The FTSE 100 was down yesterday for the fourth straight trading day. Unfortunately for the pest control company Rentokil Initial (LSE: RTO), it was front and centre of this decline. In fact, yesterday’s 12.3% decline represented the single worst trading day this company has seen in 13 years. The reason? Rentokil announced that it will be buying American rival, Terminix. So far, it’s not so much the acquisition that seems to have caused concern but rather the price tag on the deal that’s really bugging investors (pun intended). Reuters reported yesterday that Rentokil would pay $6.7bn (or £5.1bn) on the deal. That amounts to about $55 per share or a 47% premium compared to Terminix’s closing price on Monday. The irony is that while Rentokil stock is reeling, Terminix shares are up 18% since the news broke on Monday.
The underlying business
Rentokil has a solid underlying business model in its own right. It was already the world’s largest company in this industry. Nearly two-thirds of its revenues last year came from pest control and it has entrenched itself as the global leader in the industry. Since 2016 the company has acquired 228 companies, expanding its presence to 82 countries. From a financial perspective, what jumps out to me is that revenues that have been consistently growing over the past few years. This is backed by very chunky gross profits that are consistently either over or close to 80%. The bottom line could use a bit of a boost but with revenues growing by 14.5% in the last quarter, I’m confident in the ability of this company to continue to grow and drive up net earnings. There’s simply no FTSE 100 comparison due to the niche and scale on which this company operates.
A creepy-crawly killing FSTE conglomerate
I think that, while a 47% premium is undoubtedly quite hefty, what the market is failing to price in is all the advantages of this merger. With $2bn in revenue last year, a presence in 47 US states and a reputation as the second-largest company in the US pest control market, Terminix is a premium company. To get premium companies, you often have to pay a premium price. This deal will entrench Rentokil as the global leader. This unfettered access to the US market is coming at a time when the $22bn global pest control industry is growing rapidly. The onset of the pandemic, as well as a growing middle-class population, means that demand will continue to grow.
Last month Rentokil stated that labour shortages and Covid-19 related medical bills are driving up costs so this must be factored in. Russ Mould, investment director at AJ Bell, also noted that the deal could attract the attention of antitrust regulators in the US, which could present challenges for the company going forward. So, while I don’t think it will be smooth sailing, I think that this is a safe pick for my portfolio with loads of potential upside. Currently trading at 40 times earnings, it’s not the cheapest FTSE 100 stock right now but definitely one that I will be keeping on my radar.
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Stephen Bhasera has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.