NPMA Knowing The Value V4

How to value a Pest Control Firm, What factors add Value and Which ones don’t

www.pcobookkeepers.com

Daniel S. Gordon, CPA

www.pmpwealthbuilders.com

Overview

Why Value a Pest Control Business?

How is a Pest Control Business Valued?

Valuation Methods

Using A Hybrid Valuation

Maximizing Your Firm’s Value

Is this Value Real? Who would buy at this Valuation?

Putting it all Together

Provide Fair Market Value as of a specific date

Annual Business Check up to determine financial strengths and weaknesses internally and as compared to other companies

Retirement Planning

Disputing conclusions of IRS audits

Estate Planning

Merger / Acquisition – Selling the company

Why Value a Pest Control Business?


Look in the Trade Magazines, …Read the Articles,

…Talk to your fellow PCOs

A Pest Control firm’s Value is a Multiple of Annual Revenue.

This one is easy!!

You can sell your company for what everyone else sells theirs for

And that multiple is……………….

IT DEPENDS!!!




Some Companies sell for 25% of Annual Revenues.

What would the value of your Business be?

Some sell for 125% of Annual Revenues.

Valuation Methods

To determine a fair value, Let’s look at several business valuation methods (this is by no means an exhaustive list of valuation methods):

Adjusted Book Value

Capitalized Earnings

Discounted Cash Flow

Multiple of Earnings (P/E)

Valuation Methods

We need a definition here before we go any further as most of these valuation techniques use the following concept:

The time period that money is received (i.e. monthly for the next 10 years)

Contd…

Definition: Time Value of money:

A name given to the notion that the use of money costs money. A dollar today is worth more than a dollar tomorrow because of interest costs. Alternatively a dollar received sometime in the future is worth less than receiving a dollar today. In order to quantify this the following would be helpful:

Time period:

Required Rate of Return:

Future Payments:

Present Value:

The interest rate you would require to use your money. This needs to be measured against risk free investments such as T bills considering the risk to be taken in the subject investment.

The amount of money to be paid over the time period (i.e. $100 per month for 60 months)

The value of the money today

Valuation Methods

Time Period: 120 months

Required Rate of Return: 0%

Future Payments: $100 per month

Valuation Methods

Time value of moneyExample:

Contd…

Present Value: $12,000

Time Period X Future Payments =

Change the Required Rate of Return To:

Valuation Methods

Required Rate of Return

Time PeriodFuture

PaymentsPresent Value

0% 120 100.00$ 12,000.00$

5% 120 100.00$ 9,428.00$

7% 120 100.00$ 8,612.00$

10% 120 100.00$ 7,567.00$

One of the least controversial valuation methods for a retailer, manufacturer or distributer. It is based on the replacement value of assets and liabilities of the business

Pros: Very objective when it comes to vehicle, equipment, and outstanding loans

Cons: Since it takes a Balance Sheet approach it leaves a very vague value on our largest asset – our customer contract list

Valuation Methods

Adjusted Book Value

Valuation Methods

Assume a Firm has

Adjusted Book Value

Example :

Assets Historic Costs(BV) At Fair Market Value

Cash 100,000.00$ 100,000.00$

Accounts Receivable 450,000.00$ 425,000.00$

Inventory 700,000.00$ 675,000.00$

Fixed Assets (net) 950,000.00$ 2,000,000.00$

Combined Debt (350,000.00)$ (350,000.00)$

Value 1,850,000.00$ 2,850,000.00$

Based on the rate of return in earnings that the investor expects. For no risk investments, an investor would expect eight percent. Small businesses usually are expected to have a rate of return of 25 percent

Pros: Quick, easy, good approach to use as a reality check once all due diligence is performed

Cons: Very simplistic approach in terms of actually understanding the business. Assumes that earnings can be projected with precision. There is usually a conflict about what the rate of return should be

Valuation Methods

Capitalized Earnings or Cash flow Approach

If your business has an expected earnings of $50,000,its value might be estimated at $200,000

Valuation Methods

Capitalized Earnings or Cash flow Approach

Example

(50,000 / 0.25 = $200,000)

Earnings would be adjusted upward for non cash charges such as depreciation and amortization

Based on the assumption that a dollar received today is worth more than one received in the future. It discounts the business's projected earnings to adjust for real growth, inflation and risk. This method considers the time value of money

Pros: This again is valuing the revenue stream and is a good reality check once Due Diligence is completed.

Cons: Also a simplistic approach in terms of understanding the business. And here again there can be a dispute over cost of Capital and earnings and revenue projections.


