Jamie Clement: If you look at most research that's been done, the biggest determining factor in the success of generating returns in M&A regardless of the industry that you're in is the purchase price that you pay.
Patrick Baldwin: J-Bug, you have a lot of controversial things to say. It's time to bring you back on the Boardroom Buzz and see what you can get on the record.
Jamie Clement: It's a pleasure as always to be here.
Patrick Baldwin: The bar has been set. Anything right out of the gate?
Jamie Clement: Not only are we about to enter a difficult period of time, but we're also already in one. There are some signs we're already in a consumer recession, quite frankly. To me, as it relates to pest control, is this a different period than 2008 and 2009 when residential pest control was remarkably stable? I don't know the answer to that question. I'm curious about your guys' opinion on it.
Paul Giannamore: We're about to figure that out. The big difference between 2008 and 2009 versus today is we had a period of disinflation in 2008 and 2009. A subsection of the population lost their jobs. Now, every wage earner in the United States, Western Europe, and Latin America is under intense pressure because real wages are negative. The last real wage print I looked at for the month of May 2022 was a negative 4% real wage growth, even though we're seeing quite a few raises.
It's an interesting situation. When I think about pest control, and you and I have talked about this quite a bit, it's far more preventative now than curative. Whereas, in the 2000s, it was largely curative. I don’t know when somebody spends $150 to fill up their car, they go home, have no ants, and wonder why they're paying $650 bucks a year for pest control. As you said, the jury's out still.
Jamie Clement: A little bit earlier in June 2022, Morgan Stanley downgraded the Altria group with concerns about cigarette demand. For those of you that don't know, that's the parent company of Philip Morris, Marlboro cigarettes. Whether they were talking about whether there would be trade down or something like that, it wasn't clear. It certainly sounded like it. At no point in time in ‘08 and ‘09 did I hear anything about cigarette demand being eroded as a result of the economy. This is probably the first time in my business career that I've ever heard anything to that effect.
Think about it. You figure a lot of cigarettes are probably being bought in gas station convenience stores. People go fill up their tank. Maybe there's not so much money left. I don't know what the budget brands of cigarettes are. Maybe somebody says, “Instead of spending X for a pack of Marlboro Reds, I'm going to spend 0.6 or 0.7 times X to buy some off-brand. I don't know what the numbers are. Maybe that's what's going on. That was something where you didn't hear about demand erosion for a habit-forming product back in ‘08 and ’09. We're starting to hear some of that now. That's a little bit scary, quite frankly.
Paul Giannamore: Patrick, your habit-forming products down in Texas tend to be barbecues and other related products. Any demand structure on those?
Jamie Clement: The price of that is way up. Patrick, when people go to the local barbecue place, do you think they're going maybe away from a rib and brisket and more towards maybe chicken and sausage?
Patrick Baldwin: I'm glad you know your barbecue there. You did correct yourself to say beef rib, singular. Only Paul could put down more than one beef rib between the three of us. The price is continuing to go up. That pulled JUUL off the market. It’s not that I was a vape guy but that's going to hurt a little bit.
I have a question. You're going all the way back to ’08 or ’09. In more recent history, the pest control industry abroad said, “Back in 2020, COVID hit, and people are stuck at home. Our industry didn't take a hit. We grew 20% and 30% in 2020. We're ready for this. Bring it 2022.” I’m like, “What is this? Captain Dan from Forrest Gump. How is this going to end up?”
Jamie Clement: Here's what's different. You hit the nail on the head inadvertently. Everybody's at home. You got your kids dropping Doritos crumbs all over the place. Plus, in a lot of cases, you got federal money that’s going into people's accounts every week. That has stopped. With people, hopefully, not in their houses as much as they were in 2000 and 2001 and without some of the federal money coming in, we had concerns back then. We discussed them. Largely speaking, the industry passed the test on the residential side. The playing field, the goalposts, or whatever sports analogy you want to use has changed. Paul, do you agree?
Paul Giannamore: 100%, I do. Here in 2022, we've got a $1.3 trillion fiscal gap versus Q2 of ‘21. That's a lot of money that's not getting pumped out into the consumers’ checkbooks. In addition to that, the fiscal spend being down, we see demand destruction from prices. The industry is recession resilient, so to speak.
Jamie Clement: Resistant.
Paul Giannamore: That's going to be put to the test here.
Patrick Baldwin: This preventative curative thing is interesting. How do you segregate that or measure that? Isn't that as simple as watching recurring trends?
Paul Giannamore: If you got a raccoon in your attic or you've got a bad pest infestation, your wife's going to be complaining at you. You’re calling the pest control operator. There are a lot of our customers out there that don't have an act of pest problem. We’re selling a pest-free environment. We're selling a warranty product. What does a middle-class American family make now, two working adults? $120,000 a year or something of that effect?
Jamie Clement: That might be what the average is for your industry but it's significantly less than that.
Paul Giannamore: Let's call it a $90,000 a year household. $600 a year for pests and you don't have a pest problem. None of us know what's going to happen. If you look at the University of Michigan Consumer Sentiment Index, I don't remember when they started that, 1971? Did you see that print, Jamie? It was the worst ever.
Jamie Clement: Ground beef around here at the grocery store is about $5.99 a pound for a pretty low-quality product. The price of boneless and skinless chicken breasts, not the good ones but just the grocery store brand, are pushing $5. The price of wings per pound is pushing $5. That has certainly already started. The big one is the price of gas at the pump. What has not moved as much as it probably will move is your adjustable-rate mortgage prices. That's where things get scary.
