Despite lingering uncertainty due to COVID-19 and a lagging global economy, last year was a record year for M&A activity. On a global level, 2021 saw more than $5 trillion in global M&A volume, according to some estimates, which surpassed prior records. Closer to home, high-equity valuations in the US, coupled with low interest rates, created an enticing M&A environment that has extended into 2022. While this year may not be another record year, financial insiders anticipate the key elements will remain strong for the M&A market.
This is a trend seen not only in the snow and ice management industry, but throughout the green industry, as well. We reached out to Jeff Harkness, the managing partner of Atlanta-based Three Point Group (3PG), which helps guide snow and landscape companies not only with the M&A process, but also succession planning, business valuations, and securing strategic capital resources for growth. He has also served as a past ASCA Executive Summit guest speaker and educator on the M&A market and how it impacts the snow and ice industry.
It should be noted, since green industry professionals who do snow and ice in the winter, or snow and ice professionals who provide lawncare and landscaping in the warm-weather months, comprise nearly 70 percent of this industry, when we mention “the industry” in our conversation we’re often referring to both entities as a single group.
Depending upon market pressure and the amount of financial bandwidth companies have to act, contractors can take advantage of either an offensive or defensive strategy in an approach to M&A. According to Harkness, the economic environment and significant capital resources still are in play for 2022 and 2023, allowing owners to consider growth through a strategic acquisition, or entertain a merger with another company or private equity partner. Size and scale matter so an infusion of capital and market expansion can solidify a long-term market position.
In our conversation, Harkness walks us through the state of the mergers and acquisitions for 2022 and explains why our industry is so attractive to investors, why M&A is an important growth tool, and why it’s so critical for snow and ice professionals to establish a long-term vision for their companies.
Snow Magazine: M&A activity was strong in 2021, and as we enter the second quarter of 2022, it appears to still be hot, hot, hot.
Jeff Harkness: It is. We’ve been very fortunate and blessed to work with a lot of companies in snow and ice, the green industry, and other contracting firms. It’s very rewarding to help create legacy opportunities for entrepreneurs and business owners in this space. It’s been a good ride and we’re still running hard, for sure.
What is it about the green and white industries that is so attractive to outside investors?
First, there’s significant staying power. There are a couple concepts that are applicable to the green and snow industries, and it starts with this idea of recurring revenue and that there are companies driven by contracts – on both the green and the snow side. The industry has proven itself. We’ve been through recessions. We’ve been through COVID. We’ve been through inflationary times and there’s a staying power with essential services, recurring revenue and just the concept of how does a customer suddenly stop mitigating risk? How does a customer or a prospect suddenly stop maintaining the exterior part of their real estate investment? So, there’s been proof in stickiness and longevity around how good of an industry this is when it comes to the essential service recurring revenue model.
Point No. 2 is you need to understand the logic behind why an institutional investor, or a strategic buyer would want to invest in a business in this space. Owners all over the industry are getting bombarded with phone calls. There’s lots of institutional money out there.
People need to understand the business model that is private equity. Private equity is a lot like landscaping and snow and ice management. There are small, medium, large, and international private equity firms. They are all professional institutions that go out and raise capital. They can raise capital in a manner where they’re going to invest in a specific business or strategy with limited partners or wealthy institutions or raise a fund where they are going to invest in different types of businesses and industries. In the end, when you “raise capital” you must “deploy capital,” and finding good businesses and management teams to invest in is harder than you would think. Raising the money might be the easier exercise.
Do the private equity groups vary in their strategic missions?
It’s really about growing great companies, and if you lead with great people and processes, a 3X to 5X return on invested capital is happening regularly in our space. Each group may have different approaches and goals, but the hold periods run 3-10 years typically before a recap or cash-out event. Again, some private equity groups raise capital related to a specific strategy, others a broader play like facility services vs just snow and ice or landscaping. For groups raising a fund, they can go out and raise $250 million or a billion dollars, but they are not going to go out and invest in Apple, Microsoft, or Chevron. They’re actually going to take that money and invest it in closely held businesses they feel they can grow and scale. As I said before, one of the beauties of institutional capital is when you raise capital you must deploy capital. Investors expect returns. That money needs to go to work.
