Residential Services: A Key Growth Industry for the Next Decade

In this episode of William Blair Thinking Presents, we interview equity research analyst Tim Mulrooney, who shares insights from his residential services report, in which he outlines the various markets poised for growth, such as pest control, HVAC, lawn care, pool services, and more. Tim also sheds light on several megatrends that are reshaping these markets and should catch the attention of investors.

Podcast Transcript

[00:00:24] Chris Thonis: Hi everybody. On today's episode of William Blair Thinking Presents, we welcome analyst Tim Mulrooney. He's the group head of the Global Services Sector. Tim and his team just published a new report focused on the residential services vertical and its many large, highly fragmented markets such as pest control, landscaping, electrical and plumbing renovation, home restoration and more. Tim, appreciate you joining us. Always enjoy our chats. First and foremost, hoping you can jump in here to provide listeners with a little more color around what this report is all about.

[00:00:57] Tim Mulrooney: Thanks for having me. Just stepping back here. What am I at William Blair? I'm the services guy. I'm your local services analyst, right? I cover blue-collar stuff: commercial services, everything from uniform rental, pest control, commercial parking, commercial cleaning, landscaping, facility services, you name it, B2B with distributed networks, branches across the country, I cover it. I also cover some sustainability services. A question I often get from clients is why aren't there any publicly traded residential services companies?

You have commercial services. You have sustainability services. Why aren't there any scaled resi-plays? The truth is there are. They're just privately held; but I don't think that they will be forever. I think a lot of these resi-services companies are going public. I think that there's going to be a lot of investor interest for these companies, which is why we tried to lay the groundwork. I know 125 pages is a lot to get through, but we wanted to really dive into what drives the growth at these companies. How are they different? How are they similar? Because you have different investors that value different things. Some investors really like the extremely large TAM and the highly fragmented nature of that TAM so there's a massive roll-up story and that appeals to investors that have seen rollup stories successfully play out.

Others don't like roll-up stories. They don't like the M&A stuff, right? They want to see organic growth. And so there's plenty of companies in here that are growing, believe it or not, 10%, 20%, 30% organically because they have a penetration story. Thirteen percent of homes have pest control.

[00:02:43] Chris T: That's actually a great segue. You talk about all these investment characteristics, right? That's probably the lengthiest section of the report, at least at the beginning. I think it would make sense maybe walking through that section a bit. One of the first things you talk about is market adoption being driven by several broad-based homeowner themes including favorable demographic tailwinds, home investment trends, and changes in homeowner preferences and lifestyles. But overall, based on what you were just talking about, I'd love to hear your in-depth thoughts about what these investment characteristics truly are.

[00:03:14] Tim M: Sure. I got this question quite often at our forum. William Blair held this consumer services forum at our headquarters where we had some of the largest privately held consumer services companies come in addition to a lot of financial sponsors. We all got together to discuss these topics and there were really five investment characteristics that were the topics de jour, so to speak. The first one that's obvious to everyone are the secular tailwinds. You have a couple and different companies would reference different ones because they affect their businesses more than others.

The same secular tailwinds that are affecting residential services companies could be different from the car wash companies versus the health and beauty and experiential companies, which are the three broad categories of consumer services. I focus on resi-services. That's what this report is.

So for me it was a couple things. Number one, it's this idea that millennials [generally] are becoming a larger percentage of the homeowner base and millennials are by and large proven through data in this report that they are DIFM. They're do it for me. Millennials don't want to do anything themselves. They can't.

[00:04:27] Chris T: What’s do it for me? Explain that.

[00:04:29] Tim M: Well, it's DIY, which is do it yourself. That's what your dad did in the seventies. He replaced everything himself. He changed his oil in the car. He did everything himself. We don't know how to do that because we're on our phones distracted with TikTok. Right? It's just not something that we're interested in.

So it doesn't matter if it's mowing your lawn or cleaning your house or killing your bugs, millennials aren't doing it. And so that's good for these resi-services companies. The same is true, the second big secular theme, secular tailwind as it relates to demographics would be aging in place.

[00:05:00] This idea that you have folks who are older that are aging and they saw their parents go into homes. They didn't like what they saw. They're not going to a nursing home.

