms back in the New Jersey pest space decades ago. Ralph engaged us years ago. We did an S selection valuation. He had a C Corp. We got him all planned to go. One thing turned into another and next thing you know, one of his sons is running the business but it was ultimately sold.
The funny story about all this is it was a complicated transaction. I told the Mexican early on in the process, “Mex, if you can get this thing done, then I will not fire you if the market goes to hell.” He came in when it was all done telling everyone he's a made Mexican. He's like, “I can't be fired if the mark goes to hell. I'm a made Mexican.” He was a Mex-I-can on this transaction as opposed to a Mex-I-can’t, which is what I expect out of him.
Patrick Baldwin: It's about time. Good for him.
Paul Giannamore: Congratulations to Viking, Anticimex, and the Cavanaugh family. They finally got it done.
Patrick Baldwin: That's awesome. Good stuff. You messaged me and I was like, “It's the end of the month. I messed up. Sorry. I scheduled this.” You went on to tell me you have four closings. I don't know if there are others that you can let out of the bag. I'm always curious.
Paul Giannamore: I'm trying to think about what else I can talk about. I probably shan't let any of these cats out of the bag because I'll never know how the acquirers are going to deal with them. One of them is a material transaction and, in some ways, will change the industry. You know about this one, Patrick, because it's been going on for a long time. I don't know if we can talk about it yet.
Patrick Baldwin: I'll keep trying. I did want to get an update. I do have some audience questions for you as well. Real estate comes up a lot. A question from Brian comes in and it’s a two-part question. One is, what does real estate look like in terms of a transaction whether it's owned or rented? The second part is, have you ever had a business that you've sold and been part of where they had a training facility as part of the sale?
Paul Giannamore: In the first part, bricks are never acquired. I can think of maybe 1 or 2 examples when at least one of the bigger players acquired real estate. On the Rollins-Clark transaction out on the West Coast, Rollins acquired a real estate portfolio of about $50 million in real estate and then ultimately has begun to sell that off. They got probably a pretty decent return on that real estate. It's rare that large companies want to acquire any real estate whatsoever. I would say it never happens. We've talked about this on The Buzz before that leases always end up being a problem in these transactions. Do you remember us having that discussion?
Patrick Baldwin: A little bit.
Paul Giannamore: For whatever reason, 2020 was a bad year for me with regard to dealing with leases. What usually happens is 1 of 2 things. If you're running a pest control business, you are either party to a third-party lease meaning you're not related to the landlord, it's XYZ management company, and you're leasing their facility, or you might have your own property. It might be from a related party. You set up an LLC, Fat Pat’s Realty Holdings. That business, of course, leases the real estate back to the company.
In those circumstances, it's pretty easy because you control that real estate. If an acquirer wants to be a lessee, they want to lease the real estate, then you can control everything and negotiate a market lease term. It's easy. What happens sometimes though is people will get into very long-term leases with a third party. I've seen you 5, 6, 7, 8, or 10-year leases. It's rare to see them that long but it's not unreasonable to see somebody get into a five-year lease.
I can think of some specific instances like people that you know, Tony Sfreddo, and Dr. Kramer. Those guys had nice facilities so they had to get into long-term leases because the landlords were doing a lot of leasehold improvements on those facilities. Of course, for these acquirers, one of the ways that they get synergies in a deal is by collapsing real estate. They don't need tons of offices. What ends up happening is the acquirer will come in and say, “You've got four offices. I only want two of them. Get rid of the other two.” What are you going to do about it? You're in a lease. You find yourself negotiating with your landlord to try to terminate it early. What termination fee will you pay?
Of course, it always depends on how tight the market is. When the rental market is very tight, landlords are like, “I'll let you out because I'll be able to get more money from somebody else. 2020 was not an easy year for me because it was COVID. Commercial landlords were hurt and they didn't want to let anyone do anything. If you can avoid long-term commercial leases, specifically when you're getting in the years toward a sale, that's a great thing to do but you will not be selling any bricks.
Patrick Baldwin: I’m thinking back to Black Bear, going to Mr. Chen, the landlord because we leased. It was a location and not so much the building. The building has been there a long time. It's an old house that was 1,600 square feet with a crawlspace. The roof is not in great shape. It’s on a one-acre lot. With the location, traffic was the best.
Going to Mr. Chen for years and saying, “Can we buy it?” Fast forward to when we sell it, there's no real transfer or sign like a typical lease. You can't have someone else take it over. We’re going to Mr. Chen and say, “There is a Fortune 500 company that is going to be taken over. We need to transfer this lease.” That's an interesting conversation.