We often think of our industry as unpredictable because success is so dependent on weather. Does our industry provide that level of financial return?
If we look at some of the case studies happening in the industry where private equity or institutional capital is deployed, we’ve seen some returns bigger than double or triple. We’ve seen returns at four, or five or six times your money all within that three- to five-year time horizon.
The reason there’s still interest is one, the staying power of the companies in our industry. Two, there’s still a significant amount of capital that’s been raised and must be deployed. And three, size matters.
The secret sauce as to why you can still get a return in this industry is it starts with scalability. There’s been a high amount of acquisition activity that’s been fueled by supply and demand – there’s only a certain number of companies of a certain size and profitability that can be acquired.
So, it’s been a very frothy three- to four-year run with a lot of strategic activity and a lot of private equity backed activity into our space because, again, there’s staying power and a track record of returns within green and white companies.
Lastly, we’re still a highly fragmented industry. We’re still an industry that lacks access to capital to acquire other companies. We’re still an industry trying to figure out the human resource and recruiting sweet spot. We’re an industry that’s still answering the phone a lot versus utilizing large marketing business development type strategies to really grow. We are behind in technology. So, these institutional investors look at our industry and say, hey, we can deploy capital here, we can introduce technology, HR, sales and marketing, leadership training, and we can go out and acquire businesses and take a company at $1-3 million of earnings before interest, taxes, depreciation, and amortization (EBITDA) and scale it up to $20 million, $30 million, $40 million of EBITDA. When you do that, it creates significant value and significant return because of multiples and valuations the bigger you get.
If you understand how the industry is built and why people are deploying this type of capital … it’s kind of like the movie Field of Dreams – if you build it, they will come. So, there is a road map or playbook out there. Build your company in a certain manner with certain metrics, size, and operational focus and we can create a legacy event for you, your family and even your employees.
That’s really exciting. Not too long ago, there was a time in the industry where you either just closed your doors or you transitioned to your son, daughter, or employees. Now we’ve been on this incredible run of creating wealth with institutional partners and we’re seeing these mega companies in what used to be a closely held family type of industry. It’s exciting, but at times it can be scary, too, if you don’t understand what’s happening around you.
Who is behind the bulk of the activity right now? Private equity or bigger guys gobbling up smaller competitors?
The strategics are the most active, so those are companies already in landscaping and snow and ice management who want to grow. There was a time when growth was all about new customers. Now, acquiring other companies brings you a lot of resources with people. It’s one thing to go out and hire one individual at a time or sign one contract at a time, but if you do an acquisition suddenly you get millions more in contracts, more crews, and some good, solid managers.
Where we see the pure financial buyers – the private equity groups who aren’t in this space yet – there are some limitations because they can’t make investments in smaller businesses.
So, we tend to see more activity with the strategics than with the pure financial buyers mostly because of size and scale because we’re still an industry that is highly fragmented.
To give you a metric, $2 million, $5 million, $10 million of EBITDA … if you’re in that range you can likely attract some interest from a financial buyer who is not in the industry yet. Whereas the strategic groups are acquiring companies from $500,000 to $3 million in EBITDA. It’s a different business model, but also an opportunity despite your EBITDA level.
Dismissing a cold call about a potential M&A opportunity is often the knee-jerk reaction with industry contractors. But why shouldn’t an owner be too hasty to dismiss those conversations?
What’s funny is it could depend on whether you’re having a good day or a bad day when you get one of those calls. It’s like anything else in business. It’s just like how you go about servicing a snow-and-ice event. You want to be intentional with everything you do, and you want to follow a process. If you’re not doing that, then at the end of the day you’re leaving money on the table, or you miss an opportunity, etc.
