M&A Remains Robust

At the end of last year, Forbes magazine declared that 2011 would be “the year” of M&A. Following 2009, when the recession and subsequent credit crisis was hitting hard, and 2010, which was a bounce-back year of increased activity, it could stand to reason that 2011 is in fact going to end up being a banner year for sales and purchases of companies. Thomson Reuters confirmed that 2010 global mergers and acquisitions had returned to 2008 levels, signaling that activity had picked back up where it had left off, pre-recession.

While every industry felt the pinch of the recession, the building services industry had pretty consistent rates of activity despite that economic downturn.

 “There’s always a certain level of activity in the contract cleaning industry,” says Gary Penrod, managing associate of GPA Inc., a consulting firm for building service contractors located in Hilton Head, S.C. “It’s an amazing industry, really, because it has been so resilient. The recession has once again shown that this industry is recession-resistant.”

That’s not to say the outlook has always been rosy; 2009 was a bad year for most industries, including the cleaning industry, which felt the effects of customers tightening their budgets and spending less on services. Mergers and acquisitions also slowed down a bit that year.

“In 2009, people were just scared to death,” says Penrod. “Whether it was in this industry or any industry, they sort of sat back and said, ‘I’m not going to be able to get the valuation I need to sell my business.’ So instead what they did was to shore up their companies, to conserve their cash, and to look for any inefficiencies in their operations.”

 The companies that were hurt the most were those involved with customers in industries such as the automobile industry, or geographic areas, that were heavily impacted by the recession — or those that were “asleep at the switch,” Penrod says. In other words, the recession did affect M&A opportunities in the cleaning industry, but not significantly.

 While some building service contractors, unfortunately, went out of business, many others learned how to be innovative, more productive and more efficient in challenging times. While uncertainty about the economy continues to set the tone for anyone who runs a business, sales and acquisitions in the cleaning industry picked up in 2010 and have returned to a healthy activity level this year, Penrod says.

Trends in the M&A market for BSCs include valuations that have held the line, small companies selling, and an increase in interest from private equity firms.

At any given time, Penrod had been representing five or six companies on the market, which tells him that the M&A sector is as robust as ever.

Growth through acquisitions

Companies seeking to improve financial performance often include acquisitions in their growth plans. Strategic purchasing can greatly benefit BSCs, whether they are seeking increased market share, service diversification, a widening of a geographical service area, cross-selling opportunities or economies of scale.

 MJV Group has made four major acquisitions in the past decade, the most recent in 2009, of two power-sweeping companies, and in December of 2010, of a Michigan BSC.

 “It’s definitely part of our growth strategy,” says James Heck, president of MJV Group Inc., Lafayette, Ind. “It helped put the puzzle together for us. We were looking to expand our geographical footprint.”

 The purchases helped MJV Group expand further into Indiana and enter into the Michigan market. Since the janitorial service market can be difficult to penetrate without local customer references, acquisitions are one way to add to a customer base.

Bravo! Building Services, in Piscataway, N.J., grew organically for many years before making its first acquisition four years ago.

“We made our fist acquisition in 2007 because of our need to enter a new geographic market that was an established market with strong providers,” says Frank Wardzinski, COO. “The acquisition gave us an immediate market share.”

 Buying companies that help BSCs execute their strategic plans helps them provide value for existing customers, Wardzinski says. Bravo purchased a mechanical HVAC, refrigeration, building automation and design/build firm in June, enabling further service bundling for clients.

Wardzinski says the M&A market has not picked up much pace over the past year or two, partially because financing has been hard to come by.

“Our acquisition of Control Temp Inc. was completed utilizing our own cash and did not rely on financing,” Wardzinski says. “Having a strong balance sheet is an absolute must for any company thinking about acquiring another firm.”

The biggest challenges faced when making such purchases include liability issues and joining potentially very different company cultures under one name, Wardzinski says. A strong management team and solid, proactive leadership will help to address those issues.

And reaping the rewards of a successful acquisition is a great experience, particularly for employees, who are given greater opportunities to grow within the company.

“Our management team has fully embraced each new partnership as a chance to develop the employees in their departments and help them rise to the next level. It has created a culture of ‘rising stars,’” Wardzinski says.

Penrod warns BSCs not to buy companies for the wrong reasons, such as simply wanting to ramp up sales. In that case, he would advise a BSC to try to increase sales internally, which is less expensive and less risky than taking on an acquisition.

 “I’ve told people before, ‘Why don’t you just go to work?’ And I don’t want to offend them but they have to understand that buying a company is risky,” Penrod says.

 He also advises BSCs to go with their instincts when considering a deal. Valuating a company is not an exact science; it’s a lot of “going with your gut,” he says.

 “The other thing you need to look at is compatibility. There’s nothing worse than buying a good company, and everything is right except you don’t like the other person, you don’t get along with them or you don’t trust them,” Penrod says. “Don’t do that deal.”

 It is crucial that any BSC involved in M&A have appropriate counsel, meaning, a transaction attorney — someone who has done these deals before.

