Paul Giannamore: The second you fall in love with one buyer over another during a process, that's when you've effectively ceded leverage not to that particular acquirer but to the entire process.
---
Paul Giannamore: Fat Pat, in the last episode, we hold the audience as to whether or not we should expand. Every text and email I have seen has been to expand to other industries. What have you heard or seen? You talk to people way more than I do. I’m somewhat of an M&A recluse down here in Puerto Rico. You talk to a lot of folks so what are you hearing?
Patrick Baldwin: I received a lot of feedback. I did want to say thank you, especially to those that are interacting and sending the texts and emails. I love it. I finished reading all the Monica Lewinsky text, I got through to the meat of the message. Yes, expand big time. I thought, “Wow. Thank you all. Thanks for making me do a lot more work.”
Paul Giannamore: I was surprised that we got some messages saying the last episode was the best episode we've ever done and we heard that more than once so I found that peculiar.
Patrick Baldwin: I did as well. I enjoy it but it's one of those ones I'll look back on. I didn't even think about it until we got done but it was a high-level course. You know the people that loved it though, it was the buyers, it was those people out in the U Group. We got some messages from the U Group. I had a good call with one member, got a message this morning, and said, “Best episode ever.” They're buying these smaller businesses and want to help get people back into reality.
Paul Giannamore: In this episode, I'm going to switch up a little bit, Mr. Fat Pat. We're going to say some things that buyers won't like.
Patrick Baldwin: Paul, you have no friends.
Paul Giannamore: No, neither buyers. I sent out a little note, did you see that come through, Patrick?
Patrick Baldwin: Yeah.
Paul Giannamore: I've talked about private equity. We're going to be switching up the website but for now, it's PotomacPest.com, and you can subscribe to the commentary. Every once in a while, I'll send some stuff out. I sent a note out talking about the transition from pest control being a strategic buyer game. The end of 2021 into 2022 was a transition phase. When we did Bubble Trouble in May of 2022, we talked about the rising rate environment and the tightening financial conditions.
We talked about the high leverage of some of the strategics. Of course, the changing environment as they got more selective were not willing to pay as much as they had historically for transactions, specifically vis-a-vis 2021. As you well know, Patrick, my focus is not getting a deal done. It may have been years ago but right now my focus is helping our clients make the right decisions for them and that doesn't always include a sale and it certainly doesn't always include a sale right now.
In the middle of 20222 when conditions deteriorated, it was probably around September-ish, the financial conditions had tightened the most as they had in many moons. Strategics were stepping away from the bargaining table. We still had private equity firms involved. We took the transactions that we thought were best suited for financial sponsors. I use that term interchangeably with private equity firms. We decided to put those on ice until further notice.
I then went out and started doing invite-only presentations for private equity firms to educate them on the opportunity to invest in pest control. There were 80-some-odd private equity firms over the course of the past several months or so that were involved in that. Here in January 2023, we've seen a massive spike in bidding activity amongst private equity firms. We have seen unbelievably transaction multiples spike.
A lot of that has to do with the tremendously looser financial conditions we've seen, which have certainly helped the credit markets. You look at everything from mortgage applications all the way up and down the corporate balance sheet. We've seen credit spreads narrow, which is, of course, good for funding private equity transactions. We've seen a lot of activity. At the end of 2022, that's when we started to bring out the companies that we thought were better candidates for private equity into the market.
Of course, in the last episode, we talked about the fact that the extreme majority of the transactions we’re working on right now are financially sponsored deals. In fact, we closed on the day we recorded the last episode. We did Romney down in Texas, that was a Thompson Street deal. We did Phenom in the Midwest and, of course, that was a Thompson Street deal.
By the time this episode goes out, we will have closed Pointe Pest Control in the Northwest. Jacob Borg, his partner, Gabe, and the entire team there are pushing about $40 million in revenue. That transaction will close a couple of days prior to the publication of the episode. That, of course, will be a Thompson Street Capital PestCo deal as well.
Patrick Baldwin: You’re bringing the Borg Brothers back together.
Paul Giannamore: That's right. Jared sold Pointe in 2022 to Thompson Street and that was the Midwest platform. He also sold Green out in the Mid-Atlantic. The brothers will be reunited as partners at Thompson Street having exited their businesses. Patrick, we're now seeing here in Q1 a massive spike in valuations related to financial sponsors. I would say that the strategic acquirers, the old usual suspects, have absolutely nothing to do with that.
What I have seen is them continuing to get bid out even on smaller deals. Now, financial sponsors will do smaller tuck-in deals but for the most part, they're looking for mid-size firms and platforms. As you look around the industry, you'll start to see more financial sponsors get into the space and that's a good thing for sellers here in the near term.