Paul Giannamore: How so?
Jamie Clement: In the sense that if a family’s housing payment ends up being up 60%, 80%, or 100% versus what it was, it's like you're tying your home payment perhaps to other payments you make around the home with pest control being one of them. When it comes to grocery store shopping or households entertainment budget, you can make significant alterations to that but you’re stuck with your housing payment a little bit. I don't know how many people got in front of this, refinanced, etc. It sure as heck looks to me, Paul, the banks themselves, their mortgage departments are acting as if this is about to get scary.
Paul Giannamore: 100%. The mortgage industry is feeling the pain.
Patrick Baldwin: Jamie, you said layoffs are coming in the banking industry.
Jamie Clement: I read an article on CNBC about this. After two years of the banks complaining that they can't hire enough people, we're going practically straight from desperation and hiring to upcoming layoffs without a period in between. Paul, you can back me up on this, like the Fed, the banks tend to overhire and overfire the same way the Fed is usually too late to the interest rate increase party and then overreact as it tightens. I'm not sure they're overreacting right now. In fact, I could certainly have made the argument that they should have gotten more aggressive than the 75 basis points, by the way.
Paul Giannamore: I tend to agree with you. The main problem is not the tightening or non-tightening. The main problem is what they've done for the last several years.
Jamie Clement: I don't credit Paul for remembering this line. Oftentimes, the cure for high prices is in fact high prices. Maybe the economy self-regulates itself for the better regardless of the Fed, Congress, the White House, or what have you.
Paul Giannamore: It's interesting to me the dynamics in the economy right now given we go through this pandemic, everyone's at home, goods, and services consumption patterns changed dramatically. Now, we're “out of the pandemic” but life has changed. You look at the Walmart and Target warnings on excess inventory, they went out and bought a bunch of 2020 crap, so to speak everything.
Jamie Clement: Yoga pants, pajamas, slippers, and sweatpants.
Patrick Baldwin: I was wondering what you were wearing today, Jaime.
Paul Giannamore: No one wants it.
Jamie Clement: I’ve worn all that stuff for years, Patrick.
Paul Giannamore: The other thing is I came off a couple of weeks on the road. I will tell you, business travel is not anywhere near what it was pre-pandemic. Everyone flying right now is a tourist. The TSA checkpoints are empty. The PreCheck checkpoints are awesome. Everyone that's traveling is a tourist and they have no need for TSA PreCheck. I'll tell you what, business travel is still down tremendously.
Jamie Clement: We've seen more flight cancellations announced over the last couple of days. I don't know if all that news hit you guys because a lot of this was United announcing cuts at Newark, which is one of its big hubs. I didn't know if that was more local news up here in the Northeast versus you guys hearing it nationally and internationally. I saw two different metrics, the price of your average ticket in the US is now somewhere between $275 and $295. Unfortunately, off the top of my head, I don't know what the number was years ago but that sure as heck strikes me as being very high.
Paul Giannamore: Jamie, we've got a situation now where in a Fed hiking phase, we saw 75 basis points in June 2022. We're likely to see another 75 basis points in Fed funds in July 2022, would you say?
Jamie Clement: That's certainly what their messaging is. We said the same thing about 50 so who the heck knows?
Paul Giannamore: Clearly, thus far in 2022, we've had multiple contractions in the public markets but we haven't seen the big hit to earnings yet, which is still yet to come.
Jamie Clement: In the next couple of weeks, the likelihood is quite high that you either see a significant number of corporate pre-announcements, guidance reductions, and/or sell-side analyst estimate reductions. If you look at the entire universe of all of the stocks that sell-side analysts cover across all the major indices, something like 90% of the analyst company coverage estimates shows 2023 earnings higher than 2022, 90% plus. Do you think that 90% of the companies that are covered out there, global domestic, or whatever, are going to see higher earnings in 2023 than in 2022?
Paul Giannamore: I'm glad you brought that up. On Bloomberg, I saw something come across the screen that said, “Sell-side analysts with regard to S&P 500 earnings haven't been this bullish in twenty years,” to your point.
Jamie Clement: I do want to make one thing very clear, though. Markets always bottom long before the estimates are as low as they need to be. In other words, the market will have already started going up and you could conceivably miss the first 10%, 15%, or 20% long before the sell-side analysts are done taking their numbers down. This is an important point to bring up. As a practical matter, if any of your readers are thinking about their 401(k) accounts or their TD Ameritrade trading accounts, that doesn't mean the market necessarily continues to go down.
I have this sinking suspicion that it's going to happen soon. A mistake out there if you watch CNBC is we're going to have to be patient and see how the next couple of months ago. I'm not entirely sure that's the case. Who knows? Maybe we have bottomed. Maybe there's some bad news over the next couple of weeks and we end up bottoming in July 2022, early August 2022, or something like that.
This isn't like, “We're going to have to wait to get into the fall and see how the holiday season goes,” and all that kind of stuff. I don't think that's necessary. I can understand why logically people say that. From an absolute market-level perspective, let’s say the earnings estimates are too high, 20 or 22 times, for Netflix, that doesn't necessarily seem so bad.
Paul Giannamore: Look at consumer products companies like Weber Grill. Weber is trading at seventeen times EBITDA for a grill company. That's a seven times business. One of my most successful shorts of recent days has been Avis, the rent-a-car company, Ticker car. That thing is trading dramatically higher than it was in 2019. I don't see a very bullish case for Avis's rental cars here in the near term.