They are going to stay in their home as long as possible and enabled by home health and food delivery and all these other things. We can age in place. We can age in our homes for longer. What that means is you might be DIY at heart, but you simply can't lean over to lay the mousetrap anymore.

[00:05:29] You need help. And so the more people are getting older, they're staying in their homes for longer. They are aging in place and they need more services in and around the home. That's good for resi-services companies, right? And there are some services companies that install bathrooms and doors and windows, very big companies, that are privately held that are now starting to move into the safety space. You put a railing on those stairs or put a chair on the stairs or change the bathroom around to make it safer. All these things that you can do for aging in place folks, it's a big opportunity.

[00:06:02] And then the third one is increasingly have hectic lifestyles. Of course, you have dual-income households now. There's not someone at home all the time able to help out with these things. You know, we're all much busier now driving our kids to sports and doing all these other things. We just don't have time to be at home to fix a door. It's just not something that we're doing.

[00:06:24] Chris T: Yeah. Well, there is an unbelievable amount of truth to that. I can't remember the last time I felt like I could just go and fix something at home.

[00:06:31] Tim M: It's just easier to call someone and these companies know that. And the last one, the aging housing stock. The median age of U.S. housing stock in 1991, it was 27 years old. In 2011, it was 37. 2021 is 42. So the average home is basically almost doubled. They're just getting older. It's the housing stock, right? It's going to get older. It's going to need more stuff to keep it up to speed.

[00:06:58] You need these services. You want your lawn looking good. You want your roof looking good. You need gutter guards. Whatever it is, there's so many things you could do to your home to increase the value—and right now we are all investing in our homes because we're not moving.

[00:07:13] You know, no one's moving with 7% [interest] rate. Now I just bought a house. But you know, don't let that be reflective of my abilities as a stock analyst, but I did not time that right. But most folks are not going to move and so what are they going to do? They're going to invest in the home instead this is a good opportunity for that. So those would be the secular tailwinds.

Then of course folks are moving south and that helps pool services, that helps pest control, it helps some of those markets. It's not for everybody, but it is an interesting one. Populations are moving south and there's a lot of these services companies that benefit from that tangentially.

[00:07:50] The next topic I think that a lot of folks latch onto is this idea that these are very large TAMs and they're highly fragmented. So what does that mean? Well, if you have a large TAM, there's growth opportunities, right? I think HVAC is like $150 billion. Well, HVAC plus plumbing and electric, are often put together for several reasons. Together those three markets, HVAC, plumbing, and electrical, $150 billion, highly fragmented.

You’ve got 60 or 70 scaled players; folks that are private equity backed, that are consolidating, that are getting bigger, some of them are getting very big, bigger than some public companies out there. But, that is still just such a small percentage of the overall market in just that market. You can look at roofing, pest, lawn, huge TAMs that you can grow organically into those, or, they're also highly fragmented as the second part of that statement, which means if you are good at M&A.

[00:08:57] If you can identify targets for reasonable purchase prices and you integrate them, you're not just stacking EBITDA on top of each other, but you're truly integrating these things. Then there's an opportunity to create real value. I would say the third category is that these markets are disruptable, and what I mean by that is professionalizing these unsophisticated markets.

[00:09:21] Chris T: Yeah, so there's this whole section that you dedicate, not the whole section. It's a little chunk of that investment characteristics section that you dedicate to this area. This area, for whatever reason, made a lot of sense to me out of everything I was reading just connected with me. And I think it's simply because as you're researching these service companies for whatever it is, there are so many of them and there's just really a lack of professionalism. You go to a website and it's something that was built in the nineties. Right? So when you say that there's this professionalization of unsophisticated markets and it's really about these new sophisticated platforms that are increasingly taking share by bringing just a simple degree of professionalism to the industry. It makes a lot of sense. So, yes, definitely dive into that.

[00:10:04] Tim M: This is something that I've learned too along the way. So basically for the last 12 to 18 months, as we started to learn about this market. I've always covered pest control and we do a lot of work there and we speak at the pest conferences and we have a pest index and we do all the pest things for so long.