Where we stand today at Potomac is every single company that we sidelined and waited for in this environment, we have now begun to bring out to market in order to catch this consolidation wave in pest control amongst the private equity firms. I don't know how long this is going to last. We're clearly in unprecedented territory but I'm certainly going to enjoy it while it lasts as will our clients.
Patrick Baldwin: I'm still smiling over here trying to figure out how you're going to upset everyone by the end of this episode.
Paul Giannamore: One thing that would probably upset the strategic buyers out there is that a good chunk of them was banking on the fact that financial conditions would continue to tighten and it would put downward pressure on transaction multiples, which it has. if we lived in a world where it was just the strategics doing deals like back in 2016, ‘17, ‘18, and even ‘19, for the most part, we would've seen a wholesale collapse in valuations but that's not been the case. I'm seeing a transaction right now where a financial sponsor is buying a platform deal, they're doing $6 million or $7 million in revenue.
In small sponsor, they're not going to grow a $500 million pest control business but these guys are reaching down. as we've talked about on The Buzz before, Patrick, every time we take a business out to market, especially amongst financial sponsors, it's important to get 25, 30, or sometimes 40 of these acquires into the mix. I know it can be a little bit nerve-wracking for a seller because you worry about confidentiality.
Amongst the private equity firms, I don't worry about it nearly as much and I talk about it quite a bit on Off The Record on POTOMAC TV. You spend your whole life building up a pest control business, you don't want to crap the bed in the last inning by not running a formal process and answering the email from the private equity firm that says, “We've researched your firm and it looks ideal for us. We want to have a conversation.” That's not the way that you do that. You can do it but it's almost guaranteed you'll leave sizable money on the table. Running formal processes, especially in this environment, is certainly the way to go.
Patrick Baldwin: Hopefully, I don't botch this analogy. J-Bug or Jamie Clement, if you're listening to this, please forgive me. I think about what you said in that last inning but I think about basketball season, the whole game is the last two minutes, and you might as well have a two-minute game. If it wasn't for selling concessions and parking or all the auxiliary things that go with a basketball game, you might as well start the score at zero and run two-minute offense and defense but that's where all the action is. As you said, at the end of your business, there are so many nuanced things that happen in running the process. Watching behind the scenes and how you do that, there's too much at risk and too many things that happen.
Paul Giannamore: That's like everything in life. You go and watch the Chicago Marathon or the Boston Marathon, these guys run 26.2 miles. These guys are running a marathon.
Patrick Baldwin: So I've heard but just not from personal experience.
Paul Giannamore: Me neither. They're running a pretty steady-paced race for four hours and then it's the last 5 or 10 minutes that these guys all start to sprint toward that finish line. That's like a lot of things in life. You want to make sure that the final mile that you do this right because it can have a dramatic impact on what you walk away with.
It's two sides to every coin. If you're a buyer though, one of the things that you can do as a buyer is do everything in your power to make sure that a seller avoids sophisticated advice and runs a formal process. If you can somehow make the buyer feel value and price is objective and build that relationship and make them feel comfortable with you in order to avoid that process, that's the best thing you can do as a buyer, try to convince sellers that the things that I'm saying right now are not factual.
A lot of buyers are successful in doing that because the approach is you talk to Mr. Seller and he's got a $5 million pest control, “Mr. Seller, you can go out and put together a bunch of materials and you can run a process and potentially you've got confidentiality leaks, which create all sorts of problems to your employees. What if they start leaving? You've built this business over the years. Do you want to blow it up from a confidentiality leak that you're out on the market? All these other buyers don't care about you, they're going to destroy your business. At the end of the day, you should trust us. We're buying this. We're going to keep your people. The multiples are high. We know we have to pay to play.”
“What's the benefit for you? In fact, it's going to elongate the process. It's going to drag out the process of you ultimately selling the business. You can work with us and we get it done in 45 days. The worst-case scenario is if you work with us for 45 days and it doesn't feel or seem right, you can always go back out into the market. You could always run a formal process.” Those words are comforting to people who haven't been through it before. As a buyer, you have a duty to yourself to go out there and attempt to convince them to never go to process.
Patrick Baldwin: Buyers, after you've told your potential sellers to read episode 118, tell them not to read episode 119.
Paul Giannamore: Perhaps.
Patrick Baldwin: This is how we've unfriended everyone, Paul, thank you. I just want to be friends.
Paul Giannamore: I'm saying it like it is, Patrick.
