ServiceMaster Global (NYSE:SERV) witnessed a disappointing public offering in what has been a busy week for underwriters. The company provides services to maintain residential homes as well as businesses.
The company, best known for its termite business, operates in a stable but attractive industry. Unfortunately, its previous private-equity owners saddled the company with debt, making an investment not attractive at the moment.
The Public Offering
ServiceMaster operates a big service network of 7,000 owned, franchised and licensed locations. The company aims to protect homes and businesses from various potential threats. Services include termite and pest control, home warranties, disaster restoration, cleaning and inspection.
The company serves some 5 million customers through a direct-owned workforce of 13,000 workers with another 33,000 people working in the franchise network.
ServiceMaster sold 35.9 million shares for $17 apiece, thereby raising $610 million. There was weak demand for the offering with the initial public price range set at $18 to $21 per share. Weak demand held back the proceeds for the firm. The underwriting syndicate for this offering consisted of J.P. Morgan, Credit Suisse, Goldman Sachs and Morgan Stanley.
Shares of the company managed to show a modest first day jump, ending the day at $17.95 per share. At these levels, the firm is valued at $2.3 billion.
ServiceMaster's mission is to simplify and improve the quality of the life of its customers, protecting and maintaining homes and real estate of commercial businesses.
The company holds leading market positions in its markets with strong brands, including Terminix, American Home Shield, ServiceMaster Restore, ServiceMaster Clean and Merry Maids, among others. Terminix, the termite service, makes up little over half of total revenues, being by far the most important business.
Terminix serves 2.8 million residential customers protecting them from termites and other pests. The typical low-cost maintenance fees are appealing to customers who understand the financial consequences of inadequate maintenance. The company stresses the high retention rate of 85% for this business. The terminate business has an estimated size of $7 billion in the US, according to Specialty Products LLC. With over 17,000 businesses operating in the industry, the vast majority has a very small scale, leaving significant opportunities for consolidation.
For the year of 2013, ServiceMaster posted revenues of $2.29 billion which is up 3.6% on the year before. The company posted an operating profit of $42.4 million for the year, compared to a loss the year before. The company took roughly $57 million in restructuring and amortization charges last year. Also note that the company paid $247.1 million in interest payments for the year, putting severe pressure on the bottom line.
The company did post adjusted EBITDA of $450.0 million for the year.
It should be no surprise, given ServiceMaster's previous ownership in the hands of private equity firms Clayton, Dubilier & Rice, that the company is saddled with debt. The company has $446 million in cash and equivalents while total debt stands at $3.91 billion. This results in a rather steep $3.5 billion net debt position. The $610 million in proceeds will be used to repay debt, lowering the net leverage position to roughly $2.9 billion.
Note that $250 million in annual interest payments result in a weighted average interest rate being paid of about 6.25% for 2013. Repayments of debt will focus on higher yielding debt, allowing the company to save about $40 million interest payments per annum.
At $18 per share, ServiceMaster's equity is valued around $2.3 billion. This values the company's equity at roughly 1 times annual revenues and roughly 55 times operating earnings. Adjusting for the $57 million in amortization charges and $40 million in anticipated annual interest rate savings, both at statutory tax rates, earnings could improve to roughly $100 million. This would value shares at a multiple in its low twenties while leverage will continue to be very high.
As noted above, the public offering of ServiceMaster has been disappointing. Shares were offered 8.1% below the midpoint of the preliminary offering range and despite a modest first day jump, they closed below the low end of the preliminary range on their opening day.
Of course, there are plenty of reasons to be cautious on this offering with the main reason being the very high debt position of the company, which the debt service costs is eating most, if not all of the earnings. On top of this are the usual risks, including seasonality, the usage of the franchise model, potentially changing environmental laws and pricing. Despite these risks, the underlying operating business is quite solid.
ServiceMaster is showing solid although slow revenue growth. Its businesses is capital light, creates stable cash flows while the high retention rates provide a lot of visibility. Unfortunately, all these benefits are already "capitalized" by leveraging up the balance sheet, creating little appeal for potential new shareholders.
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