Jamie Clement: There's no way that the tourism business, particularly with the price of gas at the pump where it is, is going to offset all of the business they have lost on the business traveler front. No way.
Patrick Baldwin: I was at the Texas Pest Expo and someone up on stage that's been an economist for years and years even advised the White House, years ago, says that we've already seen the worst. He was very bullish on the future, almost like the worst is behind us. What do you say to that?
Paul Giannamore: I've got some thoughts. Here's my issue with all of that. Irrespective of what the equity markets do, I don't think people pay attention to this but we are a twin deficit country. We have debt-to-GDP at about 130%. We are in a situation where productivity growth has come to a screeching halt.
Everyone's levered. There's been so much malinvestment and distortion built up in the market after 13 or 14 years of reckless monetary policy. It's going to be time to pay the piper. The only way out of this for the US government is to run double-digit inflation for 5, 6, or 7 years. That's the only way you liquidate this debt.
The alternative for the US government is to not make good on its current pay obligations, which is interest on treasuries and retirement like Medicare. A lot of these folks are just not doing basic math anymore. We've lived in an environment where we've got all this ESG crap. We've got horrible fundamentals in energy markets. Whereas there's been underinvestment. Companies are penalized. Who wants to build a refinery now?
We've got Joe Biden coming out saying, “These guys are price gouging and they're criminals, effectively.” Who wants to invest in refining capacity in the world that we live in right now? All this rhetoric from the government? Clearly, the Russia-Ukraine situation has created energy market problems. At the end of the day, even push that aside, the fundamentals for this industry, energy price is going to skyrocket irrespective of what Putin does.
Jamie Clement: You have the administration come out and say, “This refining capacity was shut down during COVID.” It was shut down during COVID but not because of COVID. It was shut down because when he took over, they rolled back all kinds of regulation that was taken away in the prior four years. It was to the point where it wasn't going to be economically viable to continue running some of these refinery plants with all of the environmental restrictions attached. Yes, it was during COVID but it was not because of COVID. That's a fine line. When you listen to them, you can tell they're trying to thread the needle on that logic.
Patrick Baldwin: What did that do in the past, Jaime? I don't know if we've gotten you on the record on ESG but I want you to say something controversial.
Jamie Clement: The thing with ESG is, in theory, a lot of that is a good idea. However, what I have noticed is there are a lot of companies out there that are using ESG to justify doing some of the crap that they wanted to do anyway. In a way, it perverted itself. That said, that's not everybody. Paul, you would agree that over the last several years, a lot of improvements have been made on the governance side.
The G aspect of things, to me, I've got less of an issue with rather than some of the E and S stuff, which is a lot more difficult to quantify, quite frankly. From a governance perspective, if the chairman and CEO roles should be split, if you want staggered election periods of the board of directors, those things, to me, that stuff is fairly easy to swallow.
It's the more vague stuff where you've got a couple of 100 years of accepted ways of public companies doing business in the idea that they are in the business to maximize shareholder value. All of a sudden, are they in the business of maximizing shareholder value? Will Twitter be if Musk closes that transaction? I don't think he will. I don't know. There are all kinds of questions there. They make it a little bit more difficult to own some of these stocks.
Patrick Baldwin: I hope he doesn't close on Twitter only because I have a side but with Dylan.
Paul Giannamore: You’re not getting off that easy. What was the side bet so we know? Let’s got to make it public, Patrick.
Patrick Baldwin: I think I have to buy him a Tesla or something crazy like that. I don't even know.
Paul Giannamore: If what?
Jamie Clement: That shouldn't be, “I think I might have to buy him a Tesla.”
Paul Giannamore: “I may have put a Tesla on the table.”
Patrick Baldwin: I have to go and look. I know it was not a Tesla on the line. I'm digging through my messages to see what the bid was. This is what it is, Elon’s face as a tramp stamp is what's on the line here.
Jamie Clement: I might rather give up the Tesla.
Patrick Baldwin: It’s bringing back some memories.
Paul Giannamore: The loser would have to get Elon’s face as a tramp stamp.
Patrick Baldwin: That's what was on the line. I don't think we ever made this official. We'll see. He's listening to it right now, Dylan. I don't know if you're ready for that tattoo yet.
Jamie Clement: I'll tell you something, Patrick, up in my neck of the woods. We talked about regional barbecue and that kind of thing. Whatever happened to a reasonable steak dinner wager between friends? Paul, am I off base here?
Paul Giannamore: It's evolved into Elon tramp stamps now.
Jamie Clement: The word is de-evolve.
Patrick Baldwin: You decided to redirect the conversation from ESG. I like how you did that. Let's bring us back. The companies are going to have to chase returns right now. Environmental and social are probably what's going to have been inflated over recent years. We're in a recession. We're in a hyper-inflationary environment. What are they going to do with ENS?
Jamie Clement: To tap the brakes a little bit, a lot of regulations coming in from the exchanges regarding how funds can market themselves around ESG. The ground rules of that have not all been figured out. That still may take a couple of quarters.
Patrick Baldwin: You're deflecting again, Jamie. Shoot me straight.
Jamie Clement: Paul, do you want to rescue me here?