Paul Giannamore: It's a problem too, Patrick. Landlords, on the one hand, like the idea of a Terminex, Rentokil, or Orkin being a tenant because they're far more creditworthy than you and Bobby and your other partners. On the flip side of that, what people often don't think of is that the landlord now might seize the opportunity to extract additional concessions due to the fact that you're in the sale process. You need to sell your business. You want to sign the lease. They might say, “I'm jacking up the rent,” or, “You've got to do X, Y, and Z.” We've seen landlords get a little bit crazy in the process of trying to extract money from the sellers.
I'm starting to see acquires do this. I always said to myself, “Why notify a landlord?” Why do you need to have a lease assignment? In an M&A deal, the acquirer will say to you, “Bobby and Patrick, go to your landlord, and get an assignment. Have the lease assigned in our name.” That way, of course, Terminix is now on the hook for the lease. I always looked at it and said to myself, “Why don't you do a side letter with Terminix, a sublease, even though it might be prohibited by the actual lease agreement?”
What does the landlord want? the landlord wants to be paid and he doesn't want his property damaged. As long as that continues to happen, you don't even have the discussion with the landlord, you can give them the opportunity to be a pain in the ass. More and more acquirers now are closing over top of lease agreements as opposed to getting assignments where they're saying, “Let's not tell the landlord. He'll continue to get his check every month and what he doesn't know can't hurt him.”
Patrick Baldwin: Interesting. That's a different play.
Paul Giannamore: Sometimes it’s the only one that works.
Patrick Baldwin: Is this the new playbook of ’22?
Paul Giannamore: I've been so tired of commercial landlords, I'm like, “Let's close overtop of this.”
Patrick Baldwin: Is it different now because the commercial real estate is softer so they don't have as much demand?
Paul Giannamore: Yeah. It's one of those things where these landlords now are not being flexible if somebody's got three years left on the lease. When the market was tight, these guys were like, “Patrick, I'll let you out a couple of years early. You'll keep paying the rent until I find somebody else. Instead of collecting $5,000 a month, I'm going to be able to rent this now for $7,000 a month.” They're looking around town now saying it's the exact opposite, “Without you, I might not collect any rent. If you want out, Patrick, you're going to pay me for those three years.”
Patrick Baldwin: Part two of the question was about training facilities. It's funny, I drove by the McDonald's franchisee. I’m thinking about Brian's question and I'm driving by knowing that in the back of McDonald's, there's a training facility behind the headquarters. He said, “Did any sellers have a training facility like Orkin, which has a mock house on their compound?” That's a Waco word, Brian, compound.
Paul Giannamore: If you've ever been to the Orkin/Rollins training facility, it's a massive place. Patrick, when we recorded Supernova many moons ago, the part that Matt Whiting was on is in the bunker that was in the training facility. They have a home there where you can do termite inspections, rodent exclusion, and whatever else.
They have a commercial kitchen. They have a fake McDonald's-style, quick-serve restaurant. I remember them having a hospital room. Within their facility, they got a variety of different commercial settings that you would commonly run into. The commercial kitchen was a fully operative commercial kitchen. It had everything that a restaurant would have.
There are other large companies that have that or similar things to it. Brian's question, does Arrow have something like that? The question was, does somebody else out in suburban America have something like that? I have seen small companies have things like a house. In a deal that we did in North Carolina years ago, they had their office. Behind their office, they had a home that was a training center.
Even the Terminix franchise in Fayetteville, they have a full training center. It's a house that you could treat for termites. You go into the kitchen. I have seen a commercial company do the same thing. They bought a cinder block facility that they may be paid $50,000 for out in the middle of nowhere. They put in a full commercial kitchen and they replicated some of the types of things that they would see out in the field to do training. Yes, I have seen it.
Patrick Baldwin: There you go, Brian. You and I were talking about these enhanced or add-on services. Changing topics here. Recurring is the cream of the crop. Everyone wants recurring. It almost sounded like enhanced or add-on services are the next best thing. You're in the process of taking a business to market. You're doing your best to isolate what these add-on services are to Mrs. Jones that might have a quarterly residential. All of a sudden, she also has a rodent or fire ant service or something nonrecurring. That service has a lot more value to it than a typical one-time service. Did I understand right?
Paul Giannamore: If I recall correctly where this was coming from because we had a chat about this where we were looking at some various different matrices related to what we call revenue quality, so to speak. Let me see if I can unpack this a little bit. If you have a business that does 40% commercial, 40%, residential, and then the remaining 20%, we’ll call them one-time services. You're going out doing a one-time wasp treatment. Let's say 40% is a recurring residential quarter lease and then 40% would be commercial.