Valuation Methods

Assume that our book of Business provides a net profit margin of 15% (including owners items) and is comprised of :


Valuation Methods

Example

Contd…

Service TypeAverage

Customer LifeAnnual Revenue

Recurring Revenue

Commercial Route Work 10 Yrs $1,000,000 $1,000,000

Residential Route Work 7 Yrs $500,000 $500,000

Termite Renewals 12 Yrs $700,000 $700,000

One Shots Undeterminable $500,000 -

Total $2,700,000 $2,200,000

Question: What is the revenue multiple? About 1.1 times recurring revenue

Discounted Cash Flow Example - Contd…

Valuation Methods

Year CommercialResidential Termite One Shot TotalDiscounted

at 6%1 $150,000 $75,000 $105,000 $ - $330,000 $330,0002 $150,000 $75,000 $105,000 $ - $330,000 $293,6983 $150,000 $75,000 $105,000 $ - $330,000 $277,0744 $150,000 $75,000 $105,000 $ - $330,000 $261,3905 $150,000 $75,000 $105,000 $ - $330,000 $246,5956 $150,000 $75,000 $105,000 $ - $330,000 $232,6377 $150,000 $75,000 $105,000 $ - $330,000 $219,4698 $150,000 $ - $105,000 $ - $255,000 $159,9909 $150,000 $ - $105,000 $ - $255,000 $150,93410 $150,000 $ - $105,000 $ - $255,000 $142,39011 $ - $ - $105,000 $ - $105,000 $55,31212 $ - $ - $105,000 $ - $105,000 $52,181

Total $1,500,000 $525,000 $1,260,000 $ - $3,285,000$2,421,670

One of the most common methods used for valuing a business. In this methods a multiple of the cash flow of the business is used to calculate its value. This is the way Public companies are usually valued. The ratio is called Price to Earnings. You may hear that reference on CNBC or other business channels. But this is the way Wall Street values stocks.

Pros: Since there are several Pest Control companies that are public, we can use them as a benchmark

Cons: It is a snapshot not a look into the future. Markets heat up and cool down so price equilibrium can be a moving target

Valuation Methods


Valuation Methods

(Yahoo reports 24.94 PE),

(Yahoo reports 28.07 P/E – PCO work is a smaller % of the company),

(Checkout European Financials – a little different but in line)

Anyone want to guess why Private Equity Firms and large services companies have such a thirst for acquisitions in our Industry?


Anyone know why went private?

Rollins


Using this hybrid method we will incorporate many of the valuation techniques discussed. Essentially, we will define and value all of our assets, subtract the liabilities and be left with a net value.

Step1 Hard Assets Valuation

Step2 Determine the Outstanding Value of any Debt attached to the Hard Assets

Step3 Determine the Net Value of the Hard Assets

Step4 Value the Intangibles – Other than Customer List

Step5 Value the Customer List

Step6 Add all the Values Together

Hard assets usually include Vehicles and Equipment.

Pest Control Companies usually don’t include Real Estate in the operating Company

What is the adjusted Bluebook Value on all your vehicles

What is the fair market value on all you equipment


Step 1: Hard Asset Valuation

Example: Your Vehicle fleet fair market value is $ 200,000

Step 2: Determine the outstanding value of any debt attached to the Hard Assets

Debt usually has to be netted against the fair market value of the hard assets.

This is because the bank won’t let you sell them without paying it off


Example: Debt on the vehicles equals $150,000

Subtract the value of the liabilities (debt) from the fair market value of the hard assets to determine the net value of the assets.


Step 3: Determine the Net Value of the Hard Assets

Example: Fleet Value less debt

This is similar to calculating the equity in your home

$ (200,000-150000) = $ 50,000

Step 4: Value the Intangibles - Other than Customer List

Bargain Lease of Office Space (if present in your company) This would be figured using the amount of rent that would be paid at fair market value v/s what you pay for rent over the period of the lease discounted at a reasonable cost of capital rate

Example:

At 6% discount = $18,015



You pay $1000 per month rent. Fair Market is $1200 per month. Your lease has 120 months (10 years) left. The value placed on the lease would be $24,000 ($200 x 120 months) with a discount applied to it.


Let's use $15,134

Step 5: Value the Customer List

Let’s use the example from before:

(this is where most of the value will come from)


The value is $2,421,670

Year CommercialResidentialTermite One Shot TotalDiscounted

at 6%1 $150,000 $75,000 $105,000 $ - $330,000 $330,0002 $150,000 $75,000 $105,000 $ - $330,000 $293,6983 $150,000 $75,000 $105,000 $ - $330,000 $277,0744 $150,000 $75,000 $105,000 $ - $330,000 $261,3905 $150,000 $75,000 $105,000 $ - $330,000 $246,5956 $150,000 $75,000 $105,000 $ - $330,000 $232,6377 $150,000 $75,000 $105,000 $ - $330,000 $219,4698 $150,000 $ - $105,000 $ - $255,000 $159,9909 $150,000 $ - $105,000 $ - $255,000 $150,934

10 $150,000 $ - $105,000 $ - $255,000 $142,39011 $ - $ - $105,000 $ - $105,000 $55,31212 $ - $ - $105,000 $ - $105,000 $52,181