Paul Giannamore: Patrick, I think about the environmental aspect vis-à-vis like all this horrendous government policy that's ultimately trying to squeeze the fossil fuel industries when there does not exist any viable alternative. I came back from Europe and the big question is, what the hell are we going to do this winter when we don't have natural gas? I know Biden would love to fight the Russians all the way down to the last European but I have a feeling, come this fall 2022, the EU says, “Forget these sanctions. We're not dealing with this anymore.” They need heat. They need oil. They need natural gas. They need that stuff.
Patrick Baldwin: Is nuclear the only option out there? I was thinking about France, it’s heavy on nuclear. Why are we not going nuclear? This is a pest control podcast but this is relevant.
Paul Giannamore: It takes a long time to build nuclear reactors, number one. It takes a long time to build oil refineries. You have this acute multi-year time periods where you run out of energy. In January, in most of Western Europe, you can't not have heat. It's a real problem.
Jamie Clement: I do agree with Patrick. Patrick, the other thing. Unlike 20, 30, or 40 years ago, you don't have the same level of humans choosing to become nuclear power engineers. You don't have that knowledge, infrastructure, and enough human beings and companies that are capable anymore of building nuclear power plants. Even if there was political will behind that, Paul, correct me if I'm wrong, isn't that a 10 to a 20-year solution? It’s certainly not a 2023 or 2024 solution. Although, Patrick, I agree with your logic, 100%.
Patrick Baldwin: Even in Russia, Ruble bought them down. It's a record high already. I don’t know what's going on there. You can’t not have energy.
Paul Giannamore: The US and Europe can print currency but they can't print energy. This is the problem that the West is facing. Patrick, you were at my house when I had this discussion. Since the beginning of this, when this first came out, I remember you and Dylan were on the porch and you got in this debate. I've always thought to myself, “World War III will not be fought on a battlefield. It's economical.”
At the end of the day, irrespective of whether or not you hate Putin's guts and want to see his demise or you love Putin and fantasize about him riding ponies with no shirt on the beach, the reality of the situation is the Russians have resources that Western Europe and the US don't have. Western governments are so over-levered and insolvent that all of me think that this was never about Ukraine.
This is about Putin controlling this energy with the West so highly levered. If the US and Western powers were going to go in and sanction FX reserves, and if they were going to sanction energy, oil, and natural gas, this was going to be more problematic for the West than it is for Putin and that has played out and it's continuing to play out. By the end of 2022, the Europeans are going to ditch those sanctions on oil, number one.
I was talking to a crypto buddy and as we were having a chat, came out G7 sanctioning Russia's gold imports. If that were a pretty pet rock, these governments wouldn't be sanctioning it. Now we have the gold sanctions here, Patrick. These sanctions were completely moronic. The West’s sanctions on Russia are backfiring every second of the day. The sanction of the central bank FX reserves is probably the most important blunder that the West has made.
Now, they've made every other country around the world that's a bad actor. Russia was a bad actor so FX reserves were sanctioned. What country hasn't been a bad actor in the eyes of the United States over the last 50 years? France and Germany. At one point, Japan was a bad actor in the ‘80s. The Saudis with Qashqai, bad actor. Israel was a bad actor. Whoever the US doesn't like will sanction their FX reserves.
Jamie Clement: South Africa.
Paul Giannamore: The list goes on. We're starting to see the rest of the world wake up and say, “Do we want US Treasuries as a reserve asset?
Jamie Clement: I agree with most of that, Paul. The issue with all this is you “fight” or rather address the challenges that have come before here by trying to figure out supply and not just “punishing” and trying to figure out demand. Unless this sounds completely all doom and gloom, the one thing that I will interject with as a potential huge countervailing positive are the fall elections.
If you see a Republican clean sweep here and Congress starts talking about major energy supply reform, even if some of that stuff may take a year or two years or even longer to come in, the market price of those underlying energy assets is going to be forward-looking. Also, it will reflect an expectation of higher levels of supply. That in and of itself can be counter-inflationary, which would be a pretty good thing, I would imagine.
Paul Giannamore: Is that what you expect to happen this fall here?
Jamie Clement: I would imagine, yeah. It seems like it. That's another one of these things where he could bring some sobriety back into energy policy in this country. If there is an expectation of a Republican trouncing Biden or whoever the Democratic candidate is in 2024, that's another thing. That likely brings down the price of oil, the price of gas, and then ultimately the refined gasoline product.
Patrick Baldwin: A few months ahead of the midterm, is the economy going to be the number one issue that’s central in the debates?
Paul Giannamore: Inflation is the number one issue.
Jamie Clement: I'm including inflation in the economy.
Patrick Baldwin: Is that not judged by what the price is at the pump?
Jamie Clement: Or in the grocery store aisle. I'm in an area. How many New Yorkers drive? Not a lot of them. What I hear about more from average New Yorkers is not the price of gas, it's the pump. It's the price of ground beef. It's the price of wings. It's the price of chicken breasts. It's the price of cereal, which has now started to get a little bit ugly.
Patrick Baldwin: since Paul started calling me Fat Pat, I’m trying not to eat as much. Here you are, throwing all these foods at me.
Paul Giannamore: Is that due to food price inflation, Patrick, your half a rib at Helberg?
Patrick Baldwin: I don't know if I held back at Helberg. You know me better than that. We should dig in a little bit to Terminix and Rentokil.
Jamie Clement: Investors have said with their pocketbooks what needs to be said. What this comes down to is how well are these businesses integrated and the improvements that need to be made at Terminix? How good a job can Rentokil do at executing an improvement plan that many other seemingly smart people were not able to do? What's the timeframe?