Commercial gets a little bit more interesting because you'll have the base contract. If you go out and do a tool and die shop and you're charging them, I'm going to make this up, $100 a month. You're going out there once a month and you're doing $1,200 a year. The tool and die shop has specific problems that you're often treating. Every fall, you'll do Interior and exterior pressure washing. Every fall, you're doing that. It's only done once a year. Maybe they got a lot of geese problems. You're doing Avitrol treatments and you're doing that in the spring.
Patrick Baldwin: Is Avitrol labeled for geese? We don't know. We'll see.
Paul Giannamore: I don't know. Is it labeled for geese? Are you not supposed to use it for geese?
Patrick Baldwin: Maybe.
Paul Giannamore: With the disclaimer, a non-technical guy talking about treating geese.
Patrick Baldwin: Drain flies are up in the North. We don't have it down here.
Paul Giannamore: Up in the north, in the fall, there's always drain flies, and that's drain fly season. August and September, that's exactly right. When I think about looking at the quality of revenue, the first thing they have to think about is obviously the more recurring in nature, the lower the risk. If it's 80% recurring versus 50% recurring, that 80% recurring revenue business is going to be less risky and therefore more valuable.
When you look at what we call expanded services or enhancements, it’s exactly what I was talking about with a tool and die shop, $1,200 a year base. Over time, you're doing these add-on services so that a $ 1,200-a-year account is a $ 5,000-a-year account. You can look through it historically. In 4 out of the last 5 years, it was $5,000. That's roughly a $5,000 per annum account.
Given the way a lot of commercial contracts are priced, people are targeting a lower base contract because they know there'll be expanded services and they can win the bid so to speak but then still charge what they need to charge. Of that $5,000 per annum, only $1,200 is recurring. That's an ongoing service. From a technical definition, that's ongoing. There's a big argument to be made that that's a $5,000 per year account.
Whenever we're thinking about things from the sell side and the acquirers want to know what's recurring, we always lump in our analysis both the recurring as well as the expanded services. We lump it all in and we call it recurring. The rent of Rentokils and the Orkins of the world are sophisticated and have been at this for decades and decades. They understand it. When we're doing these private equity deals, it's hard for them to understand what's occurring and what's not recurring.
That's far more prolific though, Patrick, on the commercial side. Sometimes people will have expanded services on the residential side. Up and down the Texas coast, I've seen this a lot. They'll do fall treatment for some a pest. That would be an expanded service. Somebody's paying for quarterly pest control and they say, “It's an extra couple of $100 and we're going to spray your trees. That's not included in the general pest.” That, we would lump right in with recurring, especially if we can substantiate that it largely tends to reoccur.
Patrick Baldwin: I love that word. Recurring is better than reoccurring, I remember that. This triggered a question from Shane. Shane had a pest and termite business and decided, “I'm good at pest and I don't have a lot of termites. I've got a few more years that I want to stay running this business. It's better for me to dump termites. It was a quarterly termite bait system, dump that off, and focus on pests.”
His question is, does an acquirer look at that as there's still meat on the bone? Is that attractive to an acquirer an Arrow, a Massey, or one of the larger acquirers in the southeast? They say, “Shane's business has pest control. We could go to Sentricon or Trelona when we do buy it. There's a lot of potentials there.” Is that attractive to them? Is Shane a beneficiary of that?
Paul Giannamore: Instead of saying, is it attractive? It's not unattractive. The market has evolved. We talked about the Cavanaugh deal signed up years ago. Years ago, Orkin would look at a business like that and say, “You're doing a $1 million to $2 million per year in Sentricon. We don't want termite. We want general pest.”
What acquirers like about termites, especially things like baiting systems and not just Sentricon but there are a lot of baiting systems, is they like the preventative baiting system setup whereby you're getting a monthly quarterly annual fee and what have you because you've got the baiting system set up. In a perfect world, it's not curative, it's preventative. You've got those up there. They love that. It's a super high margin. It’s very sticky. Anyone that gets a baiting system on there has already got that sunk cost of payment. Why do you want to quit paying and have it pulled out when your house is being protected? That's a good thing.
I don't know that Shane will find himself at a disadvantage because he got rid of termite. It's probably a mature decision of a business owner saying, “Everything in life has trade-offs so I'm going to not go after everything. I'm going to get rid of termite and focus on general pest.” If you could only choose one service on the spectrum of what a pest control company would do, if you could only choose one, you would always choose recurring general pest whether it's commercial or residential.
