OlsztynskiEditorial: Why Contractor Consolidation Fizzled
In 2001, Encompass Services Corp. laid claim to being the nation's largest mechanical contracting firm with revenues of $3.8 billion (including electrical and janitorial services). Last year, the NYSE dropped the firm's stock after it had shrunk to 14 cents, then last November Encompass filed for Chapter 11. Recently it began "selling" some of its commercial units back to former owners (I'm told they paid virtually nothing) and unveiled a plan to reorganize as a private residential service company with operations in nine states.
Encompass' problems parallel those of all the other contracting giants that sprang from last decade's roll-up craze. ARS was the first to get organized in 1996 and the first to blow up. It got purchased by ServiceMaster several years ago for around $25 million when it was doing more than $500 million in annual revenues. Service Experts was the shining star of roll-ups whose IPO price tripled at one point, then dropped like a rock. The company is now owned by Lennox.
Comfort Systems is the only one of the roll-ups still in business under its original name. Last year the company sold a large chunk of its affiliates to Emcor and shows little prospect of fulfilling its goal of national supremacy in commercial piping and HVAC. Blue Dot Services came into the roll-up picture about the time IPOs took a nosedive and never went public. They still exist as a sizable residential service organization but excite nobody. AMPAM was a roll-up of plumbing companies specializing in new construction but also premised on yesterday's dream of an IPO. Their fortunes also have turned south, as did the ambitions of the R.S. Andrews organization based in Atlanta.
These companies were cobbled together from some of the nation's premier PHC contractors. They still employ plenty of good people at the operational level, but their business model has proven about as workable as Yugoslavia. In none of these cases has the whole been greater than the sum of its parts.
What Went Wrong?
Consolidation was touted as the cure for many industry ailments. The national organizations would be able to offer pay, perks and advancement opportunities to attract top-notch personnel. They'd have the resources to train managers and the service technicians that are in short supply. The consolidators promised to bring badly needed business professionalism to PHC contracting.
None of that came to pass. It's because, to their financiers, consolidation was an end unto itself. They had previously made quick killings in various other industries such as waste management and funeral homes, and our industry's service sector fit their profile as another one ripe for rolling up. That meant buying companies willy-nilly and adding up their revenues and profits into an attractive pro forma. Then when the organization's valuation got about as good as it was likely to get, the roll-up artists would cash out. They paid lip service to operational excellence, but every dollar invested in operations was a dollar not available for the empire building needed for share price run-ups. These folks never gave a damn about the PHC business or the industry at-large.
The experience has made most contractors believe big is bad, and local ownership a must for success. I don't completely buy that. Consolidation has taken place in so many industries there seems an inevitability about it. Emcor is now the country's largest mechanical contractor with more than $4 billion in annual revenues (including non-mechanical services), thanks in large part to acquisitions. Yet, they are doing quite well both in stock valuation and marketplace respect. The difference is Emcor sees itself in the mechanical contracting business, not just playing a Wall Street game.
Something similar can be said about the PHCP wholesaling chains. They are vibrant companies anchored in the wholesale-distribution business. They make acquisitions to achieve purchasing power, economies of scale, new markets, more market share and other competitive advantages. Not every acquisition has panned out and there's been some indigestion, but nobody claims Ferguson and Hughes are on the brink of disaster for having grown so big.
Contractor consolidation was based purely on financial manipulation. Theirs was a world of make-believe value that could be peddled to naive stock analysts. It wasn't illegal, but shared with all the corporate scandals of recent years the underlying premise that appearances count for more than reality.
Our shaky stock market is still feeling the hangover from this kind of thinking, but it's all part of sobering up. When the head stops throbbing, investors once again will realize that business value comes not from accounting tricks, but from grubby businesses where people get their hands dirty making things, building things, fixing things, or distributing things where and when they're needed.