Paul Giannamore: What becomes interesting is Rentokil traded off quite a bit from its November 2021 high. That's a fixed shared deal. 80% of the considerations chair and 20% in cash. The enterprise value of Terminix has declined since that deal was signed on December 13th, 2021. Those guys are trying to walk the tightrope over there with regard to the fact that if Rentokil continues to hold up, it's been trading in a tight range in the 470’s as of late. Patrick, it was at 660 when the deal was inked. They'll get it done but that thing continues to roll over. It gets below 400. It makes it more difficult to get the thing done.
Patrick Baldwin: When would a shareholder vote happen?
Paul Giannamore: Probably in August 2022.
Jamie Clement: That sounds right.
Paul Giannamore: They sent out proxies.
Patrick Baldwin: Episode six goes way back to May of 2020 maybe. Going back and listening through episode six was funny. Paul, you wrote, “This conversation has been on and off since 2018,” which was news to me. I don't know when you discovered that.
Paul Giannamore: It's not this direct conversation, Patrick, because we had got different people at the helm there at Terminix. Although, Naren was still around at the time. The NDAs were originally signed in May of 2018. Terminix approached Rentokil. They had chats through May and then that fell apart. It wasn't until October of 2021 that Andy Ransom rekindled that. I put the actual timeline in a recent market update comment on PotomacPestControl.com.
Jamie Clement: Very well done, by the way, Paul.
Paul Giannamore: Thank you. I lost steam there on the storyline, though. I wanted to make it more interesting. I got tired of looking up Taylor Swift songs. The most interesting part of that discussion for me, Jamie, was where the Rentokil debt was priced. Its current issuances had 2024s, 2026s, and 2028s out at 95 basis points, 87.5, and 50 basis point coupons.
Jamie Clement: It’s practically free.
Paul Giannamore: They priced a hair shy of $2 billion value of Euro and Great British Pound medium-term notes. I'm talking about the coupons here. those priced at 3.875%, 4.375%, and 5%. By the time the auction was done, the most pricey of the notes was the Great British pound, a £400 million note at 5.213%. It’s a dramatic uptick in debt financing in a matter of a few years. Jamie, we're seeing that all throughout Corporate America as these corporate bond credit spreads continue to slowly but surely eek up.
Jamie Clement: One thing that your readers who perhaps don't work directly in the markets may not understand is that, at the end of the day, particularly when you're talking about corporate debt, the market determines when interest rates are and not the Fed. The idea of this slow pace was 50 and now at 75 basis points a month meeting increases. In the actual real world for companies that want to issue debt, those numbers can get a lot more expensive much more quickly as to, by the way, mortgage rates.
Paul Giannamore: We're seeing it happen in both markets.
Jamie Clement: Paul, perhaps you know more about that. I assume you know more about this than I do. Certain pools of debt financing have already dried up for private companies, haven't they?
Paul Giannamore: Yes.
Jamie Clement: That phenomenon precedes real public market tightness by 6 to 9 months sometimes.
Paul Giannamore: That's correct.
Jamie Clement: It's another thing to consider.
Paul Giannamore: I'm always watching HYG and JNK. Those are exchange-traded funds for those of you who are not aware of what they are. HYG trades somewhat equity-like but it tends to front-run the equity markets and that is the US high yield ETF. We're seeing that continue to sell off as OIS spreads increase. We've had well over a decade of extremely easy money. From a historical perspective, it's not that corporate debt is quite expensive relative to the past, it's just extremely expensive relative to where it's been in the last ten years. It will impact private equity deals. It will impact the ability of companies like Rentokil and Rollins to go out and purchase smaller acquisition targets.
Jamie Clement: I'm going to jump in and I'm going to disagree with that a little bit on one of those names, Paul.
Paul Giannamore: I know because Rolins has a sub-optimal capital structure, no debt.
Jamie Clement: Sometimes, when you talk about suboptimal capital structures, depending on what's happening in the interest rate market around them and what investors are looking for, maybe that capital structure starts looking a little bit more optimal in some ways. At least from the ability to have your stock work. If there isn't any real huge deal out there, can’t Rollins comfortably fund an acquisition program through free cashflow?
Paul Giannamore: Yes.
Jamie Clement: If you want to look at some of these companies, Rollins is in the catbird seat as far as I'm concerned with respect to being able to operate an acquisition program without becoming stressed at all. Quite frankly, because there are probably fewer potential other bidders at the table, they might be in a great spot with respect to an acquisition program.
Paul Giannamore: The way that I would look at it is, irrespective of what debt is priced at, at least from modern corporate finance theory tells me, it's always less expensive than equity. Rollins should be using debt. Rollins, for years, should have had a more optimal capital structure incorporating long-term interest-bearing debt in their capital structure. Wouldn’t you argue that?
Jamie Clement: Of course, I would. My counter-argument would be to look at the long-term share price performance.
Paul Giannamore: Jamie, I got to wonder. None of us knows the answer to this or maybe you do. We're going to wait to see how this goes. You go back decades, Jamie. It wasn't until quantitative easing began that Rollins traded at a premium to the S&P 500. Has it been this search for yield that has driven Rollins above the pack? If we see a reversal of that era, are we going to see a reversal in Rollins’ fortune?
Jamie Clement: There are other factors involved, though. The resiliency of the underlying business.
Paul Giannamore: It was always resilient. How is it not?
Jamie Clement: Dare I say the consistency of earnings?
Paul Giannamore: Now that's been demonstrated. Is it the EPS program? What do they call that?
