What follows is a composite. I have watched versions of it run in more than one fund and more than one industry, and the details rhyme often enough that I no longer think of them as accidents.
I find it amusing to watch the stumbling and mumbling of highly educated, well-manicured participants in the high-finance world of private equity. Musical chairs for the smartest guy in the room, everyone jockeying over who gets to be king peacock for the day, while the people nominally responsible for the business seem more interested in reliving their university glory days than in the thing they just bought.
Alas, behold the brethren of capital-backed funds, screaming for deployment into the marketplace just so they can collect bloated fees and unreasonable dividends from their portfolio businesses. All while chasing a thesis that has been revised more times than anyone in the room would care to count.
Enter the latest phase: the roll-up of field services. Facilities work, grounds work, seasonal work, all pushed under one roof on the theory that a route is a route. And boy, have these worlds collided. You can hear the stuttering, a Fred Flintstone “Yabba-Dabba-Doo, but what can I do?!” Well, young spreadsheet warrior, you have entered a world where cost certainty and straight-line accounting have about as much chance of working out as a lottery ticket has of being a solid financial plan. You have bought into a business where the outcasts unite.
Every one of these businesses has a Johnny. Your superstar foreman of last month has had a change of circumstances this month. Life has intervened, in the way it does, and he has decided to come to work four days out of five, and when he is at work he is — let us be charitable — not at his best. His production has dropped by 40%. That hits his crew too, because Timmy is now covering the shortcomings of his supervisor, and Timmy is not paid for that.
Meanwhile the finance team has already forecast the profits from Johnny’s project into a pro forma presentation for the bank in order to meet debt covenants, and now the world has come crashing down. Free cash flow disappears. Working capital requirements increase. The project misses its milestones, and the liquidated damages start rolling in. So the scramble begins, and the board runs out of fingers to point at everyone but itself.
Further down the road, the thesis has bound the fund to a narrow set of end markets, and the discovery arrives that capex in this world is an annual commitment rather than a one-time line item. Somewhere in that meeting a board member vaguely remembers Charlie Munger calling EBITDA bullshit earnings, along with his line about the owner who surveys a yard full of equipment and calls it his profit. Now it makes sense. Whether he says anything is another matter, because by this point the room has settled into the posture rooms settle into, where the discussion is bounded by twenty-year-old case studies drawn from industries not remotely related to the one on the table.
Finally, the recapitalization event. The get-out-of-jail-sort-of-free manoeuvre that arrives after sweating the assets, losing the key personnel, and enduring leadership that reacts faster than it thinks. But it is all fine, because at the end of the day the recap pushes the founders — the ones who sold businesses that churned out steady dividends — outside any hope of recovering their rolled equity. They sold us something that ran fine before we broke it. Must be their fault.
And should the recap not work, there is always rescue capital at ridiculous returns, structured to shut out anyone who is not already inside the circle. Can’t burn those ones. They’re the cash cow.
So let me be fair for a moment. I understand the need to spread your wings, to go and find fragmented industries throwing off an appreciable share of revenue as recurring, year over year. But these industries operate in commoditized environments. So what is your differentiator? What are you actually going to do differently inside a sector under permanent margin pressure?
You are not going to find it by importing strategies from unrelated industries and shoehorning them into a business that runs on physical labour and boots on the ground. These crews are under relentless pressure to hit deadlines. And labour is the biggest line item there is — 35% to 45% of revenue, at the top of that range for straight maintenance like snow and turf.
Which brings us back to Johnny. This is a business where deadlines are actually deadlines. The grass never stops growing. Winter events start and stop on their own schedule and ask nobody’s permission. That 45% labour line is volatile on a good day — so naturally, this is the moment somebody chooses to roll out a CRM with no cross-platform integration, during the “slow” season, which is not slow.
So put down the deck and take a look inside.
A ten-million-dollar operation carrying a 45% labour burden is spending $4,500,000 on labour. Now watch it grind to a crawl. Crews sitting through two-hour tailgate meetings every second day. Documenting fly splatter on windshields. Logging who left an empty bag of chips in the back of a truck. Call it a 30% drag on labour, which is generous. That is $1,350,000 — thirteen and a half points of revenue.
Your 15% EBITDA was $1,500,000. At 6x, that is $9,000,000 of enterprise value — the number in the model, the number in the deck, the number the LPs were shown. Run the same multiple on what the business is actually producing and you are holding $900,000 of it. It is McConaughey playing Mark Hanna in The Wolf of Wall Street: “Fugayzi, fugazi. It’s a whazy. It’s a woozie. It’s fairy dust. It’s not real.” Then the scramble starts, and you normalize everything right down to the toilet paper.
The funny thing about business is that the outcome is rarely a pleasurable experience on the other side, and the chase for more has a way of costing the people doing the actual work. The only thing any of us needs more of is the life that money cannot buy.
This is the life of private equity in the field services world. It does not have to be.
None of the above is an argument against the model. It is an argument about sequence. Every number in that spreadsheet is downstream of something physical — a crew that shows up, a machine that starts, a route that gets run before the snow stops falling. Get those right and the model has something to stand on. Get them wrong and no amount of normalization, no recap, no rescue capital will put the earnings back, because the earnings were never there to begin with.
Structure before sophistication. Every time.
Gerry Visco