Are trucking company owners – particularly those approaching retirement age – racing for the exits, fearing the exits may soon close? A private equity investor recently posed this question to us in a conversation regarding one of our client companies. The investor had been receiving an unusually high volume of solicitations regarding trucking companies for sale, five or six over the trailing 60-day period. “What’s going on?” he asked. Perhaps business owners, scarred by the Great Recession, anticipate a looming recession? Or maybe headwinds - real or imagined - are the culprit, whether from the pending implementation of electronic logs, a looming driver shortage, or other concerns.
A tone of fear certainly has seeped into some of the industry dialogue lately. A quick read of recent Transport Topics headlines tells the story: “Fleet Failures increase in 4Q; Pace Could Accelerate in 2016” in the February 1st, 2016 edition, “LTLs Post Lower Results During Challenging 4Q” from February 8th, 2016, and “Tonnage Index Drops 1.4%” on February 29th, 2016.
Does this mean we are going into a “buyer’s market” for trucking companies?
What can we conclude from these recent market comments and trends? Is there an over-supply of trucking company sellers at a time when there are few, if any, buyers? These questions don’t have simple answers, but further analysis of market activity, historical trends and our active dialogue with strategic buyers and financial sponsors reveals a steady appetite for acquisitions of trucking companies that meet certain key criteria.
A Few Key Buyers Have Hit “Pause” . . .
In the public arena, XPO Logistics is one prominent case in point. The company has been a driving force for consolidation in the market, with notable acquisitions including its $3.5 billion purchase of Norbert Dentressangle which closed in June 2015 and its $3.0 billion purchase of Conway Inc in October 2015.1
Now, XPO appears to be out of the acquisition business, at least for 2016. American Shipper quoted XPO Chairman and CEO Bradley Jacobs along these lines in January: “We’ve slowed down the acquisitions. We’re going to take a year off. This year is about getting organized.”2
Another publicly traded, serial trucking acquirer recently told us much the same thing, in the context of (briefly) considering an acquisition of one of our clients. The potential buyer passed and flatly communicated that it will delay further acquisitions until the 4th quarter of 2016 or early 2017.
. . . But Several Other Players Have Stepped In
FedEx Corp. Chairman and CEO Fred Smith recently argued a contrary view, according to The Wall Street Journal:
“I think you will see a significant amount of M&A driven by low growth,” Mr. Smith said at the Journal of Commerce Inland Distribution Conference. “The reality is that a lot of people get put under a lot of pressure when growth slows down. Growth hides a lot of sins and covers up a lot of inefficiencies.”3
Smith speaks from decades of experience in the transportation industry, and indeed, several other industry players seem to have lined up behind his view. A few examples from across various segments:
- “Flatbed entrepreneur Don Daseke continues to build his rapidly growing company by hunting for merger candidates,” reports Transport Topics.4 With aggressive deal-making and a flexible holding company strategy, Daseke has built the second largest flatbed and heavy haul company in less than 8 years.
- “Amid a new leadership shake-up at freight shipping provider Hub Group Inc., Chief Executive David Yeager said the company has big plans to grow through acquisitions—starting this year,” according to The Wall Street Journal.5 In fact, Hub Group just recently reinforced this growth-through-acquisition strategy by hiring a former investment banker into a new role as head of Corporate Development to focus on finding acquisition targets.
- “Having just completed the acquisition of Advanced Distribution Services, Scott Dobak, CEO of Dicom Transportation Group, is already out looking for another deal.” Transport Topics cites “brokerage or linehaul business” as key areas of emphasis.6
Historical data further supports the notion that trucking deals get done in both up and down markets. As can be seen in the chart below, the number of transactions completed year by year has been relatively consistent over the past decade. The recession year of 2009, for example, saw 22 deals while the “boom” trucking year of 2014 saw 21.
Views from the Front Lines
With all that said, what is the view from the front lines? Our sense of current market dynamics is informed by having recently brought three trucking companies of varying sizes and types to the market. Over the same period, we have actively reviewed several trucking company acquisition opportunities for buy-side clients.
In dialogue with potential buyers – both strategic and financial – we have found willingness to consider opportunities. Buyers will present strong bids when a target aligns closely with the bidder’s investment criteria. However, buyers generally have become more discriminating in their screening of opportunities.
A clear-eyed view of the market is critical for success in this shifting environment, both for buyers and sellers. Every deal is different. That said, when we review the sweep of feedback received across different situations, patterns do emerge.
Key Issues for Strategic Buyers
What do strategic buyers – other trucking companies or logistics providers – typically ask of us as investment bankers representing a trucking company for sale?
Not every time, but with startling regularity, the first conversation surfaces three issues:
- Driver Model – does the target operate with a company driver/company equipment model, or with an owner operator/independent contractor model?
Industry operators have strong (and varied) opinions about the relative merits of each model. A company built around owner operators typically will not consider acquiring a company driver model, and vice versa. Moreover, with government pressures on the owner operator model, most buyers will take a hard look at any owner operator model, and whether a target company has operated in compliance with state and federal law.
As many trucking company operators are painfully aware, the difficult reality these days is that what constitutes a “compliant” model seems to move around month to month (day to day?), and depends on who you ask. We could write pages on this topic alone. Suffice it to say, recent lawsuits and settlements underscore the risks involved. FedEx wrote a massive check to settle some of its issues in this area.7 In the M&A context, XPO acquired Pacer International and inherited potentially substantial driver classification claims as a result.8 And to underscore the point, Hub Group recently shut down its internal drayage operation in California, not long after converting its drivers from owner operators to employees under pressure from driver classification litigation.