 “You’re dealing with a lot of legal documents. You absolutely always need legal counsel and they’re going to keep you out of trouble,” Penrod says. “You don’t want a labor lawyer or a family lawyer or somebody that specializes in malpractice to do the transaction.”

More small operations for sale

Despite consolidation and partnerships that have made some of the biggest industry players even bigger, the majority of building service contracting firms are small to medium operations started by entrepreneurs. Inevitably and with regularity, these companies go up for sale as their owners decide to retire or move on to another career.

 Industry consultant Dick Ollek knows that scenario too well. In 2005, he sold his Wichita, Kan.-based janitorial company, which he had started 33 years earlier. He made the choice to sell the company after deciding it was time to start a consultancy, Consultants In Cleaning LLC.

 Giving yourself time to make the right decision, for the right reasons, and knowing what you want to do after your company is sold are two of the most important things a BSC can do, he says.

 “Did you just lose your biggest account? Did you just have your operations manager leave? Did you just get denied at the bank for a loan?” Ollek says. “Those are all the wrong reasons to sell.”

 Ollek has witnessed a rise in the number of small companies going up for sale, but, frankly, he says, some of them may not have much to sell — because they’re selling for the wrong reasons.

 “I’ve seen an increase in smaller companies wanting to find somebody to buy them because it’s getting increasingly difficult out there to compete with companies that have good systems and good processes and an organized sales approach,” he says. “Either the people don’t want to, or they’re tired of trying to, compete.”

 It’s difficult to find anyone who will buy a very small company, Ollek says. For example, if a company that is for sale is doing $100,000 a year in good business, it makes more sense for a buyer — who likely has accounts that bring in more than that — to hire a salesperson to bring in a comparable amount of business.

 “Those kinds of companies are finding it difficult to survive, frankly,” Ollek says.

 Many BSCs have noted an uptick of interest from private equity firms in the form of acquisition letters.

 “Interest from private equity funds and venture capital firms, that’s really picked up,” says Heck.

 While it’s unclear whether many BSCs are acting upon these solicitations, Penrod says the interest is a sign of the industry’s health.

 “Strategic buyers have always been out there and there are still strategic buyers that are interested,” Penrod says. “The equity funds are looking at this industry as a good place to invest.”

Capital gains tax rate

Another factor influencing activity in the M&A market is the tax rate paid by corporations on the net total of capital gains. The long-term capital gains tax rate has been at 15 percent since 2003 and after some speculation that it would be raised, it was extended through 2012 by Congress and President Barack Obama at the end of 2010.

 “That was a motivator in 2010, the specter of the increased capital gains rate,” Penrod says. “It didn’t happen, but we didn’t know it wasn’t going to happen until December of 2010. … We saw a little boost in 2010 because of the possibility of an increase in the capital gain rate.”

 The likelihood that the rate on these so-called “Bush-era tax cuts” will increase in 2013 depends on the administration that is put into place in the 2012 presidential election. Depending on what buyers and sellers anticipate, M&A could see a flourish of activity next year as well as sellers take advantage of the current capital gains rate.

 “It may go to 20 percent, it may go to 28 percent, and it may not,” Penrod says.

 If the capital gains rate is expected to jump, M&A activity will increase prior to any legislative deadlines, as it did in 2010 — and perhaps more so. Sellers who have been considering putting their company up for sale certainly want to make as much as they can off of the purchase of their businesses, and will likely flood the market with offers.

“The tax rate does weigh on the overall timing and size of an acquisition,” Wardzinski says. “Our plan is to hold on to our acquisitions long-term and achieve full value for our shareholders.”

While Wardzinski observes that valuations seem to be down, Penrod says they’ve held the line.

There is no Blue Book for the valuation of cleaning companies, Penrod says. Valuations have, however, remained relatively stable for janitorial companies, even compared to what they were decades ago, Penrod says.

Many valuation techniques are used to determine a fair value of a company, including comparing them to similar publicly traded companies, analyzing comparable transactions in the industry, discounted cash flow analysis, adding the sum-of-the-parts of multiple business lines to come up with a total value and a leveraged buyout analysis.

Valuations depend greatly on perspective and perceived value for the buyer, Penrod says. A company could easily get multiple different valuations, and none of them are necessarily wrong, because they’re relative to what the buyer values.

 “I could look at a company that’s doing $10 million in a certain metropolitan area. Somebody else looks at that same company, and we’ll each come up with different valuations. Our valuation’s going to be based on our particular perspective, and what is valuable to us,” he says.

Whether this has been “the year of M&A” in the cleaning industry is debatable, but activity seems to be steady and healthy even if some BSCs are waiting on the sidelines for the economy to get a little bit better.

Heading into 2012, financial experts are predicting that the possible expiration of the Bush-era tax cuts will drive M&A activity across most industries, though concerns about economic growth may linger, causing companies to hang onto their money for a while longer.

 “Overall, the industry has proven itself to be very, very tough and resilient and the people engaged in it have once again shown that they’re very innovative and that resilience is there if they can work it,” says Penrod.