Jamie Clement: I don't remember.
Paul Giannamore: Jamie will not comment on certain topics and I respect that. A lot of things have not changed. One big thing that changed is the new regime that we live under from a monetary perspective. The jury is out and we'll see how these equities perform.
Jamie Clement: I've worked in the public market for 25 years. It's not just what the Fed does with interest rates, it's this unwinding of the balance sheet. I don't know what that does to prices on a day-to-day basis, week-to-week, month-to-month, or short periods of time, and how that impacts the bond markets.
Paul Giannamore: I'm less concerned about, quite frankly, the Fed manipulating the front end of the curve with policy rates and more concerned to your point with this massive $9 trillion balance sheet, which is experimental. We don't have a lot of experience as to how the unwind of that looks. It’s the Fed's balance sheet that has forced real yields into negative territory over the last decade. It was the balance sheet that did that.
Jamie Clement: I'll ask you a provocative question. If you want to evaluate the business that you're in and presumably the readers of this podcast, if Terminix/Rentokil is going to be on the sidelines from an acquisition perspective versus where they have been over the last several years. If you've got leadership change at Anticimex, maybe that causes them to pause a little bit. Also, you've got the discount rate broadly rising. Regardless of what's going on in the financing markets, maybe Rollins gets a look at perhaps some better prices.
Granted, they were never going to be the company that wrote the biggest check anyway. If you look at most research that's been done, the biggest determining factor in the success of generating returns in M&A regardless of the industry that you're in is the purchase price that you pay, the multiple that you pay. Maybe Rollins is in a better position now in this environment than it was before with respect to acquisitions.
Paul Giannamore: That's a potentially valid argument.
Jamie Clement: Thank you very much. I tried.
Paul Giannamore: That might be the smartest thing you've said all day. Let's unpack that for a second. What you're saying is they have a monetary and fiscal policy recession, you name it. All these external macro factors cause prevailing acquisition prices to decrease in the pest control industry. This in itself might put Rollins in a stronger position.
Jamie Clement: More advantageous.
Paul Giannamore: That's the counter-argument to multiple compression in the public markets.
Jamie Clement: Correct. It's particularly relevant when you look at a company like Rollins, an enormous insight ownership position. Clearly, Gary has always played the long game. It's something to think about. It highlights, broadly speaking, the kinds of companies that are going to be in better shape over the next couple of years. I'm in better shape day-to-day operationally and not worried about as many things as less risk. I don't know what's gonna happen with their share price by any stretch of the imagination but they're going to have an easier time managing this than some over-levered, cyclical industrial manufacturer.
Paul Giannamore: I'm with you on the whole Rentokil-Terminix thing, Jamie. This horse has been beaten to death. The one area that might be interesting is vis-à-vis the performance of Rollins. We now have a substantially larger business with more resources competing with Rollins. It’s something we have yet to say. Rollins has always been the elephant in the room. If we put your equity research cap on, let's pretend that you are publishing and you're covering Rollins. What do you say that this new combination does to industry competitive dynamics amongst the publicly traded peers?
Jamie Clement: I'd argue that you have to look at the residential business as perhaps way different than the commercial business. Much work still needs to be done on Terminix residential. I'm not sure there's any material change that happens anytime soon. Longer-term, if the Rentokil team can make the improvements that everybody seems to think needs to be made at Terminix, that's potentially a long-term perhaps modest negative for Rollins. If Terminix’s service metrics can improve, if their retention rate can improve, particularly retention.
On the other hand, it's been hard for me to figure out what the Copesan and post-Copesan lay of the land did in commercial. This deal in perhaps Rentokil’s higher level of competence in commercial in North America, does that present more of an immediate competitive challenge for the rest of the industry, Rollins included? I don't know, Paul. What do you think?
Paul Giannamore: It does. When you look at the residential market, there are so many players out there and it's not that competitive. How many pest control companies are banging on your aunt Susie's door out in the suburbs?
Jamie Clement: We haven't talked about door banging yet.
Paul Giannamore: I'm sure that's coming up. I would say that this potentially changes the commercial market on the margin. As we all know, Terminix wasn't a powerful player on the commercial side anyway. Sure, they own Copesan but that was small. Rollins has always been the king daddy of US commercial.
Jamie Clement: Longer-term, does a more professionally, competently, Rentokil-managed Terminix residential change things even in the face of a largely fragmented industry? I don't know. Maybe yes. Maybe no. I don't think we know the answer to that question for 2 or 3 years. I don't know. I don't think that's immediate. The macro is a far bigger thing to worry about in residential than Rentokil closing on the Terminix acquisition. The commercial side, on the other hand, to me, that's trickier.
Paul Giannamore: I agree 100% with you. Push the merger side. In general, do you think we're going to start to see a deceleration of top-line growth in the US pest control industry as we move into 2023 given the fundamentals?
Jamie Clement: Sure. Are you going to see minus 300, 400, or 500 basis point top-line numbers in residential pest control? Probably not. The first quarter of ’09 was the only quarter that I'm aware of that Rollins won. They went slightly into the red and it was less than a percentage point if I remember correctly. Could you see a plus 4.3 become a minus 0.2? Sure. Could it conceivably not go into the red? I certainly don't think all hell is going to break loose. In terms of the rates of growth that most people are used to seeing probably highly likely that those rates decelerate.
Paul Giannamore: Do we think 2008 and 2009 are a good analog for today or just the best available in our lifetimes?