Patrick Baldwin: I know. As you're talking through this, my head is going somewhere with it. I know in the last episode, we got talking about residential pricing and residential frequency as you're talking about financial sponsors. I would think that they are buying a lot of residential businesses such as Pointe, case in point.
Paul, there are these auxiliary services, and I'm not talking about the model of business like ABC, Rottler, or Killingsworth where you've got this amalgamation of service lines. There are things that sit on the periphery of pest control and moisture control like Karl’s piece, encapsulation, insulation services, wildlife, and bird control. There are things that sit outside of pest that sit outside of termite. Even fumigation touches some nerves there. You've got these extra services.
With the end in mind, the financial sponsors probably don't have as much forgiveness or familiarity with these extra services such as strategic acquirers. Rollin, Rentokil, Terminix, and Anticimex understand some of these nuanced businesses. What does that look like when you're talking to the private equity and they look at these extra businesses?
Paul Giannamore: That's a great question. I would say a general answer is the strategics are often going to be more concerned with things like mold remediation, moisture control, and fumigation than the private equity firms. Remember, we're talking about roughly 100 financial sponsors out there in North America that are, in one degree or another, attempting to get into pest control.
Let's say half of these guys think it's a good idea and they're doing some basic research on the industry and it's consolidating and they can build a platform and turn around and flip it at some point in the future but they may never get in. They may not want to pay the multiples to get in. They might, for one reason or another, change strategy. It's been demonstrated that, thus far, there has been a handful of these guys to get in and there'll be another handful more that will. Every one of them has faring levels of sophistication as well as has done appropriate research.
I'm working on a project whereby a private equity firm is in the late stages and have done its quality of earnings. They're making an investment in a pest control business and as they prepare for their investment committee report, they're trying to track things down like retention rates. I'm trying to understand, “The target here we're investing in, what's their retention rate, and then what is the industry average retention rate look like?”
Some of the problems with that are the data is extremely opaque as far as retention data goes. Some of the publicly traded companies do publish that stuff, although it's much less common than it was in the past. They do sometimes talk about that at investor day conferences but, for the most part, they never go into the methodology.
One of the issues that we always have with something like retention, for example, Patrick, and there's a point I want to make here, is when you talk about a retention rate, how Orkin, Terminix, Rentokil look at retention will be different based upon the methodologies. Orkin might say, “We're going to look at the monthly churn and we're going to annualize it.” They might say, “In the month of January, how many customers did we lose? How many customers did we gain? What was our net gain and loss?” You do that over the course of the year and you annualize that number, it gives you your retention rate.
Another company though, historically, under Alan Brown and now Andy Brunning, Rentokil, Alan was always a big fan of the opening and closing portfolio method, which is taking customers in and putting them in cohorts based on the month that they became customers. For example, you would look at all of the customers that were signed up in January. How many of those customers are still on the books at the end of the year? That tells you, with that particular cohort, “What was my opening number? What was my closing number? That's my retention rate.”
There are a lot of other nuances in there. For example, depending on your bad debt policy, if somebody doesn't pay you after 45 days, you might call that a cancel. Whereas another firm might not, they might have a 180-day bad debt policy. That's still on your mind, or at least on your books, an active customer. What about the customer that's on a residential program, quarterly, for example, and decides to skip the Christmas season? “I don't want to take a service.” Is that a cancel, especially if it's a service charge?
If you're not billing monthly and they're paying per service, you sold 3 services and not 4, that's not even a quarterly account. There are a lot of nuances in here and there are a lot of bad numbers in general thrown around the industry. Sometimes a lot of this stuff tends to be overstated. Pest control, of course, like every industry, is an echo chamber so you hear things.
Patrick, I don't know how many times we didn't get caught up too much in retention rates just because it was a duopoly. Orkin and Terminix were buying these businesses. I can't tell you how many times back in those days an acquirer would sit across the table from a seller and say, “What's your retention rate?” The seller would be like, “It's 88.6%.” There's no way he knew that because he never calculated it. Retention comes down to definitions and methodologies.
Why I bring all of this up is because you asked about auxiliary and ancillary services. Private equity firms are not as concerned as strategics around certain things and other times, they overblow it. Sometimes they've heard something from one person. They've made one call in the industry and somebody had a bad experience with moisture control. The next thing you know, they don't want to acquire anything that has a moisture control division. Also, an issue with wildlife exclusion.
As we've always said here on The Buzz, if you're building a pest control business, you should focus on general pest whether residential or commercial. Termite as a baiting preventative termite, of course, is a good add-on. You could, of course, do ancillary services. One of the questions that I got at the POWER conference was a company that did a lot of wildlife and the question was, “Wildlife is one time, it's a big ticket, but it is one time and it takes resources as a firm. Should we do it or should we not?” It's a hard question to answer because it depends upon what you want to do with wildlife.