But I would have people saying, well, have you looked at lawn care? Have you looked at landscaping? Which is different, you know? Lawn care, weed and feed, landscaping, mow and blow. It's different things but then you’ve got pool services, you got all these things and have you looked at them and I admittedly didn't know much about a lot of these resi-services markets until we started talking to the operators and getting an appreciation for what it is that these guys are doing and why they're able to grow as fast as they're growing.

[00:10:48] Even some of these remodeling guys, home renovation, home restoration, the more we talked to these people, the more we realized that there were basically three ways in which they were winning. And you were probably, this resonated with you, Chris, because you went through it, right?  Have you ever had your roof done?

[00:11:04] Chris T: I bet. I’ve had it all done.

[00:11:07] Tim M: Okay, you've had it all. I mean, you don't know what's the price going to be. I mean, I think I had four different roof people come out here when we had a roof issue. We need to get it replaced. Could you imagine if a roofing company came in that had transparent pricing, had efficient processes, made you feel good about the whole thing? Right? That is a game changer. It's disruptable.

[00:11:27] Chris T: It is hard to find. It's the same thing with contractors.

[00:11:30] Tim M: Same thing.

[00:11:32] Chris T: It's just very difficult to find.

[00:11:33] Tim M: So, we found three things, basically three categories as it relates to professionalization of unsophisticated markets. The first one is winning the customer. The second one is keeping the customer, and the third one is keeping the technician and honestly, it's that simple...if you can do those three things.

Now, of course, the big Wall Street they’ve got advanced names for it so it's not winning the customer. It's called advanced go-to-market capabilities. But, what is it really? It's winning the customer. It's creating a funnel through advanced digital marketing and SEO and other things and there are some companies out there with contracting companies, remodeling companies that are growing. It would blow your mind how fast these folks are growing. I'm talking like SaaS type growth, right? But they're doing that by building the funnel. Then of course there's retaining the customer, which is also known as an excellent customer experience. Like how do you get those Net Promoter Scores to nine and 10? But it's more than that because sometimes you'll get a net promoter score of 10, 10, 10, 10, and then cancel.

[00:12:32] And you're like, what the heck? We had great scores from this person and they canceled. So you have to get more sophisticated in how you think about retaining that customer because the lifetime value is so much greater if you can keep the existing customer for another year than finding a new customer and signing them up for a year.

[00:12:47] And the incremental margins associated with that are very different. So that's important. And then lastly is employee retention. In this market, it's almost like the technician is more important than the customer for some of these companies. I'm not kidding. And some companies actually think about it like lifetime value of technician, unit economics of technician, because the technician is so valuable. No one wants to be a plumber anymore and these companies so desperately need plumbers, and these plumbers are making a killing being a plumber.

[00:13:18] So that's the professionalizing, unsophisticated markets. I would say the two other reasons real quick. It’s got attractive financial characteristics, these markets do. Some of them are non-discretionary, some are more discretionary, but some are non-discretionary. Some would surprise you on whether or not they're discretionary. You hear about pool services, and you think, oh, pools are discretionary. Like if I have bed bugs, even if I lose my job, I am paying the money to get rid of the bed bugs. If my HVAC unit breaks and it's the middle of summer, I'm paying the money whether or not I have the money, it's going on the credit card. If my roof breaks and it's leaking, you don't have a choice. You'll destroy your entire house. You have to get it fixed, right?

[00:13:55] But if my pool's a little green and I lose my job, maybe I'm not going to spend it on the pool. Which is true. So then you think, well, pools are discretionary like landscaping or something. Actually, you talk to these pool folks and they'll tell you what they found is throughout macrocycles, pool services, this isn't pool distribution this is actually pool services companies, there are scaled pool services players. They go from house to house. They service the pool. They'll tell you that yes, the nature of the service is maybe slightly more discretionary, but because the customer mix is upper income household, most customers that have spent the money on a pool, you find the right mix of those customers and it doesn't matter what kind of the macro conditions are, they're going to continue to pay for their pool service and they don't see much fluctuation in their organic growth from quarter to quarter, year to year because of the discretionary nature of the customer rather than the service itself, which is interesting to me. So some of these things might surprise some folks on how discretionary or non-discretionary it is and also having a green pool is really gross and it starts to smell, and people aren't willing to have that.

[00:15:07] So, and then, I would say recurring revenue. A lot of these companies have recurring revenue streams and strong free cash flows because they're asset-lite.