Jamie Clement: Best available. Your comments about the degree to which residential pest control is more preventative now. That's something that's valid to watch. The idea that you don't see bugs necessarily the way you used to is a big deal. Consumer inflation is far worse right now than what we saw in 2008 and 2009 and that's a potentially incremental negative. I'll tell you a little bit of a silver lining here. These business travelers you brought up are already so depressed anyway that maybe we don't have to be as worried about commercial as we might have otherwise been maybe in a recession scenario.
Paul Giannamore: Quite frankly, my mind's more on the old consumer than it is on commercial with regards to what’s going down. I agree with you on that.
Jamie Clement: The bigger picture, looking at industries other than pest control. Pest control should be in far better shape than things that are more cyclical. Patrick, let me ask you a question. When you talk to other independent pest control operators that you've met over time, how big an issue has labor availability been over the last two years or so? Is it possible that with inflation, maybe there are some folks that decided to retire? Maybe those folks want to come back to the industry. Maybe that gives pest control companies a little bit of relief on labor.
Patrick Baldwin: It's definitely the number one issue by a long shot.
Jamie Clement: If the price of beef ribs, ground beef, chicken wings, and all that stuff is up, especially the price of gas, the pump, do technicians that are nearing retirement are ever allowed to go part-time a little bit? Maybe they want more hours again? Maybe that helps the industry.
Paul Giannamore: We're starting to see that. They got another word for it. We had the great resignation. Now, it's the great unretirement or something to that effect.
Jamie Clement: Are we seeing that to the level we could be seeing it? Most of the companies that I talked to and all kinds of industries are still seeing labor availability and labor inflation is being a huge issue. If folks unretire or go from pre-retirement part-time back to full-time, maybe that's a cross current that helps the industry that people aren't necessarily thinking about.
Patrick Baldwin: Pick up some previously trained technicians, is that what you’re saying? They retired a little too early or they retired and then the economy took a different turn.
Jamie Clement: Think about what happened in some of the hospitals around the country with nurses during COVID. They were summoned back in. That was more about personal morality and wanting to help out their communities and those things. In this particular case, it's like, “Shoot, if I'm paying $6 a gallon for gas and $6 for ground beef, maybe I need ten more hours a week.” That's making a pretty big assumption that demand is still going to be there.
Paul Giannamore: As you're talking, Jamie, I was thinking back to when I was in the UK. I swung through Pest-Ex, which is like MPMA in the UK. I was talking to a lot of the owners there that were telling me that, in additional labor issues, one of their number one problems was the theft of petrol right out of the old truck.
Jamie Clement: Siphoning it out with their mouths?
Paul Giannamore: Technicians like siphoning gas. They’re rolling up to the gas station and having their wife come up with the car behind them filling up the truck, filling up the car, and driving off. I never would have thought that would become such an issue but it was. Also, we push them $10 a gallon there too. It’s expensive.
Jamie Clement: It was coming up from higher levels anyway, though.
Patrick Baldwin: I still want to talk about the merger but I'm not allowed to just because I have a quote here.
Jamie Clement: Read it.
Patrick Baldwin: Episode six. Paul, the question was in regards to value creation with a Service Master and Rentokil deal. Jamie, you said value creation. Paul said, “The way I see it, it's not based on financial engineering, synergy realization, or any of those kinds of things. It's ultimately coming in with a plan that you can execute. You can execute not over a 12 to 24-month period of time. Investors’ expectations will be this for a 3 to a 4-year timeline to turn around the culture of that organization.” I've heard you mentioned this three-year-plus timeframe. What is this deal going to get done, Jamie?
Paul Giannamore: This quote was from May of 2020. It’s way back before this happened.
Patrick Baldwin: A long time ago. In the time machine. What's changed? Would you repeat that sentiment? It sounds like the timeline to turn it around and make some substance here.
Jamie Clement: I would if this deal doesn't get done. In other words, if Terminix shareholders are going to vote this deal down, who's going to run Terminix? You got a management team that was perfectly willing to sell this company. They'd have to explain, “Why did we think it was a great job to structure the deal as we did and not make it more fixed cash?” Think about all the time that’s probably been lost from an internal initiative perspective while this deal has been pending. What's the alternative to closing this transaction?
Patrick Baldwin: You're saying the deal falls through?
Paul Giannamore: He's basically saying TINA, there is no alternative.
Jamie Clement: You got Arabs that are already in this thing. Does the same thing even have real shareholders left in it? What are you going to do?
Paul Giannamore: The only way that this deal doesn't happen, in my mind, at this point, Patrick, Rentokil stock would have to hit the skids and go south. That's the only way this doesn't happen.
Patrick Baldwin: It could happen between now and a shareholder vote. Correct? It's a possibility.
Paul Giannamore: Anything could happen in 2022 given the world that we live in right now and the performance we've seen thus far this 2022 but unlikely. Although I have noticed a short interest slightly in building an RTO but it's not material.
Jamie Clement: Is that possibly because of some of the financings though?
Paul Giannamore: Maybe.
Jamie Clement: Some people might be buying the bonds and shorting the stock.
Paul Giannamore: That's potentially what they're doing.
Patrick Baldwin: If the deal doesn't go through, you're saying the management of Terminix X is not there. They’d go, “I guess you're stuck with us.” I haven't thought about this before.
Jamie Clement: How do you reinvigorate fundamental institutional interest in the name after these things? It's a tough thing to do.
Patrick Baldwin: They lacked leverage at that point.