In some ways, wildlife can A.) Provide cash flow to fuel the growth of the business. Two, it can insulate you. Let's say that you've got an industrial park that you service or it's an industrial park that Orkin services, for example. Maybe in that area of the country, they don't do any wildlife at all but that place has rodents or wildlife issues. Now, you've got that edge of the wedge to get in, which is like, “We're experts in wildlife and we'll do your pest control. Bye-bye Orkin.”
Vice versa, it protects you from another firm that can do that. You got a bad wildlife issue, another firm comes in, takes care of it, the ownership or the management is super happy, and you're out the door. Wildlife, if run Mike Rogers style, can be a lead source for general pest control. It’s like diet, perhaps in moderation.
The other thing I will say about services like wildlife is you could build a $10 million or $20 million in revenue wildlife company. There's nothing wrong with that and there will be value to it. As long as you go into it saying, “If I build a company that has $20 million per annum in wildlife, I know that I don't have recurring revenue or it's very low. I know that there's a higher degree of risk in the stream of cashflow going forward and therefore the higher the risk, the lower the valuation today. I shouldn't expect relative devaluations in general pest. I should know upfront that I'm not going to get that.”
Ten years from now, you're not looking around saying, “I got a $20 million wildlife business and there's a $20 million pest control business and that business is selling at fifteen times EBITDA and you're only offering me $6 million.” You were the one that grew the wildlife business so if you go into it knowing that the multiple will be substantially lower, there's no harm in it. It's when you try to justify the fact that you should be at the same valuation multiple as a general press firm, that's when you get into problems.
In the closing of that, long answer to your short question, I had better dealings with private equity firms with regard to sellers that have potentially questionable ancillary services that we would question in the industry as to whether or not a Rentokil or an Anticimex, for example, would value that. The financial sponsors are more looking at cashflow. You can tend to get away with a little bit more with private equity firms than you can with the strategics. That would be my answer in a nutshell.
Patrick Baldwin: In terms of cashflow and the wildlife companies that have kickoff great cashflow, those are high-margin services. What does the universe of potential buyers look like then if it's a pure play wildlife business that's high risk but not as much recurring business high cashflow.
Paul Giannamore: I've personally tended to shy away from that. These markets are dynamic. I remember back in the mid teens, 2014, ‘15, and ‘16, in that era, you had Kevin Clark and he sold Critter Control to Rollins. Terminix and Rentokil were also looking at wildlife because, back then, all the large firms weren't focused on wildlife at all. They didn't have the capabilities. They were getting hundreds of thousands of leads per year. You've got a raccoon in your attic, you're a homeowner in the suburbs, and you might search online or otherwise be like, “I got to call Terminix, they got to deal with bugs and creatures.” They weren't. They were oftentimes throwing those leads in the trash.
Back in the mid-teens, all the big players decided, “We want to get involved in wildlife.” In the first year, what we did is, Buck, whom you know Patrick, his parents owned a business up in Michigan. It was largely a wildlife business and they acquired that business. Buck, who was in his 30s at the time, ended up going with the business and took a position at the corporate headquarters in Memphis for Terminix to roll out the wildlife at all 302 of their service centers. At the time, they had 302 branches back when we did that deal. They were going to roll wildlife out to not throw away leads.
When we did Cat’s Eye, that transaction in early 2016 and went to market in late 2015, 70% or 80% of that business was wildlife exclusion. Rentokil looked at it and Orkin and Terminix. Terminix ultimately ended up buying it and that was an effort to roll out wildlife. It didn't work out that way because of course there were a lot of management changes at Terminix. Every time a new CEO and president came in, they start and stop. If you get lucky from a timing perspective, you can get a hell of a lot of money for a wildlife business if you're in the right place at the right time but that's an aberration.
Those deals available to Cat’s Eye and to Buck’s business up in the Midwest would not have been available to them a year or two after that and I don't know if they would be available to them right now. It's a capability play. That's an example of a company being acquired for a specific capability to augment the capability of an acquirer. Certainly, they're buying a stream of cashflow but at the end of the day, they're looking at revenue enhancements from being able to deal with wildlife referrals, cross-selling, and so on and so forth, and those tend to be fleeting.
Patrick Baldwin: It sounds less predictable and more dynamic but also do you see a private equity player coming in and getting wildlife?
Paul Giannamore: I suspect it's possible.
Patrick Baldwin: All things.
