Writer, Gertude Stein once wrote, “There’s no there, there,” in reference to Oakland, California. Increasingly, this seems to be the case with private equity.
Personally, I’m a fan of private equity’s encroachment of the service trades. After all, I sold to private equity and did pretty well. Allowing contracting business owners to exit well is the biggest benefit PE provides.
The second benefit is raising the price ceiling. Sometimes I wonder if PE has a ceiling. Regardless, PE-owned companies have led the market in setting new price levels, allowing contractors to raise their prices in turn, becoming more profitable. Traditionally, poor pricing has been the most common problem among HVAC contractors.
A third gift to the industry has been the increase in employee benefits. Contractors have traditionally offered mediocre benefits if they offered them at all. PE, as a rule, bumps them up, causing more contractors to improve their own benefits to stay competitive. When we need to attract more people to the trades, benefits matter. Moreover, this is the right thing to do.
Finally, PE has brought lots of attention to the trades. More people are seeing HVAC and other trades as career destinations of choice, rather than places for people who can’t cut it in more exciting and lucrative professions. In addition, more entrepreneurs are noticing the opportunities in the industry and creating solutions to solve industry problems.
No question, PE has helped the industry overall and many business owners in particular. But is PE making the companies acquired better?
PE doesn’t buy companies in need of a turnaround. They look for well-run companies and pay premiums to acquire them. Companies that would have sold for a 4X multiple a few years ago are commanding 8X to 10X or higher.
One of the first moves by PE after an acquisition is to exert their buying power. Companies get better pricing on equipment, though this might sacrifice long-held business relationships. The nature of the supplier relationship diminishes to one that’s purely transactional.
Next, PE boosts employee benefits. While this is a positive, it does raise costs. PE then centralizes HR, which adds overhead costs since HR was usually part of the office manager’s job. The time the office manager spent on HR doesn’t go away. It gets replaced by dealing with corporate HR.
When the owner eventually steps down, he’s replaced by a general manager at half the cost. However, the GM typically lacks the owner’s entrepreneurial drive, local civic and charitable involvement, and local relationships.
PE-owned companies typically press technicians to sell replacements or flip leads, boosting replacements and bringing in greater revenue and profit. Some techs reject the pressure and seek to leave for more of a family-run business, especially if the owner has stepped down.
Marketing is often centralized and run by millennials who focus almost totally on digital. This has driven up the cost of search engine marketing. Simpler, more traditional marketing gets overlooked and de-emphasized.
A layer of overhead sitting above the local operation is added by the PE group. Then, owners or general managers find that significant time is consumed by Zoom meetings with corporate and the need to provide ever-increasing amounts of data to the higher-ups. If the company is not already on a leading field service management program, the switch is forced on the company. This gives management more data, if not more insight.
The core of the business, which is demand service, maintenance, and replacements, remains largely the same. The ownership may change, but the business is still butts-in-trucks and trucks-to-homes. Service managers are still required. Office personnel are still required. Headcount is largely the same.
The goals appear to be squeezing efficiencies out of companies that were already well-run and driving revenue and EBITDA higher by force of will. When combined with other acquisitions, PE grows total EBITDA with the end goal of flipping the portfolio for a higher multiple of earnings than was paid for the original businesses.
Several PE groups have already succeeded in taking “the second bite of the apple.” Others are working hard with this in mind.
In the end, the businesses do not change much. There’s lots of buying, pressuring, and selling, but no secret sauce.
Is there greater value? Does PE result in a sustainable competitive advantage? Is there any there, there?