You raised some topics that I deal with on a day-to-day basis. For example, you'll see a company that does $10 million in general pest. They don't do termite and they don't do mosquito or any ancillary services. An acquirer will look at that and say, “It's a customer base. We've got this huge menu of services. This company only does general pest. We could cross-sell.” That, in and of itself, is true. It’s probably potentially something more valuable dealing with a financial sponsor like a private equity firm than it is dealing with a strategic because they're not going to give you credit for that.
They're going to look at it and recognize, “That's one angle. That's a great potential synergy. That falls under the revenue enhancement synergy bucket.” It's something that you as the seller are not going to be able to extract value for that per se. What you would have been better doing is, if you could slightly expand your service menu and do mosquito and termite yourself, you would have made more money, more cashflow, and a more robust business to sell.
I got a phone call from a guy who has a business that does a lot of one-time. They do pests but they also do a ton of rodent proofing and wildlife exclusion. They've got thousands of customers. It's a pretty decent-sized operation. The guy calls me up and says, “I was referred to you. I wanted to pick your brain on this. People are telling me that I need to have more recurring revenue but I don't think that I should.” I said, “It depends on what you want to do.”
He said, “When I ultimately sell this business, an acquirer could do this. If I've got 10,000 rodent proofing and wildlife exclusion customers in my database, and they're all relatively recent, let's say within the last few years, it's highly likely that the customer still lives in the home. Why do I need to go out and sell a renewal on that when I'm trying to sell a permanent solution? I don't want to go out and try to sell my work and then say, ‘Customer, you should pay us every year for renewal.’ I want them to feel like, ‘They hired us. We're going to do a way better job than other jokers.’”
He said, “I want you to tie-break this for me. What do you say?” I say that an acquirer will see value in the fact that they can do it. My opinion is no. He could do anything. There are a lot of things he could do. He could discover a new element. There are a lot of things that he could do. He can go to Mars. It's what he does and what the company does and the company's capabilities.
I always get into these circular conversations. On the one hand, acquirers aren't buying the past, they’re buying the future. The valuation is always forward-looking. It can't be something that they can do. They're not going to pay you for something they can do. This was a live conversation that I had so I thought I would bring it up as part of that.
Patrick Baldwin: There's a certain threshold of recurring where the lowest that comes to mind is 50% recurring. You had a deal and still had a good offer on it for business. Is there a point in which the acquirers are like, “We're not going there, a bunch of one-times.” It can be millions and millions of dollars at one time but there's no structure to it or recurring business. There's too much risk.
Paul Giannamore: There are not a lot of durable objective opinions on what is the right thing to do. Now that we're out of the 2021 woods, so to speak, at the end of 2020 and all of 2021 as we talked about on Bubble Trouble and everything that we've done thus far, Patrick, we focused on the fact that in those years, we had relative scarcity amongst big assets. We also had a tremendous amount of competition from acquirers with extremely low costs of equity and debt capital. The prices were screechers, completely off the chart.
You can draw a lot of similarities between private markets and public markets. In the public equity markets and the stock markets, when investors are prone to speculate, they're indiscriminate. They're chasing and everyone's in there and everyone's getting rich and those who aren't are missing out and things go crazy.
The private markets, to a certain degree, are like that where acquires become indiscriminate. In periods where there's somewhat of a speculative mania, that masks all manners of sins. You're able to sell businesses that have relatively low recurring revenue and have other blotches because acquirers are buying everything in sight.
As we've moved out of 2021, as the equity markets have rolled over, acquirers have become more and more selective. Now, those things that didn't matter before like the whole Buffet comment about, “We know who's naked when the tide comes in,” type of thing. Now, when fundamentals start to matter, you can't sell that business that does 40% recurring. Acquirers are going to look at it and say, “We're not going to do that.”
That's what we have been seeing, in earnest, over several months. As we are in the summer of 2022, we're seeing a lot more selectivity. We have seen valuations simmer down since 2021 and they're still dramatically elevated. They're still on that trendline but they're not where they were at the end of 2021. Like public markets, when you get into these grinding bear markets that take place over the course of long periods of time whether it's a year or three years, you tend to see a lot of disparity in the market whereby long-duration stocks like tech stocks tend to fall. Also, massive declines whereas value stocks that are priced more appropriately tend to be more buoyant. Investors are more selective.
In the private markets, that's what we're seeing, we're seeing selectivity. We're seeing valuations remain extremely high in certain parts of the market. In a year, lower quality and run-of-the-mill businesses, that ship has sailed. 2019, 2020, and 2021 were the years to sell it. That was the period of time when you can sell anything. Now it's back to, what are we buying here?
Patrick Baldwin: I lost you at Warren Buffett said, “You can find out who's naked when the tide comes in.”