[00:15:20] Chris T: You talk about residential services as a defensive growth market focusing on two particular areas. One being non-discretionary expenditures and then two, insulations from key risk factors that impact many consumer-facing businesses. But beyond those two factors, I have to imagine that being AI or e-commerce proof, maybe you call it disruption proof would also be important. Do you mind just digging into that a bit?

[00:15:44] Tim M: I like the way that you talk about that is defensive in the context of, is it disruptable? You see some of these e-commerce platforms that have programs where they're actually trying to create home services platforms to connect small mom and pops with the consumer. And everyone had their, you know, this happened five years ago, and investors had their arms up in the air, like, oh, that's the death of home services. Because e-commerce is going to come in and it's going to disrupt it. And what you saw though, was that these demand aggregators could not control the quality. And if you look at the resi-home services companies that I am talking writing about in this report, they control the quality of service.

[00:16:34] They have W2 employees, they have advanced training programs, onboarding programs, tracking capabilities, and they can make sure ensure the quality of service is consistent from market to market. That's something that these e-commerce platforms simply could not guarantee. They didn't know who they were sending to your house.

[00:16:54] Chris T: Right. You cannot just emulate this. This is, these are businesses that have been in the business for decades.

[00:17:00] Tim M: And to that point, we've seen several e-commerce platforms actually back off of this home services idea. Now they offer very limited services because they realize they can't win here. And I would also say another common conversation around disruptability is topical AI. Generative AI. AI generally. And so I always say, I'll ask you, what's the last bastion of a disruption from AI?

[00:17:24] Chris T: What is it?

[00:17:25] Tim M: It’s a plumber.

[00:17:26] Chris T: Yeah. Unless we're talking about a robot who's going to come in and do your plumbing. I’m not assuming that AI is coming in to do my plumbing anytime soon.

[00:17:35] Tim M: It'll be the last thing. Services are e-commerce proof. You can't outsource them to a third-world country. You have to get a haircut here, right? They're not disruptable or they're less susceptible, I should say, to disruption from AI and other things. And I think that that's going to drive incremental demand and more and more focus over time to these types of businesses.

[00:18:02] Chris T: So there's much more to this report including an extensive market overview. We could probably talk about that for over an hour, but we only have time to cover really one more area. Let's focus on what you label in the report as the metrics that matter, quote unquote. To take verbatim what you wrote, “Unlike other consumer markets that rely on metrics such as same store sales, sales per square foot, four wall unit economics and store expansion, residential services companies track progress and success by a different class of metrics. These metrics align closer with commercial services markets with the primary difference being that commercial services industries are B2B, whereas residential services industries are B2C.” What are some of these metrics?

[00:18:50] Tim M: Yeah, happy to do that. Percentage recurring revenue I think is one that is something that everybody wants more of. So if you look at some of the companies that get the higher multiples in the companies that I cover in my coverage list, they have high recurring revenue. Now, what is recurring revenue? Well, technically it's revenue that's backed by some sort of subscription or contract. What most people won't tell you is that these contracts, these quote-unquote contracts that undergird the recurring revenue are cancelable by either party. For any reason within 60 days of contact. They're not as ironclad as you think. So what is recurring revenue? Companies that have truly recurring revenue? I think about like a lab company that tests for environmental impurities in your water, that you're required by law to get tested every single month and you have no reason to switch from that lab because they've done a great job for 10 years.

[00:19:53] That is, that's like, that's recurring revenue, right? But I think most investors still consider these commercial services companies because they have these three to five-year contracts. Even though they're not ironclad, they consider it recurring revenue. And there are some of these residential services companies that have it and some that don't.

[00:20:07] But it's interesting I think, because you can also think about it like reoccurring revenue. Let me give you an example. The HVAC business. Great business. We wrote a lot about it in the report. For anyone that wants the report just hit me up there. We basically spend 20 pages on these secular themes. Maybe 30, 40 pages. I don't really know. But then we spend, you know, five to 10 pages on each of these markets and we cover a lot of them and we talk to a lot of private assets in the space. A lot of people running these businesses to try to get to know them and understand them better and happy to walk you through any of it.