Total$1,500,000$525,000$1,260,000 $ - $3,285,000$2,421,670


Step 6: Add all the Values Together

Step 1: Vehicle fleet fair market value is $200,000

Less: Step 2 Debt on the Vehicle $150,000

--------------Equals: Step 3 Net Value of the Hard Asset $50,000

--------------

Step 3: Net Value of the Hard Asset $50,000

Add: Step 4 Discount @ 10% $15,134

Add: Step 5 Value of Customer List $2,421,670

---------------Equals: Step 6 All Values Together $2,486,804

---------------


Based On our discussion – the asset that contributes the most Value to our firm is the customer list. This is the machine that needs to be oiled and maintained

How do we grow the value of the customer list?

Sell Service Contracts Uniform in their Service Obligations Easily Routed (efficiency) Acceptable Dollars per hour (Profitable)

Retention Keeping the customers active in your customer list.

Gross Margins – If we value our customer list off of cash flows, the higher the gross margins the higher the cash flow

Reduce Call backs – high level of call backs reduces our gross margins


The purest analysis comes from the public filings of Rollins (Orkin) since the highest percentage of their revenue comes from pest control:

Data provided by, except where noted


Market Cap (intraday) 1.91BillionTrailing P/E (ttm, intraday) 24.94Forward P/E (fye 31-Dec-10) 22.42Price/Sales (ttm) 1.83Profit Margin (ttm) 7.21%EBITDA 15.70%

EBITDA

When Looking at the Net profit of an Orkin vs. your company we need to make adjustments for all the interest and Amortization that they take for all the past acquisitions and other charges not present in your company.

So when we look at Orkin’s net profit of 7.21% we know that at our firm’s we can do much better. That’s why its probably a better comparison to look at Orkin’s EBITDA then their net.

EBITDA at Orkin is at 15.7% which is in line with most of the Clients we work with after adding back owner items



So rather than using a straight Price to Earnings analysis lets equalize the comparison by comparing:

Our Firm’s P/E = Orkin’s Price EBIDTA

So now the P/E that we spoke of before goes from 25 to about 11.8



So we know that at a 15.7% Profit margin (EBITDA) Rollins the market has priced Rollins at 1.83 times revenue.

Is it realistic to think that you can sell your firm for 1.83 time revenue?



Probably Not.

A very Compelling reason for the large players to aggressively pursue the smaller players is the spread and value that is unlocked as a portfolio of pest control companies are assembled.

IMO …… The reason for all the M&A activity in our industry relates to the spread between the purchase valuation and that of what the market will value a portfolio of pest control companies



Has anyone heard of a firm called Clayton, Dubilier & Rice?



You may have:

They bought a little company called !!

Why would a Private company want to purchase a public company and take it private?

Because of the spread!!!!

ServiceMaster was not being valued by the market the way the way the best in breed in our industry was valued.

In short, they were having growth and profitability problems and the market penalized them for these issues



From the CD&R Website:

We invest in market-leading companies that are typically underperforming. Often, but not exclusively, our portfolio businesses are distribution- or services-related.

Rather than pursuing specific industry segments, we concentrate on companies with broad “spread of risk” characteristics, such as large customer and supplier bases and diverse revenue streams. In all cases, we only invest where significant value can be created through operating performance improvements.



So in order to create “significant value that can be created through operating performance improvements,” They are taking measures to improve performance operationally as well as making an aggressive push to purchase well run PCOs. In order for other players in the industry who seek to make acquisitions, the price of these firms are being driven up.

That’s the way an auction works!



What is the Point?

The point is that well run profitable Pest Control Companies are fetching higher prices than ever before



How Long will this last? No one knows but history repeats itself……

Anyone remember Waste Management’s entry into the market? After bidding up and purchasing several PCOs, they realized that running a PCO firm was a little different than running Trash routes and ultimately got out.




So let’s Summarize…..


Why Value a Pest Control Company?

Provide Fair Market Value as of a specific date

Annual Business Check up to determine financial strengths and weaknesses internally and as compared to other companies

Retirement Planning

Disputing conclusions of IRS audits

Estate Planning

Merger / Acquisition – Selling the company

In a nutshell how do we value a Pest Control Company?

As a Multiple of Profitable, Recurring Revenue

Recurring Revenue

Multiple Based on

Profitability

Business Value


In order to use any of the valuation techniques discussed, we need to have


Organized Records,

Streamlined Operations and

Accurate Accounting Information

PMPWEALTHBUILDERS.COM

Best Business Plan for PCO’s Who want to grow their business

PCOBOOKKEEPERS.COM

ACCOUNTANTSFor Growing Pest Control Firms

P.O. Box 810Newton, NJ 07860

Phone: (877) 682-8118Fax: 866-273-0101

Email: [email protected]

Join us now to grow your business

Documents

NPMA Knowing The Value V4