Paul Giannamore: This has become one of those platitudes, one of those cliches. He said something to the effect of, “We know who's swimming naked when the tide comes in.” That was the exact quote.
Patrick Baldwin: Do you have that on a coffee mug? Are you going to put that on Instagram?
Paul Giannamore: I don't use coffee marks, Patrick. If I did, I would put other things on there. What do I have on my coffee mug? Let me make you read this.
Patrick Baldwin: “I’m the Mex-I-can, not the Mex-I-can't.” Was that from Shane?
Paul Giannamore: That was Shane Hoy’s deal, Pro Pacific. That was one of the deal toys that was made, “I’m the Mex-I-can, not the Mex-I-can't.” A Potomac mug.
Patrick Baldwin: The John O’Hurley video.
Paul Giannamore: Yes, that's correct.
Patrick Baldwin: He will be at Pest World.
Paul Giannamore: That's what I understand.
Patrick Baldwin: Hopefully, you are too.
Paul Giannamore: I may go. Did I say something on an episode about me not going to Pest World?
Patrick Baldwin: You did. Now I don't know. You're on the fence, Paul.
Paul Giannamore: Since that episode came out, I did get a lot of text messages saying why aren't I going? Maybe I'll be pressured into it.
Patrick Baldwin: Are you going to be peer pressured, Paul?
Paul Giannamore: I might be.
Patrick Baldwin: I didn't know you’d be that type. I'll make sure you have a coffee mug with a Warren Buffet quote on it.
Paul Giannamore: I appreciate that. I need that.
Patrick Baldwin: I could see you pictured in front of a nice car with some nice sneakers and some platitude.
Paul Giannamore: I know where you're going with that, Patrick.
Patrick Baldwin: I'm calling you out on another one, Paul. Earlier this 2022, you said, “Patrick, I bet you Potomac will do $1 billion in private equity and sell-side transactions excluding the Terminix’s divesture In Europe.” I don't think there was anything on the line, fortunately, because I don't know where this is going yet. Paul, it's August 30th, 2022. I’m going to take your temperature. What's going on?
Paul Giannamore: If I remember correctly, I said that in 2022, in private equity transactions, excluding Norvester Terminix, we will do over $1 billion in private equity transaction volume. If I were a betting man here in August 2022, that's a bet I would take. If you want to make it friendly, we can lay some money down on it. Do you want to do it?
Patrick Baldwin: What’s the wager, Paul?
Paul Giannamore: If I win, I come down to Waco. It's the whole weekend of food at Homestead, whatever it’s called.
Patrick Baldwin: Hellberg and Homestead.
Paul Giannamore: It's all on you, PB.
Patrick Baldwin: Paul comes to visit Fat Pat to make him fatter.
Paul Giannamore: If you win, we've got Cayo Caribe. We’ve got Paulina. We've got all those things down here in PR.
Patrick Baldwin: That is the best bread pudding ever by the way. That's Paulina’s. That is a staple of my San Juan trip.
Paul Giannamore: It's loved by all. If you ever make it to Puerto Rico, what Patrick's talking about is there's a restaurant called Paulina on Ashford Street. The chef is Puerto Rican but she was trained in France as a pastry chef. The pastries are fantastic. It's also a restaurant that has great food but they make bread pudding. It's the best bread pudding I've ever had in my life.
Patrick Baldwin: It's wonderful.
Paul Giannamore: You got the Southerners beat on that.
Patrick Baldwin: You've traveled more than me. With bread pudding, you've probably tried more than me but I'm Fat Pat so I know my bread pudding. You're willing to take the bet? Can you give an update on deals, private equity, or not?
Paul Giannamore: It's in the market. 70% to 80% of the transaction that we're working on are with financial sponsors. This 2022, maybe in January or February, I expect to see 5 or 6 new entrants in the space. That's how this year will finish. My gut tells me pretty quickly in 2023 that I don't think that that's a long-lived proposition. Private equity will be here for the next six months or so. They're going to dramatically slow down. Patrick, a couple of months ago, you and I talked about the whole cash on the sidelines.
Patrick Baldwin: How money doesn't come in and out of the market, it goes through the market, Fat Pat. I remember.
Paul Giannamore: If you talk to 10 people in the industry, 7 of them are going to repeat the platitude that there's tons of cash sitting on the sidelines and it has to go somewhere. Of course, it’s a nonsensical comment in general. Clearly, there are a lot of private equity firms that have raised funds but they're under no compulsion to commit this capital. In fact,
I've had a dozen private equity firms down here in Puerto Rico and asked every one of them these questions. What I inevitably hear is, “We've recently raised fund X rent.” They're always raising new funds, “We're sitting on a lot of cash that we have to deploy but it doesn't mean that we're going to go out and do stupid stuff.