[00:20:41] But anyway, getting back to my point on HVAC, where we spoke to I think seven or eight of the largest platforms in the industry. The privately held, of course. They all think about it as re-occurring and here's how. Every HVAC unit needs to be replaced every 10 to 15 years. Okay, so let's just take the midpoint, let's say 12 years.

So now you have a customer set of 12,000 customers that you're doing maintenance work on. You don't make a lot of money on these maintenance contracts, but it means you put your sticker on the side of their HVAC unit and anything happens they're most likely going to call you first. It's an expensive job and they're all after that expensive installation. They’re doing the maintenance. They're coming to your house twice a year to clean it out and it's not working.

But let's say you get 12,000 of these subscriptions, right? That means out of a customer base of 12,000 customers, well, you can basically set your watch to the fact that a thousand of those customers are going to need a replacement, a big expense, a big ticket, $10,000 replacement every year.

[00:21:40] Is it recurring revenue? Is there a contract? No, there's no contract to replace your HVAC unit, but is it reoccurring? Can you reliably depend upon about a thousand of those breaking and needing to be fixed every year? Yeah, you can. And you could do that in roofing. Now that's every 10 to 20 years, so your midpoint’s 15.

But the same thing's true there. But there's a way to think about it. Like if you think about moving. That's another reoccurring. So I'm a moving company. Do I have contracts with anyone? No. But can I look at suburban Chicago land and see what existing home sales are every single year and get a pretty good idea of how many people are going to move in any given zip code in any given year?

Yeah, I can do that with good precision. So there are ways to think about these businesses, maybe not as pure contracted recurring revenue, but in fact a reoccurring, predictable revenue stream every single year and that's what got me excited about some of these. Another big one is customer retention.

[00:22:43] I'll walk through these quickly. You can't run a good business with a leaky bucket. For most companies that deal with subscription services, pest, lawn, pool, landscaping, the more valuable business is going to have the higher customer retention rate. There are other things, of course, like EBITDA margins, but those are correlated.

But I would say that when people call me and ask me about some of the companies that I cover in pest control, and they're like, what are the top three most important metrics? I say the top three most important metrics are customer retention, customer retention, and customer retention. Those are your top three. Like that's really the name of the game. It's not rocket science.

[00:23:22] And, customer satisfaction. We talk about Net Promoter Scores, customer effects scores, employee retention, because employee retention is highly correlated to customer retention. You're not a customer of Bob's Pest Control. You're a customer of Jim, the technician that knows your kids' names.

[00:23:41] Chris T: Yeah. Jim has become a trustworthy contact. You know, he does a great job. He’s great to the family.

[00:23:46] Tim M: You got it. So, you need to make sure that the person that you're putting in front of your customer every day is someone that can be trusted, someone that can be good. And if they've been doing it for seven years instead of two, they're just going to do a better job.

They're just going to do a better job. And, so, employee retention's important, route density is a critical metric. Service levels, which are measured a bunch of different ways, depending upon which industry you're in. We walk through that. Services per customer, of course. How much can you cross-sell? Can you cross sell, pest with mosquito?

Can you cross-sell termite with pest? Are you going to offer lawn care services? What are some of these renovation companies that were doing doors and windows moved into bathrooms. Now they're moving into home safety. Now they're looking at gutters. There's lots of different things and then you can hit that same customer that you did a great job with last year.

[00:24:35] If you did a good job, well now you have this opportunity to cross sell. And then I would say, of course, lifetime value in CAC, two separate categories. We had an hour panel with four well-known companies, the leaders of those companies were up on stage.

They spent an hour on lifetime value and a separate hour on CAC. So like there's a lot we could get into that we won't get into, but they're very important metrics. And then of course your marketing metrics, cost per lead, cost per sale, all that kind of stuff, the SEO. But these are the types of things that we're thinking about as we assess whether or not a company's going to be successful in space.

[00:25:12] Chris T: Well, Tim, I have to say, I always enjoy our conversations. I'm pretty sure we could probably do this for another hour, but we can't, so unfortunately, I'm going to have to cut it there. But I appreciate everything you've done today. I know that your time is very valuable. Would love to do it again soon. But with that, we'll close it out. Thanks for coming on the show.

[00:25:32] Tim M: Thanks for having me, Chris.