Paul Giannamore: I could see a private equity firm finding a large wildlife control business and saying, “We'll buy this wildlife control business and then we can buy another pest control business added on maybe a smaller one and we can start cross-selling pest control services to wildlife.” They're not going to pay the same evaluations that you would see in generic pest control but I don't think that's out of the realm of possibilities.
Patrick Baldwin: I'm still stuck thinking about Fat Pat. You did throw in a little moderation and diet comment in there. Thanks, Paul. You didn't slip that by me. At POWER, someone had a lucky chance to ask a question about a book. I get to see all the books behind you. I was surprised by the one you referenced and I've not read it. Thinking, Fast and Slow was the book that you like.
Paul Giannamore: I carried it with me. I didn't get a whole lot of reading done this Christmas break, it was quite hectic, but that was plain reading for me.
Patrick Baldwin: Why is it an annual staple of your reading diet? I need to go by the book and find out myself.
Paul Giannamore: It's because it’s changed a lot of the way that I've thought about things over the years. As you may recall, Amos Tversky and Daniel Kahneman received the Nobel Prize for their work in cognitive biases and heuristics or decision-making under uncertainty. For me, that's an interesting book. It's a long book and it's certainly not an easy read but so much of that is relevant to my life in the M&A realm.
That's one of those books that if you read it once, I don't think you'll get most of it. Every time I go back into it, I get more nuanced thought processes. You and I talk a lot about investing in general. We talk a lot about buying and selling securities and commodities and so on and so forth. That's even helped me be a better thinker when it comes to being active in the markets because it is difficult for us to think statistically in our brains.
I mentioned that book because people started asking me about books. How many books are behind me right now? I drew a blank on some of the other recommendations. I do think it's great for business people in general. It's practical and pragmatic for everyday life and it's extremely pragmatic for guys who are in behavioral finance and fields such as mergers and acquisitions.
Patrick Baldwin: I didn't mean for this to turn into a book review but I'm going to ask you one more question about it. You talked at POWER about you wearing an owner hat and an operator, owner as an investor and operator more of a CEO role. Most people are doing both. Sometimes you're terrible at one or the other or both or whatever that is. Does that book apply more so to an investor that's looking at the business or both, owner or operator? Is it a good book for the majority of the audience if they commit to reading it more than once?
Paul Giannamore: Personally, it's caused me to think about how my own mind is biased. In the body of knowledge, when we talk about cognitive biases and heuristics, there are hundreds of these things. We have the overconfidence bias, which is an important bias. Entrepreneurs are, by nature, extremely optimistic. You don't quit your job and go out and start a business unless you're optimistic. The book talks a lot about the benefits of that but also the potential detriments that we overlook being overconfident.
It gives a lot of suggestions on how to counteract a variety of different biases. It's not a book where you're going to sit down and it's not paint-by-numbers, “Here's how to run your business.” It is a book that if you read it and you think about it, it can help you in professional development. I will warn everyone that the first part of the book, maybe the first 5 or 6 chapters, is probably my least favorite. The second part of the book is far more interesting.
Patrick Baldwin: Do you suffer, if you will, through reading the first 5 or 6 chapters every year whenever you put the book back up or do you skip them? I’m curious.
Paul Giannamore: I always carry a red pen with me and I'll underline things and I'll make marks as I've gone through that many times now. Now, when I reread a book, I do it for the purpose of rereading so I know where I want to focus my attention. As you can see, most of my books are hard-bound. For the ones that I'm going to continue to read, I'll make notes, outline, and underline so that when I go back through it, I can skip things that are less interesting or irrelevant. I do that. When we had Professor David Dunning, he brought up the concept of the premortem. Do you remember that?
Patrick Baldwin: Yeah.
Paul Giannamore: That was from Kahneman. That's talked about in the book. If everything goes wrong on this particular project, what's the worst-case scenario? How can this thing blow up? You think about all the negatives prior to starting the project. That comes from Kahneman's body of work. We talked extensively in the Dunning interview about Kahneman and some of the things he raises in Thinking, Fast and Slow. The brain has two systems and he refers to them as System 1 and System 2.
System 1 is the subconscious mind or the non-conscious mind, breathing, heart beating, and you being in a car by yourself on the open Texas roads on a warm July evening. I don't know what the heck kind of music you listen to down there, Patrick, I would imagine it's some sort of a mix of Southern baptist chorus music and maybe every once in a while, a little Miles Davis perhaps. Riding down the open road, you're almost non-consciously driving the car. You can think about all sorts of stuff. In your case, in the Tesla, you are not driving the car.