Today’s owner operators should get up to speed on the state of the market and what the opportunity looks like in today’s environment. It’s like any other business decision. You want to have a plan. You want to be intentional with what you do, which takes the emotion out of it, but it also means maximum returns. We encourage companies to educate themselves on building a better business. As part of your annual planning – or your three-year or five-year plan – you should include your growth and exit plans.
While institutional money (private equity and mezzanine debt) can fuel growth by acquisition … We’re certainly conditioned as an industry to go to your traditional banks and ask for money. That’s great for purchasing equipment or expanding working capital, but acquisitions is a whole other play. It’s not where our traditional lenders (senior debt) want to be. The limitations are too great with collateral if you default. If I need $5 million for deals but I don’t have enough equipment, real estate, and cash assets for collateral I’m out of luck with my traditional lender. It’s not that your traditional banker is wrong, it’s just they don’t have the same model as mezzanine finance and private equity firms. So, if I’m a business owner in an industry where you can grow enterprise value and legacy opportunities exist, then I need to be educated and make it part of my planning practices – with my growth plan and exit strategy. Just like you’d plan with an annual budget. We see that as simply good business.
What signs or signals should contractors be aware of that this current M&A environment is starting to cool down?
There are several things – and I’m going to be more bullish than some other folks because I’ve been in this business for 27 years and we’ve seen just about everything. First, anytime there is uncertainty in the world and uncertainty in our country you wonder about consumer spending. It’s inherent in the human emotion that when there’s uncertainty customers tighten their wallets and don’t feel the same about spending money. They don’t feel the same optimism about spending and costs are up. So, what is that impact on a go-forward basis with the services we offer as an industry? Now, I would counter that with the essential services [component] and as it relates to risk management, you can’t just not plow or not salt a commercial or retail property. So, there’s a lot of stickiness there.
Second, as interest rates continue to go up – and they are given inflationary pressures and some raw economics – the cost to borrow money will increase. Private equity groups don’t just spend their own money when acquiring businesses. Instead, they put debt on it so they can own a bigger slice of the pie or grow the business for a bigger return. So, as that cost to borrow money increases it narrows or decreases returns on investment in the short term.
Third, I would look at inflationary costs. Now, we’ve seen this before. Yes, there are inflationary pressures. Just look at the costs for fuel, labor, materials, and fixed assets. But I’m here to tell you this industry has been grossly lagging in communication with prospects and customers about raising your price by 10%, 15% or 20%. As those costs go up, if I’m not making pricing changes to my model – and there’s fear you’ll lose the customer – if you’re not raising those prices, then you’re not going to grow your EBITDA organically.
As an industry, we need to go out and get price increases. I’m here to tell you that our customers in the green and snow industries get it. They’re seeing it in their food bills. They’re seeing it in fuel prices. They’re seeing it in the products and services they buy. There’s never been a better time to get out there and get those increases. I’m bullish that clients are ripe for price increases. That’s a big offset to starve off any erosion in profit and EBITDA.
Lastly, there’s supply and demand. There are a limited number of companies in each market that will become available to acquire over the next year or two. If the market is not a target-rich environment for deals, then a buyer’s size, scale and ROI will become limited or capped. Investors have capital to deploy. If I can’t acquire, then my growth and return of investor capital gets tied to just organic growth. That extends the timeline for investors to get a liquid return which is not ideal. Size matters and so does scalability in doing deals.
At the end of the day, I’m bullish on this industry we call snow and ice and the green space. Facility management services have staying power and a strong track record. You will continue to see movement.
2020 and 2021 proved it again despite no one seeing COVID coming. I believe the same is going to continue despite what’s happening in the world and in our society. You can’t say that about every industry. It’s why our industry is so good despite some of those external factors. So, if we do have some slowdown, it will be more short-term than long-term. But being a good business owner, you want to have a plan, you want to know the facts, and you want to be in a position where you’re not making emotional decisions. Instead, you want to put yourself in a position to keep up with the competition and maybe create generational wealth. That’s smart business. And I’m going to continue to bet on this industry.