November 21, 2015 - 7:24pm EST by
2015 2016
Price: 36.83 EPS 0 0
Shares Out. (in M): 135 P/E 0 0
Market Cap (in $M): 4,990 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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Brief History

ServiceMaster Global Holdings (SERV) was founded in 1929 as a moth proofing company. In 1986 it acquired Terminix - pest and termite control business - and in 1989 it acquired American Home Shield (AHS) its home warranty business. In March 2007 the PE firlm Clayton Dubilier & Rice took SERV private for $5.5bn or approximately 11x EBITDA. In Jun-14 SERV returned to market, IPOing at $17/share; proceeds were used to pay down debt and the PE reduced its stake from 90% to 80%; PE still retains an 18% stake.

Summary Thesis

SERV can be split essentially in two parts: part A includes a relatively stable and cash generating pest and termite control business and a fanchised cleaning division which together account for c.68% EBITDA); part B includes a rapidly growing home warranty business (c.33%). The combination of the these 2 parts provide an asset light decently growing business, generating good cash which will be initially used to pay down debt (to 3.5x-4.0x net debt/EBITDA) and then to be returned to shareholders. Note the CEO holds c.$23mn of stock (joined in 2013). SERV trades on FY16 FCF/17 yield of 6.4%/6.9%, which seems too high for the combination of stability and growth the group offers: targeting a FCF yield of 5.5% implies 24% potential upside.

Key Positives

  • Market leader in terms in a highly fragmented industry.
  • High retention rates: north of 75%, drive a recurring revenues business model.
  • Decent resiliency: if we exclude the divested True Green cyclical business (2010), organic growth was flat/+1% in FY09.
  • High margins: EBITDA of 24% in FY15, with accretion uninterrupted since 2007 (c.12%)
  • Asset light: capex/sales c.2%.
  • Deleveraging: from net debt/EBITDA of 4.3x in 3Q15, management targets 3.5-4.0x and hinted intention to return excess capital to shareholders.

Key Negatives/Risks

  • High financial leverage: currently c.4.3x.
  • Industry highly fragmented and will take long to consolidate.
  • Cash tax shield about to end in FY16.
  • Historic ROIC and cash conversion impacted by LBO.
  • Terminix facing contractual customer losses (though revenues have been stable).
  • Management team relatively new (started in 2013) and with no consumer background (previously working for industrial groups).
  • Ex-PE owners retain c.18% stake - likely to sell down.

Summary Financials

  • Mid single digit grower (c.4-6% including organic + bolt-on)
  • EBITDA growth around high single digits (6-8%) due to decent operating leverage (incremental margins of c.35%, with aspirational EBITDA margin target of 30%).
  • Low double digits EPS grower due to balance sheet deleveraging
  • Capex/sales c.2%
  • Cash conversion has been lumpy, likly being disported by LBO
  • Historic ROIC impacted by high leverage, gradually will return to pre-LBO low teens level.
  • Target leverage of 3.5-4.0x
  • In FY16/17 I forecast FCFE of 315mn/344mn based on EBITDA of 660/710mn.

Terminix Business (57% sales, 55% EBITDA)

Terminix is a pest and termite control business with 300 company owned and 100 franchised branches, focused mainly on residential customers (75% of divisional sales). The business serves 2.8million customers a year via 5,000 directly employed technicians.

The pest and termite control business is relatively underpenetrated in the US, with only c.30% of US households utilizing a professional extermination service (according to RBaird analyst). SERV is the market leader with 21% share, competing mainly with Rollins (19% share); the rest of the market is fragmented (though Ecolab also operates in it with c.5% share).

Importantly this business enjoys high retention rates, averaging 85%, and c.70% of sales derived from upfront annually paid fees and the remaining 30% of sales tied to ad-hoc one-time service visits.

In the medium term Terminix should be a GDP+ growing business (c.2-3% volume + 1-2% price increases) and given the high incremental margins (c.40% in the last 4 quarters) it should continue to enjoy good profit growth, on top of minimal capital investments (mainly related to vehicles and IT). The negative working capital dynamics, coupled with decent visibility make Terminix a slightly above average business in my view.