System 2 is the active process of the mind, you're thinking about things consciously. He talks about anchoring, for example. We've talked about that quite extensively on the show before and that's an important construct here when we talk about negotiations. As I've said before, the older I get and the more experience I get, the more I see the power in anchoring. From an M&A perspective, if I want to buy something for $1 million, as a buyer, I might take control of those negotiations, put the offer on the table first, and anchor to a substantially lower number.
My counterpart on the other side of the table is now adjusting from that anchor. He wants $2 million but the $500,000 offer is on the table. He's got to overcome that now. He's adjusting from an outside anchor. Kahneman goes through a lot of the experiments done in clinical and social psychology over the years with regard to how that works.
For example, in one of the social experiments, test subjects are split into two groups, and the question might be, “How old was Gandhi when he died?” The test subjects that were exposed to a high anchor number like 150 would guess that Gandhi is quite old when he died because they're adjusting to that higher number. The subjects that hear a number even in passing like 30, for example, now they're adjusting from that lower anchor. Overwhelmingly, they all estimate that he died much younger than he did.
Patrick Baldwin: You're not setting a price or an asking price. I don't even think about you incorporating anchoring into the process.
Paul Giannamore: There are certainly particular cases where we would anchor but you make a good point. In a controlled auction process, when you take a business out to market, there's no asking price on it. Let's say right now, today, when we would go out to 25 or 30 financial sponsors, in a lot of cases, there might be 2 or 3 strategics in there.
Let's say we got 30 buyers. Executed NDAs are in, materials get sent out, and then there's a process letter and the process letter says, “You've got two weeks time to review these materials. You've got to send in an indication of interest. The indication of interest has to have these 5, 6, or 7 items, including purchase price or a tight range of purchase prices, financing assumptions, and so on and so forth. You got to submit that to us in two weeks.”
What we do is use those IOIs to help determine which companies will be allowed to move forward to the next round of bidding. After we get the IOIs, we might kick some folks out, and then we ask the acquirers to revise their bids. In order to get a meeting with management or the ownership, they've got to step up their game.
It's an iterative process but there are instances where we do use anchoring. For example, sometimes we will provide guidance at certain points in a process. If I want to sell a business for $100 million, we go through the first round or two. We don't give individual guidance. If we're going to give guidance, we give guidance to all buyers simultaneously because we always want everyone to be on the same footing. There might be instances where, if the offers are clustering early process at around $70 million and I need to get to $100 million, I might anchor high. I might anchor guidance at 130 or 140. You made the point that we don't put an asking price on the business but aren't the buyers attempting to anchor?
Patrick Baldwin: Yeah, with their letter of intent.
Paul Giannamore: Correct. Me understanding how an anchor can potentially impact how I'm viewing evaluation range is important to ultimately how we take that business through a process. Sellers who are not extremely experienced in this, which is most of them, find themselves in a position where first-round offers cluster at $50 million and they wanted $100 million. All of a sudden, they're like, “This is a disaster. The market is showing us $50 million.” Now they're anchoring up from $50 million and that's not the way to look at it.
The way to look at that is to continuously walk those acquirers up but don't anchor to that lower number because I've seen sellers, all of a sudden, adjust their expectations based upon early offers, preemptive offers. It's more about understanding yourself and understanding how your mind thinks through things so that you can defend yourself intellectually and you can defend yourself cognitively from other folks using anchors, for example. Anchors was 1 chapter out of 50 or 60 of them in the book.
Patrick Baldwin: I'm going to chase this one more time. You've already said this, you can't unsay what you said. All of the acquirers that are reading this, you told them how you run a process.
Paul Giannamore: They know that. A sophisticated buyer will understand how control processes run. We always talk about, Patrick, when you're negotiating a transaction from the sell side, you're a process setter. You're negotiating two things simultaneously, process and substance. As an auctioneer, you're setting the process rules and also negotiating substance, which is terms and valuation.
The most important aspect of what any sophisticated sell-side advisor could do is focus efforts on the negotiating process, having shutdown moves, and a variety of different tools in their arsenal to combat acquirers who have become sophisticated over the years in counteracting the negative consequences of competing in a controlled auction process. It's a battle of wits.
The good news is as a seller with a scarce asset and multiple acquirers buying to buy that business, you've got leverage. If you run the process right and you set the right process rules, you can cause the majority of the negotiations to be on the same side of the table and that's not the side of the table you're on. As opposed to cross-table negotiations, you against an acquirer, you can make those acquirers effectively negotiate amongst themselves so to speak.
Patrick Baldwin: Nothing brings you greater satisfaction than watching that play out.