Jamie Clement: By the way, I'm not I'm not picking on Terminix here. Given the history of the management changes, it’s probably more exposed to this.
Paul Giannamore: It's the same. It doesn't matter what company it is. It's a tough spot to be in.
Jamie Clement: That's what I meant. There are plenty of ways one could pick on a Terminix management team over the last decade. This is not one of them.
Patrick Baldwin: J-Bug, I've probably dug pretty deep on episode six already. Why not throw another one at you? Anticimex has news. Jarl, a golden, Swedish beast moniker, all the sweet names you threw at him. Is he the chairman of the board at Anticimex?
Paul Giannamore: He’s chairman of the board.
Patrick Baldwin: Now what?
Jamie Clement: If we go back in discussing a potential Terminix acquisition, what I said was that I thought that probably the person best equipped to be able to make the necessary improvements at Terminix. Paul, I believe, agreed but made the case that Rentokil was, in the real world, the far more likely buyer. Of course, Paul was correct on that. Recapping that episode, Paul, are you at all surprised that Jarl is elected to step away from his day-to-day duties as CEO?
Paul Giannamore: It’s one of the things that I was shocked at first but then, when you think about it, taking all the relevant facts into consideration, it's not that surprising. The big event for Jarl was the IPO. That didn't happen. That's not going to happen for a long time now. He told me, “Paul, I'm on the road for 190 days a year. You know what that feels like.” I certainly do. For him, he did what he was there to do. He did a phenomenal job.
Jamie Clement: One of the reasons that I was pleased to be able to talk about this is I have noticed this across so many industries. The real pressure from COVID has dissipated, hopefully, knock on wood. You've got a lot of these very successful C-Suite managers, CEOs, CFOs, and COOs that had to navigate their businesses through very difficult times.
I have now realized that their businesses are stable in that regard, perhaps on a personal level because of the whole pandemic. Maybe they say to themselves, “Life is too short.” Maybe they're just seeing hassles in terms of air travel. I don't know. I'm seeing an awful lot of people that I thought had a few more years in the tanks so to speak as CEOs of big companies that have elected to step away.
Paul Giannamore: It's interesting because it's a huge trend. We even saw it at Anticimex North America with Brian Alexson stepping down. He said, “I don't want to travel like I was traveling before.” For folks out there that don't realize this, C-Suite executives of publicly traded companies, specifically CEOs with companies that are broad-based whether in one country or internationally, spend a ton of time on the road. They've grown up their whole life doing it. It was the way it was.
The pandemic grounded everyone for an extended period of time. The conditions that were keeping everyone at home all of a sudden receded. Jarl woke up and said, “I haven't had to travel for months and months and I love it. I don't want to do it anymore.” I'm the same way. I do not like to travel anymore.
I would make 50 or 60 transatlantic flights. I'd crossed the Atlantic 50 or 60 times a year. COVID came and I don't want to do it anymore. The Mexican was complaining to me, “You don't even like to travel. You don't like to go to any meeting.” No, I don't. I like Teams meetings. I like people coming down here to see me.
Jamie Clement: I hope nothing family or health-wise was wrong or whatever. It's absolutely a threat. All of a sudden, you see a press release. Do you know what the amazing thing is? I had a boss years ago who said, “When you see a press release and a C-Suite guy is stepping away and says to spend more time with their family, you know it's all BS.” Now, I think it might be true in some cases. It's interesting. Not all cases, some cases. Those press releases need to be highly scrutinized but I do think in some cases, it's not BS.
Paul Giannamore: I agree with you. We’re seeing it a lot.
Jamie Clement: The other thing that's come up is, has all that travel been necessary? Has what defines face-to-face business forever changed? I suspect that, in some cases, the way things are being done now is problematic. Particularly when you see perhaps Millennials and younger, they think they shouldn't have to go to the office or physically interact with people. They're doing their careers an enormous disservice. You're starting to hear some stories about that.
Broadly speaking, if you're talking about a well-regarded CEO who's got a couple of decades in the industry, at some point in time, they've already hit that number that they need to hit in their bank account that they don't need or care to work anymore. Maybe they feel that the last couple years and all the difficulties associated with COVID, they've been shown other aspects of life and want to be a little bit more of a homebody or they got into home cooking and they want to continue that. They developed a hobby that they didn't have before. God bless him as far as I'm concerned.
Paul Giannamore: Yo your point, Jamie, in a lot of ways, we're not going back to 2019, at least when it comes down to corporate travel and corporate FaceTime in the office.
Jamie Clement: Especially with the sheer expense of it right now, Paul. Obviously, somebody somewhere in all these companies, they're doing the math on all of this. What happens when a recession starts? Unnecessary corporate travel gets cut. It could be personal family decisions from COVID, the fallout from COVID, or it could be economics that crystallize if you will. I agree with you. If we're talking about a year or two where companies because of recession or inflation on the cost of travel, I agree, for the time being, that stuff is not coming back anytime soon.
Paul Giannamore: Jamie, as per usual, it was great to get you on The Buzz. I'm looking forward to my next trip up to New York. We appreciate your insight as always.
Jamie Clement: It's always a pleasure to join you. There are a lot of interesting things to keep an eye on over the next couple of months. Hopefully, not all of them are bad.
Patrick Baldwin: I love it. You’re such the optimist. Thanks, J-Bug. I appreciate you.
Paul Giannamore: Thanks, J-Bug.
Jamie Clement: Take care. We'll be in touch.
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