As valuations roll down, can we afford to sit around and wait for a year? Sure, we can if we can get a much better return a year from now.” It's not like that money is burning a hole in their pocket. At the end of the day, they certainly have to commit capital. Remember, private equity firms don't go out and raise a $1 billion fund and have that sitting in a bank account. They go out and they raise that commitment at a capital and they'll get 10% of it upfront, sometimes 20%.
They start to deploy it and then they call for capital when they need it. If they don't need it, it's ultimately not deployed. In a lot of circumstances, it’s not committed capital. It’s just that, it's capital that's committed. I can say, “Patrick, I'm going to invest X amount in your new venture. If your new venture doesn't come around like Fat Pat’s Pest Control doesn't work, I'm not going to write you the check.”
Patrick Baldwin: How could it not work? It's wonderful branding.
Paul Giannamore: You're under a restrictive covenant in the state of Texas.
Patrick Baldwin: Not all of Texas. It's a big state. You just have a little sliver.
Paul Giannamore: Will you ever get into pest control again?
Patrick Baldwin: I’ve not left pest control.
Paul Giannamore: Meaning, will you ever own a pest control company?
Patrick Baldwin: I already have a name. I have a URL. You gave me the Twitter name so I'm pretty sure.
Paul Giannamore: Do you own Fat Pat’s? You do. Look at this, Patrick went out and bought it. Somebody should do Fat Pat’s Pest. It's funny.
Patrick Baldwin: I wonder. Paul, maybe I've got four years, maybe three and a half before I even think about it. We said five years so we're not going there. I love the industry. We'll see what's coming. Maybe I'm up to something. Who knows? What's Paul's private equity play? Paul's got Fat Pat’s Private Equity Pest. The private equity fund, are you going to let that money “sit” on the sideline, Paul? You've raised it. Are you going to deploy it? Are you going to start the platform? Are you going to average down as you do smaller transactions? What's your play?
Paul Giannamore: What would my play be in this market? What the evidence is showing us is that the private equity firms want to get into this space face. Private equity was picking up interest in pest control. They started at the end of ’16, that's when we first started to see some interest, and then ‘17. By the time 2018 came around, they started to get active in processes where they were bidding, Jim McHale being one of them. He and I talked about that during Bubble Trouble. In Jim's process, if there were five strategics or five private equity firms, he got IOIs. There was a big delta back then between what a private equity firm would be willing to pay for a $26 million in revenue pest control company versus what a strategic would pay. Ultimately, Anticimex won.
When you fast forward now to 2021, RESEA services have all been accelerated by COVID whether it be pest control, lawn care, and HVAC. People are sitting at home with no air conditioning working. All of these home services have been buoyed during the pandemic. Of course, we saw the private equity firms look around and say, “These are fragmented industries. We can go out, we can buy a platform, and consolidate.”
Every 10 or 15 years, you tend to see the private equity rollout model happen. It usually coincides with extremely low-interest rates. The roll-up model is getting long in the tooth now. On the RESEA service consolidation, the last logs in on the PE Fire as far as getting platforms. Especially in pest control, the pickings are slim. The transaction multiples for platform acquisitions are astronomical. They're face-ripping high. Crazy high multiples for platform acquisitions are still here in late 2021.
Patrick Baldwin: Late 2022.
Paul Giannamore: I was on a UK call at 4:30 AM, Patrick, so I apologize.
Patrick Baldwin: Did Seth Garber do the 4:00 AM wake-up call service he did to me?
Paul Giannamore: He did not. I didn't even know he got up at that time.
Patrick Baldwin: I'll make sure he dials your number.
Paul Giannamore: I should have employed him because I got to get up again super early for closing. In late ‘22, we're seeing still high transaction multiples on private equity platform businesses. The goal is they've got to pay to play now. They do the deal and then they average down their multiple by buying smaller businesses, consolidating on the cheap, and adding on capabilities. It's going to get more difficult here for them.
Since Q4 of ‘21, we've seen the ability of private equity firms to lever transactions to go out and take out debt. It's night and day where it was a year ago. It is difficult to raise debt capital. Debt capital is tremendously more expensive, which has impaired multiples. We fully expect that a year from now, it's going to be that much more difficult.
Patrick Baldwin: Paul, this leads me to ask you, what's left for the remainder of the year? We're about to get into Q4. Have you got the crystal ball? You know what's in the pipeline there. What do you expect to see?