Paul Giannamore: Somebody asked me why it is that I get up every day and continue to do what I do. It's exciting, it's the funnest part of the job. I do like the relationships that I build with the clients. Some of these guys are my best friends. I do get excited about being the best. I want to be the absolute best at what it is that we do but not for nothing. It is exciting.
Patrick Baldwin: It's a sport and it's competitive nature and you enjoy it. It's this pursuit of perfection at the end of the day.
Paul Giannamore: Southside Advisory work, in general, is like any sort of craft. It's like being an attorney, you got a greenhorn attorney using Texas parlance right out of law school. It takes decades to practice the craft to get good at it and quite frankly, a lot of unlearning. The more that you become an expert at something, in the words of Kahneman, we're talking about Thinking, Fast and Slow, the more you tend to exhume or exude somewhat of an overconfidence bias.
You know your shit, you've learned it. The more expert you get at something, you've got to have the humility to stand back and say that times change and circumstances change. Things aren't always done the same way that they have been done and be able to sit back and effectively assess yourself and what you think.
One of the dangers, in general, that I noticed in 2021 more than any other point in my career is that, in 2021, we had a dynamic M&A market globally in every asset class but in pest control, in particular, is what we're talking about. Every time we have a client, we'll do a preliminary evaluation and we look at the business and we say, “You take this business to market today, based on all the data that we see coming in on a day-to-day basis, you're likely to sell this business for between X and Y. Here's a tight range.”
Patrick, you're going to sell your business for between $90 million and $100 million or $85 million to $100 million. That data is based upon traditional and contemporary financial valuation metrics but it's largely based upon supply and demand in a market, which is changing from week to week based on the entrance of new participants, bidding activity, and so on and so forth. As transaction values ratcheted up month over month, it was hard to pin numbers down.
Remember, in 2021, everything including 855Bugs was selling for valuations higher than what I thought. If you don't have the humility to sit back and say, “For many years, I preach that the market sets the price, I don't. The only thing that I can do as a consummate professional in the M&A realm is set the process. If I set the process right and I run the process right and my clients understand what's going on, I let the market dynamics play out.”
One of the dangers an inexperienced advisor could cause some problems looking at a few comparable transactions and saying, “Here's the value based upon what AX is doing, what Rentokil is doing, or what the private equity firms are doing.” Having that data be incorrect because every asset is unique, especially in a market where scarcity premiums rise as other assets are acquired now.
It was an interesting year for me because I got to see it play out in real-time. For the entire firm here, I said to myself, “We got to do the absolute best job we can in giving our clients a sense of where they would likely end up in a financial process.” We suspended all guidance in 2021. We had zero guidance. No buyers got any sort of guidance. Typically, buyers don't give guidance from us but every once in a while, if I got to juice something, I'll give some guidance. That's based on professional judgment but we just let it play out. I was amazed at what happened.
Patrick Baldwin: From our experience as sellers though, that's very high-trusted. Trusting you that's trusting the process and us not going through that was a once on a lifetime thing. As numbers started to come in and you said, I know we've said this on The Buzz, “Trust the process. Trust me. Trust the Mex.” That was 2 out of 3.
Paul Giannamore: I remember on your process with the Mex, we had a lot of different acquirers bidding on that thing. I do remember saying those things, “We got to trust the process.” I know you and Bobby had better feelings for buyers, one acquirer you like better than the other, and that's natural because everyone feels that way. You can shortchange yourself if you get emotionally involved in that. I always say that if you do this right, you have to let the price and terms speak to you first.
You can always leave money on the table at the end of the day. If you want to go to an acquirer, that's not quite there. The second you fall in love with one buyer over another during a process, that's when you've effectively ceded leverage, not just to that particular acquirer but to the entire process. You're allowing buyers to effectively bid less. Yours was an interesting case study, Patrick.
Patrick Baldwin: It was fun.
Paul Giannamore: You finally got to see it play out.
Patrick Baldwin: It was fun.
Paul Giannamore: Mr. Fat Pat, I know we talked about some POTOMAC TV stuff. If you're not a subscriber, go to Potomac.tv. Dylan and I will probably be taking the show on the international road here relatively soon. There is a lot of international travel I have coming up that needs to get booked. The next session we will be doing will not be down here in Puerto Rico and it will not be in the United States, it will be probably in Europe so we've got that coming up.
We've had readers unanimously tell us to expand and pull in from other industries so that's what we're going to do. I'm going to roll into the Mike Rogers School of Pest Control and we're going to open this up. We're going to get restoration and HVAC. I'm going to bring some tech firms on here. We're going to start to look at some of the high-level strategy development of some of the other firms and other industries. We're going to think about how they systematize their business and how they build various routines that are directly applicable to pest control and all other residential and field services businesses.
