The Takeaway: A Q&A With Disha Mehta on the Facilities and Residential Services Sector

Let’s start with the sector landscape, so to speak. How does Houlihan Lokey define the facilities and residential services sector?

It’s a good place to start because what we would call the “blue collar” services world has evolved significantly over the last decade. Previously, we used to just categorize everything as either industrial services or consumer services, and there was nothing in between. But the true value for our clients lies in deep sector expertise and sector specialization, so over the last few years we have made a concerted effort to define subsectors that resonate with the market.

For facility and residential services, Houlihan Lokey defines that space as essential, outsourced labor-based business models that serve commercial, light industrial, or residential end markets. Within that space, we further divide it into technical and managed services; managed services typically involve field labor that performs recurring or reoccurring maintenance for commercial or residential property. That includes things like power washing, landscaping, pest control, janitorial, response and restoration, exterior cleaning and maintenance, pool cleaning, and so on. In other end markets, there is security, catering for schools or hospitals, and light industrial services like pavement maintenance, snow removal, and that sort of thing.

On the technical side, it’s a little bit more related to systems—your HVAC, your electrical, your elevators, any equipment repair, fire and life safety…essentially services for which someone needs to have either a certification or a tool belt, we like to say, in order to handle those services.

What do investors like about these spaces? And what makes it attractive to the world of private equity?

There are a number of attractive characteristics. For one, the range of services is so vast, making the TAM (total addressable market) virtually unlimited. This type of work needs to get done to ensure safety, operational efficiencies, they maintain the image of a business, or regulatory compliance. It needs to get done day in and day out, every week, every season—it's not dependent on economic cycles. We saw the true impact of the critical and essential nature during the pandemic.

However, it’s not just the cycle resilience that makes these companies attractive. We’re seeing a generation shift from a DIY mindset to more of a “do it for me” mindset, right? On the residential services side, people used to do their own yard work or fall cleanups, and now they are increasingly hiring someone to keep up the properties. 

But the bottom line is that there is just a lot of that type of work that needs to get done, which is very attractive. As you know, private equity loves resilient businesses that are not going away, that are not getting replaced by bots or technology in some way, and that are not at risk.

The second reason these services are attractive to investors is the asset-light nature of the businesses—typically, they have low capital expenditure, there is no heavy equipment that needs to be maintained. That said, it is labor intensive, so investors need to be aware of the cost dimension there, which is maintaining labor compliance, safety, maintaining training and education programs and standards, and retention of your labor pool. Asset-light nature, combined with high free cash flow, means that credit/leverage is more easily available for the businesses.

The third reason is the classic requirement for all investors, which is where do I go from here, right? And in this space, the fragmentation of the sector is very attractive. Each of these subsectors I mentioned earlier all have hundreds of thousands of businesses, many of them essentially mom-and-pop businesses, and there has been significant consolidation in the last five to seven years. But don’t misread that trend: It’s still just the beginning, the tip of the iceberg, and business services as its own industry sector has only gained popularity in the last decade. There’s a lot more to come.

What is the typical company size?

It’s actually a little bit of a Goldilocks situation because of how the private equity world itself has evolved, with varying fund sizes and different mandates.

There is a huge swath of lower-middle-market and middle-market funds that have had success rolling up the space. Some might start quite small with mom-and-pop companies with a million dollars or less of EBITDA, acquire dozens of businesses, add a professional management team and operational processes because they know there is a market for a $10 million–$20 million EBITDA business, while some are focusing on acquiring scaled platforms in that $10 million–$20 million EBITDA size and growing to $40 million–$50 million during their hold.

How have these sectors performed over the past several years?

That’s a two-part answer. During COVID-19 and soon after COVID-19, there was a massive rush toward the sector because of resilience and essential nature and everything we talked about earlier, and because of that, a lot of platforms were created. Many of those platforms have traded hands and they fetched premium multiples. The companies have generally performed, and the sponsors told the right story.

The second part has to do with the question of how these businesses are going to trade in this next round of swapping hands—that is just about coming up, right? Generally speaking, the demand for these services has not decreased, nor has private equity’s view on their value proposition.

Are valuations reasonable, or are you still seeing a valuation gap in this space?

I think it really depends on the subsector. Valuation and multiple have not changed as much, but there is a focus on quality.

During COVID-19 (and just after), in every one of those subsectors, every time a deal came out, it would get snapped up because investors had a fear of missing out. Today and over the last several quarters, there is a higher bar for what is considered a high-quality asset worthy of a premium multiple.

Let’s look ahead a little bit. What do the next three to five years look like?

I think there’s going to be continuous consolidation in the next three to five years. The consolidation trend is far from over—there are still thousands of businesses with those attractive qualities I mentioned. Transactions involving some of those “COVID-era” businesses that will be trading soon will dictate how many new platforms get created and how excited people are about certain sectors.

However, there’s just so much, both in terms of number of sectors as well as in terms of businesses, in each of those sectors that I don't see the sector slowing down or having a downturn of any kind. The sponsor community loves it when a sector has so many of these characteristics that create opportunities for growth and value creation. We expect the sector to remain very active, even amid the current unpredictable market environment.