A sinking ship
The hostile takeover of rival BET in 1996 fashioned the newly named Rentokil Initial into a complex collection of businesses in hygiene, security, pest control, tropical plants, conferencing, parcels delivery and facilities management. For a while, Sir Clive's chosen measure of success, EPS, held up, helped by a spot of acquisition accounting. But he had flown too close to the sun. Now, hoist by his own hubris and fighting the law of diminishing returns, he began to sail too close to the wind.
Power was centralised. The squeezed organisation looked inwards. Sir Clive dominated. When the company missed its profits targets in 2000, he hived off a third of the group and bought back equity. This helped to support EPS. Later, he would claim that directors had blocked him from also selling the parcels delivery and conferencing businesses.
Rentokil's shareholders have been accused of imposing unrealistic short-term expectations on Sir Clive, but that was hardly the case. It was Sir Clive himself who had planted those unrealistic expectations. Instead of ousting him, in 2003 the board made him chairman - always risky. Former chief executives often act as though they are still running things. James Wilde was made his successor. There were two other executive directors and only four independent non-executive directors at this time. This balance hardly made it easy to unseat either, but after a profits warning in 2004, both were bundled out.
The nasty company
Finding a chief executive for a company that's been driven into the ground is not easy. Doug Flynn was not an obvious choice. He got off to a rocky start. Some shareholders wanted the company broken up. Then the company was threatened by a potential hostile takeover. Instead of being able to focus on the operational difficulties, Mr Flynn had to spend half his time persuading major shareholders that Rentokil Initial was viable as it was.
As he got to grips with the company, he and his team discovered exactly what a masterclass of short-termism Rentokil had become. Sir Clive had jacked up prices and slashed costs. Squeezed budgets had fostered silo mentalities. Headcount reductions had produced staff shortages. Many employees were on rock-bottom pay yet, in what had been dubbed "a truly nasty company to work for", all had been driven ever harder to produce results. Morale had been undermined, service quality had suffered and sales efforts had been impeded.
Internally, Rentokil's operational indicators should have warned of the impact of poorer service quality and uncompetitive pricing. But the management information wasn't there. A squeezed IT budget had seen to that. So executives had been both slow to realise how many customers were terminating contracts and slow to react to disappointing sales efforts. Until this percolated through to the financial figures, directors had been in the dark - and so had the shareholders.
Mr Flynn and his new management team set about repairing the company's fortunes. They made progress, but that lossmaking parcels delivery service would come to haunt them. It needed critical mass. "Had we waited until challenges in other divisions were resolved we would have missed out on the value-creating acquisition of Target Express," the chairman, Brian McGowan, and Doug Flynn trumpeted in the 2006 annual report. It proved disastrous. Unexpected losses in 2008 forced a couple of profit warnings. Rentokil's share price nosedived and so did their careers.
Once again, desperate shareholders lobbied the non-executive directors to act. By sacking both, shareholders and directors did exactly as they are supposed to do when change is called for, but this was in the middle of the global financial crisis. Markets were collapsing. Finding a senior executive to risk filling a vacancy in a struggling company where three chief executives had tried and failed seemed almost impossible, so what happened next was extraordinary. Even then, it strained the accepted boundaries of corporate governance, and reforms currently proposed could block anything similar happening again (as discussed in 'A question of control', last month's No Free Lunch).
The ICI three
By a stroke of fate, ICI had just been sold. Headhunters wondered whether John McAdam, its chief executive, would be up for a new challenge. If so, they'd have to reach him before retention payments locked him in. Frantic phone calls led to breakneck negotiations. The outcome? Not just one senior executive, but three. He agreed to be chairman; ICI's chief financial officer (Alan Brown) would become chief executive; and another ICI executive (Andy Ransom) would take charge of Rentokil's corporate development. Incredibly, the three were headhunted and the plan agreed, all within 24 hours. A typical shareholder reaction was: "This is stunning - we don't know how you pulled it off."
That was an insider's view. But that wasn't how the media saw it. Headlines slammed their apparent £100m recruitment package:
■ Each executive would be awarded 7.5m shares, but the shares would vest only if "a minimum share price of £1.20 has been met over a sustained period... At £1.20, 20 per cent of the award would be earned, rising on a straight-line basis to 100 per cent at a share price of £1.80". Between £1.80 and £2.80, up to 50 per cent more of the original award could be earned.
■ So each could potentially earn: 7.5m shares x 150 per cent x £2.80 = £31.5m. With the rest of their pay over the three years, that could be worth £100m between the three of them.
■ What does "sustained period" mean? It was defined as "60 consecutive dealing days during the performance measurement period".
People often complain that pay is too complicated. This was simple. There was an obvious risk: if stock markets recovered, Rentokil's share price would go up anyway. But that seemed unlikely. In the gloom of the financial crisis, most people expected markets to remain depressed for years. So: big numbers, but a lower risk for shareholders than it might appear with hindsight. To be paid out in full, the company would have had to gain well over £2bn in value - worth shelling out almost £100m to achieve. It was, though, a big risk for the participants. The odds were stacked against them, and they knew it.
The long grind to turn the company around continued. Early on, the new team delved into cash generation and discovered that some customers seemed to be under the impression that Rentokil provided its services for free. After the squeeze on costs, staff had had little time to chase up unpaid invoices.
Over the next five years, operational improvements started to bite, but it would be a long haul. Stock markets recovered strongly, but the Rentokil share price did not. Eventually, they gave up on parcels delivery. City Link was sold for £1 in April 2013 to Jon Moulton's Better Capital who, notoriously, would tell its staff that it had gone bust on Christmas Day 2014. Initial Facilities was sold as well, in March 2014.
And the £30m?
The trio squeaked home by the skin of their teeth. Remember that definition of "a sustained period"? There'd been a window. In February 2010, the share price had crept above £1.20, and held on for about 100 days before falling back again. This is hardly most people's idea of sustainability, but it was enough to pay out a third of the award, netting the ICI three something like a gross £2.5m each. For Mr Brown, this was just as well, for without it his take-home pay averaged about £0.6m a year. None of his other share awards paid out and for a couple of years he had no bonus. The non-executive directors stuck rigidly to the terms of the performance conditions, which was fair enough: they had not been met. But turning businesses around is hard going and they must have been tempted to make discretionary payments for near-misses. They resisted. That was good governance, but they lost their man. Mr Brown stepped down in 2013.
Build a better rat trap…
Rentokil turned to the heir and the spare. John McAdam took over from Alan Brown before handing the baton to Andy Ransom. Now, underlying earnings are starting to pick up after years of being flat. Debt is still high and some markets remain challenging. But long-term planning, investment and selected acquisitions are gradually paying off. They have developed high-tech pest control - not just of rodents, but of insects as well - an area that now generates half of Rentokil's profits. It is a growth market too - not bad for a defensive stock in an uncertain world - for pests thrive with climate change in densely populated areas, such as urban North America. Investors have also spotted that 90 per cent of its revenues are earned outside the UK and have pushed its market value to over £4bn.
So why a fable for our times? Shareholders and directors are often accused of failing to hold executives to account. Here is a counter example that also illustrates the importance of "comply or explain" corporate governance. Had those high-speed hires been stifled by regulation at that critical point in 2008, the current Rentokil Initial, whatever its form, would probably not be so admired today.