Patrick Baldwin: I'm tracking some people down already. We're doing this. This was fascinating. I need to go buy a book. I know we jumped around, talked about wildlife, and talked about private equity. I'm always learning, thank you. One more, Paul, I saw this week, FOMC, 25 basis points. It's what you expected or predicted. How's the market reacting and what's your takeaway there?
Paul Giannamore: I always spend more time on the Powell presser than I do on the actual formal FOMC statement. Inflation has of course come down, which we all know. It's nowhere near the target of 2%. I feel like Powell is being much less concerned about the wage-price spiral. Although you saw that the non-farm payroll came out, it was about 180,000 jobs. The consensus estimate was 180,000 and we created over 500,000 jobs. Of course, futures sold off extensively.
We're in this interesting situation now. Fed fund futures, markets still expect the Fed to pivot at some point this year. Of course, a pivot is defined as cutting rates higher for longer. The equity markets, of course, have loved this, which has been painful for me because my shorts in 2022 was a great play for me, and I've lightened those up quite a bit in January. I'm trying to determine the path forward. The markets have been on a tear. The markets love the fact that inflation has peaked and the Fed might pivot.
I personally think that they're going to try to keep financial conditions as tight as possible for much longer than the market anticipates but that's neither here nor there. I take what I can get and what I can get right now is this has certainly been a reprieve for the M&A market. For all those potential sellers out there, things were going the wrong way quickly in 2022 and they will ultimately end up there here in 2023.
Look at earnings, Patrick, there's no doubt about it. We've got inventory builds across the board. We've got forward guidance coming down. We are going into a recession. Soft landings do not cure the aggregate demand equation, they don't bring prices down, and that's not what soft landings do. There will have to be extensive demand destruction. Soft landings are always predicted even before the most hardcore of recessions.
Of course, if you look back to the financial press in 2007, there was a ton of talk about a soft landing and we got anything but. Anything can happen. I think to myself, “We've got this window of time.” I told the Mexican, “It is 2023 and everything must go here in the first quarter. Let's get this stuff out into the market.” It's been very successful here in the first 34 days of the year with where we're seeing the market. On the financial sponsor side, it's been great. We shall see, Patrick.
Patrick Baldwin: Keep the Mexican employed.
Paul Giannamore: He'll make it at least through Q1. We'll see if he can stick around for Q2.
Patrick Baldwin: I'll be at Myrtle Beach for NICOA.
Paul Giannamore: You're going to NICOA.
Patrick Baldwin: It's the National Wildlife coa.
Paul Giannamore: What is this?
Patrick Baldwin: It's a wildlife conference, part of NPMA. I’ll be there hanging out. I heard it's crazy so wish me luck.
Paul Giannamore: That's where?
Patrick Baldwin: Myrtle Beach, all 60-degree weather. I'll get out of this 30-degree weather to go to a beach at 60 degrees.
Paul Giannamore: Myrtle Beach, I haven't been there in many moons but it almost reminded me of like if you were to go to the worst Redneck Walmart in the United States, empty it out, and take all those people and put them next to a body of water, it would be Myrtle Beach. Does that sound right?
Patrick Baldwin: I will let you know. We'll make sure we talk about that next episode.
Paul Giannamore: You've never been there?
Patrick Baldwin: No.
Paul Giannamore: I did go there many moons ago.
Patrick Baldwin: Why is that so easy to picture? Thanks, Paul.
Paul Giannamore: Patrick, it's a strip of broken-down motels. I won't spoil it for you. We'll get your report on your return.
Patrick Baldwin: I'm glad you told me that before I went. You've set my expectations. You anchored for me. Thank you, Paul.
Paul Giannamore: There you go.
Patrick Baldwin: Have a great weekend.
Paul Giannamore: Safe travels. Until the next episode.
Patrick Baldwin: See you, man.
---
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.”
As part of giving back, we have this podcast, but more than that, Paul and I have been working our tails off over at POTOMAC TV. We've spent a tremendous amount of time, energy, and resources to build out that platform to bring you market updates, to bring you visual breakdowns of the merger acquisition process, and to tell stories and present information in ways that, frankly, it's not possible for us to do on The Boardroom Buzz.
Adding the visual element takes it to the next level. I want to invite you to go to YouTube and find us, it's POTOMAC TV. Potomac.tv will get you there. Go there and subscribe. Check out some videos and leave some comments. Let us know what you like and let us know what you don't like. Let us know what you want to see more of and we'll see you over there.
PotomacPest.com
POTOMAC TV
episode 118
Thinking, Fast and Slow
Professor David Dunning – past episode