Paul Giannamore: Patrick, we will likely see Rentokil and Terminix close somewhere at the end of September 2022 or probably early October 2022. I don't see any problems there so that'll get done. Of course, Terminix has been extremely quiet. We're going to not see any more announcements from them between now and the closing. Rentokil has done a lot of focusing on the rest of the world from an acquisition perspective.
The strategics are relatively quiet. We closed Rollins’ largest transaction for 2022, which was Bug House. Until I got a call from the owner, I didn't even know it existed. It's 200-some-odd employees down there. It was one of those sleeping giants that don't report on the PCT top 100. That's done and Rollins said, “That'll be our largest transaction of 2022. We probably will not do anything else larger than that between now and the end of 2022.”
Previously it was Jackson Hole. Central bankers from around the world descended on Jackson Hole as they do every fall. Fed Chair Powell came out and wanted to make sure that the market understands that there will not be a Powell Pivot. In June, July, and the first part of August 2022, we saw the equity markets come off their lows. Everyone believed that the Fed, at some point, was going to need to capitulate, quit raising rates, and ultimately cut rates. That wasn't good from a financial conditions perspective. The Federal Reserve wanted to see asset prices go down.
Fed Powell came out. I was rereading the speech here but his message was heard loud and clear by the market, “There will not be a pivot. Don't expect us to capitulate. Of course, the markets have been selling off.” It's going to be a rough fall from a credit spread perspective and an equity market perspective. The good news for sellers is there tends to be a lag in the private markets versus the public markets. Knowing me, Patrick, and having known me for a long time, you probably know what my book looks like in the public markets right now today.
Patrick Baldwin: I could take a wild guess and I'd probably be right.
Paul Giannamore: Pretty short.
Patrick Baldwin: You're short and I’m fat. Have a good week. What does this mean for gold right now? It seems like gold is not going anywhere.
Paul Giannamore: Gold has been confounding. You've got gold bugs and then you've got normal people that look around and say, “If there's ever been a time for gold to take off, why hasn't it done that.” We've got the highest inflation in four years. We've got all these geopolitical issues. We've got Ukraine and Russia. There's a lot of crazy stuff going on, which is an ideal environment for people to be putting money into gold.
I tend to think about it from the standpoint that the gold market has changed dramatically over the past 30 years and it's become financialized. If you think about gold back in the 1970s and the early 1980s when it went from $35 an ounce up to $400 and a change. It was a dramatic increase. You had the oil embargo. You had the Vietnam War. You had a lot of high inflation. You had all those things. The gold market was a physical market then. Now, there are a lot of paper claims on gold. You can buy the GLD and ETF. It's become financialized and it tends to trade, in a lot of ways, more a risk asset than exactly what it is, the ultimate insurance. GLD is traded on an exchange.
The other thing that probably impacted gold to a certain degree is there were probably some flows into “digital gold.” People viewed cryptocurrency as some form of digital gold. I don't believe that to be the case. There were probably some flows into that. I'm not a big holder of paper gold. When I hold gold, I like to hold physical gold. For me, it's the ultimate insurance policy. I don't have a ton of gold but I like to have physical gold in the event that everything goes to hell in a handbasket.
I would have thought there would be some more upside moves in gold. I suspect what will ultimately end up happening is I do think gold will probably get its move on but it's not going to happen until the Fed is going to continue to raise rates or maintain higher rates until they break something. September 2022 is coming up and this will be the first month of full quantitative tightening. The Fed is now going to attempt to decrease its balance sheet by the tune of almost $100 billion a month.
This is the second time in history that they will have attempted this. It's going to have dramatic negative consequences on the prices of financial assets. I don't think gold takes off until the Fed comes public with the fact that they're not going to be able to decrease their balance sheet. They're going to have to engage in some financial repression, which is effectively running 10% to 20% per year inflation to try to inflate away some of this debt. When that ultimately happens, that's probably when gold takes off. We might have some real-time before that happens.
Patrick Baldwin: Are they going to keep ramping up the interest rate until something breaks? Are they looking for the consumer price index? Is that how they're measuring inflation because that's how the American public feels it? What are they monitoring?
Paul Giannamore: The Fed looks at a variety of things. They look at sentiment indicators like the Michigan survey. They're looking at manufacturing surveys, PMI for example. They're looking at broad financial conditions. They look at things like the equity market. The higher stocks and equities go, the more wealthy people feel. That creates the wealth effect. They want to see a slowdown in lending. They want to see lower asset prices. They're looking at core inflation. As opposed to headlines, they take out food and energy-type things. They are looking at those things.
When I talk about they're going to do this until something breaks, I don't mean until inflation breaks. I mean until we have like a Lehman Brothers type moment where there's some Continental Bank way back in the day, the Mexican tequila crisis, or the Asian Tiger crisis of 1997 and 1998. When there's some chain reaction where people go out to eat less and then restaurants closed down.
