CD&R Finds ‘Strike Zone’ with ServiceMaster

Target: ServiceMaster Co.

Price: $5.5 billion

Sponsor: Clayton, Dubilier & Rice

Seller: ServiceMaster Co.

Financial Advisors: Banc of America, Citigroup, JPMorgan Chase and Wachovia Securities (sponsor); Morgan Stanley and Goldman Sachs (seller)

Legal Counsel: Debevoise & Plimpton (sponsor); Sidley Austin (seller)

Buyout firm Clayton, Dubilier & Rice is looking to add another household name to its portfolio with the $5.5 billion take-private of ServiceMaster Co., the owner of Terminix, Merry Maids and TruGreen Chem Lawn.

Assuming the deal earns approval from shareholders, the New York-based firm would pluck from the public market a company ripe for private equity, boasting reliable, strong cash flows and minimal capital costs. In 2006, the company reported EBITDA of about $408 million on revenue of $3.4 billion, while spending $52 million on capital improvements.

“To us, ServiceMaster is the perfect private equity holding,” wrote Sam Darkatsh, an analyst for Raymond James Associates Inc., in a research report. Additional favorable attributes include clear add-on potential, barriers to Asian competition, and deep-pocketed strategic buyers that “could ultimately present an endgame,” he wrote.

Richard Schnall, the CD&R partner who shepherded the deal, considered the deal a “strike-zone” transaction for the same reason. “It has market-leading brands, great recurring cash flow and very few capital needs,” Schnall said.

Like Kinko’s, Hertz and Culligan, Downers Grove, Ill.-based ServiceMaster is a well-known, branded business that operates in multiple locations—5,500 company-owned and franchised locations, to be exact. ServiceMaster also fits the profile of CD&R’s major deals in that the company is at an inflexion point. The company, whose stock has more or less flatlined during the last five years, is moving to a new headquarters in Memphis, overhauling the sales system for the TruGreen division and altering the chemistry of its termite-control product. “We buy companies in transition. That’s what we like to do,” Schnall said.

Founded in 1929 by a devoutly Christian minor league baseball player, ServiceMaster has accumulated a host of domestically-focused consumer businesses, from on-call handymen and exterminators to a maid service and carpet cleaning division. Its stock rose steadily for decades but hit a rut since coming off its all-time high in 1998. Last fall, the company lowered its earnings forecast for 2006, citing slowing sales in its lawn care and termite-control businesses. Under pressure from hedge funds, and convinced a buyer could shield the company from inflated expectations, ServiceMaster in November hired Morgan Stanley and Goldman Sachs to run an auction.

That was music to CD&R’s ears, since the firm had been interested in ServiceMaster for years and had even been in previous discussions with management, Schnall said. Because the buyout came through an auction, there’s no go-shop clause, and analysts believe the $15.63 per share offering price will earn shareholder assent. The agreement represents a 31 percent premium on the stock price before ServiceMaster announced its intention to sell.

The $5.5 billion price tag includes about $700 million in debt. CD&R is pitching in $800 million in equity, with Banc of America Securities, Citigroup Global Markets Inc., and JPMorgan Chase splitting the remainder of the $1.4 billion equity check.

The deal relies on what Schnall called a “state-of-the-art” covenant-lite debt structure comprised of a large cash-flow-backed revolver and a “significantly sized” payment-in-kind toggle note.

As with the Hertz and Kinko’s deals, CD&R plans to install Operating Partner George W. Tamke, former chief of electronics company Emerson, as chairman of ServiceMaster once the deal is complete. Other members of the existing management team are expected to remain in place.

With the ServiceMaster deal, Clayton Dubilier & Rice Fund VII, a $4 billion pool closed in the first quarter of last year, is nearly half-invested, according to the firm.—J.H.