As I write this column, it’s the eve of the signing of the agreement for Rollins Inc. to purchase Fox Pest Control — a deal our firm negotiated. According to William Blair Equity Researcher Tim Mulrooney, the deal is the fourth-largest pest control transaction in history, and the industry’s largest door-to-door (D2D) deal ever.
What took so long for the pest control establishment to recognize that D2D sales companies deserve serious attention as formidable competitors? Why did they hesitate to place the higher valuations on D2D firms that other best-in-class pest management professionals (PMPs) have been getting?
As we know in business and in life, we have good players and bad players. D2D is no different. Take Fox Pest Control and several other clients of ours, for example. These companies have high growth rates and retention rates similar to non-D2D firms. Why? They focus on sales, yes, but their main focus is on tight operational controls and customer experience.
Let’s look at the math:
Gross margin. Gross margin is revenue minus direct costs. It is the single-most predictive indicator of operational efficiency. There are three ways to impact gross margin:
- Increase gross revenue.
- Decrease costs.
- Do both.
D2D companies blanket neighborhoods with salespeople to drive up route efficiency. This route density improves revenue per hour while dropping the labor percentage.
Marketing costs. It’s expensive to run a D2D team. In fact, the cost can be as high as 80 percent to 100 percent of the first-year revenue. Over the past several years, the marketing method of choice among traditional pest control firms was digital marketing, which delivered sales for far less money than D2D. However, it didn’t provide the kind of route efficiency that D2D provided. Just like with the phone directories of old, the easy money has been made. Today, the price of digital is increasing at an incredible rate, and soon will catch up with D2D.
The choice becomes: Are we willing to pay a higher price for a cluster of sales in the same neighborhood sourced through D2D, or is a scattered customer base derived from digital more desirable? I think the former. As a company grows, more of its book-of-business becomes second-year-and-beyond customers with no marketing costs associated with them — only strong gross margins.
Strong valuations. I base pest control company valuations on three major key performance indicators, or KPIs:
- Ratio of recurring to nonrecurring revenue.
- Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). Many refer to adjusted EBITDA as cash flow to ownership.
Best-in-class D2D firms experience very high growth, with a ratio of recurring to nonrecurring revenue usually in excess of 90 percent.
There is a bit of a negative: Cash flow to ownership is usually less than best-in-class due to the large D2D spend.
However, once a firm has been successfully operating for five or more years, adjusted cash flow climbs.
In fact, if management rolls back the D2D sales efforts in any way, the strong gross margins become the catalyst for EBITDA expansion — in many cases exceeding 30 percent.
After several years of not recognizing the power and benefits of D2D companies, pest control company buyers are seeing things in a new light. Those who operate best-in-class D2D operations will finally get the respect they deserve and will be able to garner the same high valuations our firm was able to obtain for Fox Pest Control.