Glory? Don't bet on it

Rentokil's massive success story may slow down as it tries to amalgamate BET
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The Independent Online
Rentokil Initial, as it is now known, has for a decade been a legend to investors - a rare exception to British failure to produce high-growth companies that get it right consistently.

Yet the company has achieved its success in such unlikely areas as pest control, office cleaning and tropical plants. Indeed, chief executive Sir Clive Thompson has shown how to build from an apparently unpropitious starting point, while other services companies have failed.

The rewards to shareholders have been great: for the past 10 years, profits and earnings per share have grown at over 20 per cent a year, a phenomenal achievement. That is in the past, however; the year ahead poses one of the toughest challenges for Sir Clive - how to manage and integrate the group's largest- ever acquisition, the pounds 2.1bn purchase last April of conglomerate BET, which had become mired in a slough of unrelenting underperformance. Sir Clive may still be able to work the Rentokil magic on this sluggish behemoth, but there are whispers that Rentokil's glory days are now over. Accepted wisdom has it that no company can grow for ever; inevitably, at some point, a business hits an insurmountable stumbling block.

The most spectacular example, surely, is Hanson, but there are plenty of other companies to have hit trouble. Conglomerates such as Tomkins and Williams Holdings, Sainsbury in retailing, and Guinness, all former high flyers, spring to mind.

Sir Clive had said some three quarters of BET's businesses would definitely remain within the new combine. The rest would be on the auction block, especially BET's plant-hire concerns, conference centres and resorts businesses. So the City was mildly surprised at the time of the last interim figures, when Sir Clive performed a volte-face, stating that there would, in fact, be very few disposals.

Sir Clive says this reflects a misunderstanding about Rentokil's intentions. "Our appraisal of the combined group does not just include disposals from BET, but also from Rentokil Group, as was. But where we believe we can improve performance in the medium term and add value, we are happy to keep those businesses."

At the old Rentokil, businesses which are being scrutinised for disposal include the timber preservatives chemical business and fire retardants. Sir Clive, however, is also willing to accept offers for some of the BET businesses: notably the US resorts, and "minor parts" of the plant-hire business in the UK, which is something of a rag bag. "But we won't sell unless we get a good price," he warns.

It is easy to understand concerns about plant hire, sitting as it does rather uneasily outside Rentokil's portfolio. Capital intensive, whereas Rentokil Initial (RI) was traditionally composed of businesses with little need for capital, it is also a cyclical business, while Rentokil has been a proven performer through boom and bust. In plant hire, however, the key area is the US, where it had been one of BET's fastest-growing entities, reason enough for it to remain. Analysts estimate the US resorts business is unlikely to raise much more than pounds 40m - small change, really.

Before the bid, BET's margins were a miserly 7 per cent, compared to Rentokil's heady 25 per cent. Although Rentokil has been at the unglamorous end of the service sector, it has concentrated on building a brand based on service and superior quality.

It sells to the middle and upper end of the market - customers who appreciate a superior service and are willing to pay for it. Against the odds, Rentokil created a premium brand for itself, in businesses where such subtleties would be regarded as irrelevant by many. And the formula has worked.

Sir Clive intends to do the same at BET. To begin with, he has promised to double margins at the former BET operations, within two to three years, to bring them in line with the industry average. "We will change the customer mix, shifting it from the bottom and mid end of the markets, to the upper end, which pays more." Costs will also be chiselled out, although the initial efforts on this front have already been completed with the closure of three of BET's head offices. The following three years will see efforts focused on improving sales and marketing.

Internationally, the group will limit its expansion to Europe, North America and South-east Asia. It does not want to enter emerging markets, where economic development means the demand for its services - which usually enhance the quality of life for employees - has yet to become a priority.

Sir Clive is ebulliently optimistic about the future, and says that, eight months on, there is nothing inside BET to suggest the deal will not stack up.

The shares are now less expensively rated than they have been at times in the past - a reflection of the market's perception of the increased risk carried in the new business. For that reason, compared to some of the other established growth stocks, such as Reuters or Reed International, Rentokil is relatively cheap. It is too soon to take profits, but investors who are pondering whether to buy should reflect that the high-flying days are probably over.

Rentokil Initial

Share price 433p

Prospective p/e 24.6*

Gross dividend yield 1.2%

Year to 31 March 1993 1994 1995 1996* 1997*

Turnover (pounds bn) 0.6 0.73 0.86 2.45 3.43

Pre-tax profits (pounds m) 147 177 214.5 335 475

Earnings p/s (p) 9.71 11.74 14.22 17.6 22.4

Dividend p/s (p) 2.85 3.45 4.20 5.10 6.10

*BZW forecasts