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Pest Control M&A Trends for 2010 and Beyond

Last year was a tough year all around, both in terms of business in general as well as M&A activity. However, as of the end of February, US M&A activity is up 46% from the same period last year, and was at the highest monthly level since July 2008. In this article, I take out my crystal ball and make some predictions for the rest of 2010 and beyond by examining some key themes and trends emerging that will impact the pest control M&A market, which include:

  • Capital gains tax rates will be increasing by at least 33% at the end of this year, pushing sellers on the fence over the edge.

  • Cheap money (i.e. low interest rates) is decreasing the cost of capital, which is supporting an increased level of M&A activity and business valuations

  • Buyers and sellers sat on the sidelines last year due to the economy, resulting in pent-up demand on both the buy-side and sell-side.
  • Government Fiscal Policy - Taxes
    For readers in the US and most Western countries, our governments are in a world of hurt, as deficits are ballooning and tax revenue is decreasing rapidly. Unfortunately, for business-owning Americans, current capital gains tax rates are scheduled to increase at the end of 2010 unless Congress steps in with an extension. This, of course, seems very unlikely due to the massive federal budget deficit; therefore, I am not counting on Congress to do us any favors.

    Federal long-term capital gains tax rates in the US are currently 15%. If Congress does not take action to extend the current rates, anyone who sells a business after December 31st of this year will instantly see his tax bill increase by 33%, from 15% to 20%. Additionally, depending upon where healthcare legislation goes, there may be an additional surcharge of 2.9% on gains. On February 23, 2010, the Wall Street Journal, in the article “Obama’s New Investment Tax,” had this to say about capital gains taxes:

    “The rate hike on investment income would presumably take effect at the same time the 2001 and 2003 Bush tax cuts are due to expire next year, bringing the top rate to 22.9% as the current top capital gains rate would also rise to 20% from 15%. That’s a 52% jump, and the last time investors were slammed with anything comparable was 1986 when the capital gains rate bounced to 28% from 20%—or a 40% increase—as part of the Reagan tax reform that reduced income tax rates.”

    Business owners considering a sale in 2010 or 2011 will likely accelerate sale plans to ensure that the transaction takes place prior to the end of the year. The specter of funding further government spending through higher capital gains taxes is sickening to most business owners and has already caused many sellers to get going while the going is good. To put this tax increase into perspective, the seller of a $3M pest control company would owe approximately an additional quarter of a million dollars in gains taxes on a sale next year, versus what he would pay this year.

    Government Monetary Policy - Interest Rates & Inflation
    Although fiscal policy, such as the capital gains tax rate, certainly has an effect on the M&A market, it generally plays second fiddle to monetary policy.

    The effect of flawed monetary policy, such as artificially low interest rates, and the pumping of trillions of dollars into the economy, has already reared its ugly head in terms of propping up asset prices, which is manifest in real estate and the stock market. Just look at the parent company of Orkin, Rollins, Inc., its stock is trading at its highest price ever…and we are in a recession! Instead of allowing the market to cleanse itself of malinvestment, the government is just postponing the inevitable, prices will fall and interest rates will go up. At some point, reckless borrowing and spending by governments will force long-term interest rates higher as investors demand higher rates of interest, which will increase the cost of capital for all acquirers.

    The M&A market, throughout history, has lagged the greater economy. Unlike previous recessions, however, the excess liquidity that the Fed has pumped into the economy this time around is keeping valuations at lofty levels. In 2010, sophisticated acquirers will begin modeling long-term increases in the cost of capital into their acquisition models which should exert some downward pressure on what acquirers are willing to pay for acquisition targets.

    Inaction in 2009 Will Give Way to Action in 2010

    In the pest control industry, M&A activity is largely driven by life events. The great majority of pest control operators do not “time the market” to get the best possible acquisition multiple for the sale of their businesses. Pest control operators sell their businesses for personal reasons, such as death, divorce, burnout, illness, retirement, etc. The pest control operators who sat on the sidelines last year due to economic uncertainly, will realize that 2010 is their year. Sale decisions for life events can be deferred in troubled times, but they cannot be avoided altogether, and we believe that pest control operators will seize the opportunity in 2010 to sell when the M&A market is still relatively strong and capital gains taxes are still relatively low.

    Troubled Companies Will Seek Exit & Strong Players will be Opportunistic
The smaller and weaker pest control companies that have been beaten up over the last few years from higher fuel costs and overall economic malaise will seek exit opportunities. Many smaller companies have deferred activity hoping that there would be a quick turnaround from this recession. As this is not the case, they will be forced with the decision to continue to fund operations through personal funds or combine with stronger players, which will drive M&A activity.

    The large regional and international pest control firms are well-capitalized and will take advantage of tremendous growth opportunities this year. The large pest control companies will become more selective and no longer compete for smaller acquisitions, opening up opportunities for private acquirers at the lower end of the market.

    Final Thoughts
    Timing the market isn’t easy. Will the M&A market be kinder to sellers this year than it will the next? It’s hard to say. One thing that we can say with reasonable certainty is that US capital gains tax rates are going up at the end of this year, making a nice dent in sellers’ after-tax proceeds from a sale. We also know that the Federal Reserve system (the Bank of England and other central banks) have flooded the global capital markets with cheap money. This has caused asset prices (such as business valuations) to remain at an elevated level, which we can only reasonably assume will come down as central banks begin to pull trillions of dollars in excess liquidity out of the market.

    Quality sellers should continue to see favorable valuations over the near-term and non-so-quality sellers will see less exit opportunities as the months progress. You will certainly see some high profile PCT 100 companies acquired in this year. As the baby boomers continue to exit their businesses at a rapid pace, opportunistic, cash-rich acquirers will be in a position to seize opportunity. Though many small pest control operators continue to have unreasonable expectations of value, many of them are about to learn the hard way that sophisticated acquirers don’t value pest control companies by applying a multiple to sales.

    Interested in learning more about valuation and mergers & acquisitions in the pest control industry? Subscribe to Potomac Company commentary and research on the Pest Control Industry.


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