American Home Shield (33% sales, 33% EBITDA)

SERV AHS business serves 1.6mn customers via a network of 11,000 pre-qualified contractors. Broadly speaking SERV’s home warranties provide customers with assurance that their home systems and appliances will be serviced and/or replaced by a pre-approved network of technicians for an annual premium ($c.550/year) and a modest per service fee ($75). Given the target population is low income households (80% of customers earn between $50k-100k annually), the relatively “low” monthly fee avoids them to have to deal with shocks to monthly cashflows if an important home appliance (such as a fridge or HVAC) requires repair/replacing (HVAC repair can cost >$1,000). The value proposition arises from (i) SERV ability to pre-negotiate with contractors intervention rates not available to the general public and (ii) buying of replacement parts at large discounts.

AHS is the growth business within SERV and it started to gather momentum when new management decided to expand it outside the real-estate channel (historically sales were tied to existing home sales transactions). When management moved to reach consumer directly through the Internet, the growth accelerated meaningfully. In theory the addressable market is very large if one consumers that only 3-4% of occupied households use the service, versus say home security penetration which is around 20% (as per ADT). SERV is today the market leader, with c.40% market share and is 4x larger than the next competitor (Old Republic and First American). In terms of regulation, the company disclosed that recently the Consumer Financial Protection Bureau has completed a review of AHS and it not take any enforcement actions.

In summary this is an asset light growing business, with decent retention rates (c.70%) and high margins (LTM EBITDA margins 22%).  Scaling the business further through geographic expansion and improving the retention rate should deliver higher returns going forward.

Franchise Service Group (10% sales, 12% EBITDA)

This business includes Service Brands focused on cleaning/janitorial and repair services that are licensed to individual franchisees. It serves c.200k home monthly via 5,400 franchised locations, with the leading brand ServiceMaster Clean generating $1.2bn customer-level sales. Essentially SERV offers its franchisee an existing infrastructure (back-office systems, training facilities and pooled advertising) and brand recognition in a low barriers to entry business where local competition is high. Growth prospects aren’t particularly exciting, however the division generates EBITDA margins of 32% due to its franchisee/asset light model.


I’ve met both the CEO and CFO and they seems sensible although probably they were mocking too much the previous management team (under PE ownership). Also, I would note none of them has previous consumer facing industry experience. The CEO owns c.$23mn of stock, and CFO c.$3mn. Short term comp is based 50% on an EBITDA target, 30% on a revenue target and 20% on cashflows (defined as EBITDA – WC – Capex).

Capital Allocation/Leverage

Historically the vast majority of cashflows has been used to pay down debt (leverage was as high as 9x in 2011) and to fund bolt-on acquisitions (c.40-60mn annual spend over the last six years, paid at 1.0x sales/ 6.0x EBITDA). Capex requirement are very limited, at 2% of sales and should not really change.

Whilst the target leverage of 3.5-4.0x is higher than I’d like it to be, this business has shown evidence it can support such a capital structure given that (1) organic growth was flat in FY09-10, (2) customer retention rates are north of 70%, (3) EBITDA ex-cyclical True Green business is relatively stable, (4) cashflow have a decent amount of payments paid in advance and (5) under PE ownership (2007-14) leverage went as high as 9x.

In addition I estimate that in 2016-17, if the group targets a leverage ratio of 3.75x, it should have c.$500mn of additional balance sheet firepower.


The most direct peer is Rollins, however it is not a pure comp and it trades on very high EBITDA multiples (>18x). Benchmarking against several other publicly listed business services companies (such as ISS for example), I believe a FCF yield of 5.5-6.0% would be appropriate, considering the stability of organic growth during the recession, the high margins and recovering ROIC towards midteens as the business delevers. Targeting a FCF yield of 5.5% implies 25% potential upside.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


In FY16 the company should announce a plan to return cash to shareholders once it hits its leverage target of 3.5-4.0x.

In addition continued delivery of growth in AHS should provide upward pressure to consensus estimates.

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