Restaurants closing down creates problems for commercial landlords and the commercial landlords default and you end up getting this chain reaction, which ultimately causes an AIG or something “too big to fail ultimately fails.” When I say something breaks, that's likely to be what happens. If you look at the world, specifically through the Eurodollar system, it’s short US currency. If you look at the DXY, have you looked at that, Patrick?
Patrick Baldwin: No.
Paul Giannamore: It’s at the twenty-plus year high. The US dollar is the highest it's been in the last twenty-some-odd years. Have you looked at the Euro-US dollar exchange rate?
Patrick Baldwin: I’ve not.
Paul Giannamore: The Euro broke parity officially.
Patrick Baldwin: I remember they were at parity and now you're saying it's below the US dollar.
Paul Giannamore: It's officially traded below that. All you have to look at is what's going on in Europe. The next-day energy contract in France is trading at seventeen times its normal twenty-year median, meaning electricity is seventeen times more expensive now than it has been on average for the last twenty years. There's spectacular pressure now in Europe. The playbook will be to print money and subsidize energy for Europeans. Of course, they can't create energy so they are in the process of ultimately printing money to subsidize it.
My largest asset position in 2022 has been long US dollar against a variety of baskets of currencies, against the Swissy, and against the Yen. My biggest asset position the entire year has been that. I don't know. I'll give the disclaimer, this is not financial advice. I'm not suggesting you do this. For me, I still believe that the US dollar probably has more to run but that will ultimately turn into a wrecking ball. It's starting to turn into a global wrecking ball. It's starting to put a lot tremendous amount of pressure on emerging markets.
I'm going to Egypt and I have some investments there. I'll be spending some time trying to determine whether or not there are some good opportunities. I like Egypt from an investing perspective. It's a large $100 million-plus country that has continued to move more and more out of poverty. It's got a lot of interesting upside potential there. It also is facing excruciating pain due to the exchange rate between the Egyptian pound and the US dollar. There will be some once-in-a-lifetime investment opportunities in emerging markets when these carry trades break. We're in the process of starting to see these things break.
When I deal with all these sellers over here, some guys sell and get $2 million, and some guys sell and get hundreds of millions of dollars. The question is, what do I do with that money? The smart ones here have been largely in cash. We are going to see some phenomenal investment opportunities here relatively soon, maybe not in the broad equity markets but in certain areas. That will be similar to what we saw in 2018 and 2009.
When you look back in retrospect, could you imagine if you had $100 million to invest, Patrick, in 2009? Imagine if you had $1 million to invest back in 2009, what you could have done in retrospect. There are a lot of opportunities that are coming our way. There’d be a lot of opportunities. In one of the conversations I have had with private equity firms, there will be opportunities in pest control. We've seen this before. We've seen these recessions. Again, the business is recession resilient.
I have these conversations with guys like Tim Mulrooney, for example, where he’s traded a spread premium to the S&P for the last 12 or 13 years. My question always is, is the pest control industry large enough when there's relative value in all corners of the earth? At what point do people begin to say, “There's a better opportunity. I can pay lower multiples in the public equity markets getting out of pest and buying other things.” You have to worry about the relative value play.
Not for nothing, the pest control industry is underpinned by Rollins. You and I've talked about this incessantly on The Buzz as well as in all the programming that we do. We're at a point of inflection with regard to Rollins. We've got Gary Rollins effectively standing back. Jerry will be CEO. There is, not for nothing, a transition at least among management in the Rollins organization. My question is what happens a year from now when Gary Rollins sells a ton of his stock or the family trust sells a ton of their stock?
We're seeing the public filings now. He sold tens of millions of dollars worth of stock. He's done that to pay taxes. I'm not sure why he's done it. My guess is that's why he's doing it. Rollins might be under slightly different ownership in the next couple of years. What does that do when the public float? Meaning the percentage of the company that's owned by the investing public is much larger than it is today. What happens when the Rollins family steps back? There are a lot of unknowns here in the next couple of years.
Patrick Baldwin: We shall see. Paul, win or lose, it doesn't matter if you make $1 billion in private equity deals because either way, it sounds like I get to eat.
Paul Giannamore: The real question is where and who's buying?
Patrick Baldwin: Safe travels. We'll see you in a couple of weeks.
Paul Giannamore: Patrick, safe travels to you too. You’re going to your undisclosed location. Have fun. Until next week.
Patrick Baldwin: See you, Paul.
Paul Giannamore: See you, Fat Pat.
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