- Electronic Logs and Hours of Service – does the target company utilize paper or electronic logs to monitor hours-of-service compliance?
Electronic logging devices (“ELDs”) won’t be legally required until late 2017. Still, most large trucking companies have worked through the sometimes painful process of converting from paper to ELDs. The transition sounds simple – plug an ELD into each truck’s onboard computer and give drivers a bit of training. In reality, though, the change requires a complete cultural and operational shift. Drivers – not the most flexible and tech-savvy work force – need to embrace the change; dispatchers and driver managers need to change how they deploy drivers. Customers too may require education.
All this reduces driver productivity, revenue per tractor, and company profitability. One industry observer estimates that a sudden, forced changeover can result in an 8 to 10 percent overall hit to productivity.9
Having been through the changeover process for their own fleets, many large strategic buyers hesitate to acquire smaller companies operating on paper logs. One public company, for example, generally screens out potential targets that have not been on ELDs for at least 12 months. Potential buyers worry that a shift from paper to ELDs following a transaction increases the integration risk of a deal, and may reduce combined company profitability.
- Fleet Age and Maintenance – what is the average age of units in the target company’s fleet?
Fleet age is the third main baseline screening criteria we often hear. New clean engine technologies and environmental regulations have increased both the cost of vehicle acquisition and the cost of ownership. In a capital intensive business, acquirers want to know that a target company has been taking care of fleet requirements.
While an aged fleet may not be an absolute bar to a transaction, many buyers will view it as one sign that a potential target company lacks a strong maintenance culture. In addition, a buyer typically will factor its perceived cost of catching up on deferred fleet replacement into the overall transaction purchase price, which in effect reduces the net purchase price to the sellers.
Owner operator fleets are not immunized from questions regarding fleet age. Rather, an aged owner operator fleet may raise questions as to the long term sustainability of the driver base. As new regulations come into force, owner operators may not be able to replace non-compliant tractors, and may instead exit the business.
The Financial Buyer Viewpoint
Speaking broadly, most private equity buyers historically have shied away from trucking company acquisitions, citing the fixed cost nature of the business and its capital intensity. However, with over a trillion dollars of collective committed capital to deploy, and intense competition for deals, this barrier has been breaking down somewhat.10 Still, finding a private equity buyer for a trucking company requires threading the needle. An informed view of the buyer community is critical.
In addition to the strategic buyer criteria outlined above, financial buyers tend to focus on three keys:
- EBITDA Margins –
When a private equity buyer expresses interest in trucking, the interest typically is qualified. Common carrier trucking companies that compete on price and service levels have limited appeal. Rather, the goal is to find an elusive, rare animal – a specialized or niche provider with a more defensible market.
Like many businesses, private equity can be formulaic. A typical middle market private equity firm sees hundreds of potential deals a month. How, then, to screen out and find the few trucking companies that might fit the profile? For many firms, EBITDA margins serve as one yardstick. Simply put, many private equity firms will screen out any trucking company with less than a 10% EBITDA margin. This benchmark necessarily eliminates most asset-based general commodity truckers.
- But, FCF (Not EBITDA) Ultimately is King –
The 10% EBITDA margin threshold is just that, a preliminary threshold. Cross the threshold, and the focus quickly flips from EBITDA to Free Cash Flow (“FCF”). Without delving into all the accounting minutiae and possible permutations, FCF can be defined broadly as operating cash flow less capital expenditures.
The problem in trucking, of course, is that dreaded capital intensity mentioned earlier. It is not at all uncommon for steady-state average capital expenditures to exceed 50% of EBITDA, and in recent years several of the large public trucking companies have been spending more than 100% of EBITDA on capital including Heartland Express, Werner Enterprises, Marten Transport, and Covenant Transportation Group. The same is true for many of the privately held, mid-sized trucking companies we see in the market.
Competing forces seem to be at play here. Market dynamics and regulatory pressures favor the asset-based, company driver model. Yet, historically at least, this model has struggled to generate the steady and sustainable FCF that attracts financial buyers. Trucking company sellers sometimes attempt to bridge this gap through a projected shift in model from asset heavy to asset light, but financial buyers generally view an operational shift of this magnitude with considerable skepticism.
- Strength of Management –
It is perhaps a truism that private equity firms value strong management. However, in the case of the trucking sector, weighed down by perceived challenges and unfavorable secular market dynamics, a strong management team can make the “deal or no deal” difference.
Of course, strong management is in the eye of the beholder. It may come in the person of existing target company executives who wish to remain on board following a deal. More and more today, it may also come in the form of an operating partner or executive recruited by the buyer, who brings strategic vision and industry knowledge.
An Unfolding, Ever-Changing Story
Today, the trucking industry is living through dynamic changes, at a level and pace unseen since President Jimmy Carter de-regulated trucking in the late 1970s. The Headwaters MB Transportation & Logistics team brings together a unique blend of industry specialists – former company operators with battle scars from the front lines and transaction specialists with extensive experience in the M&A markets. We always enjoy engaging with business executives, decision makers and thought leaders in the transportation and logistics space. Please reach out if you wish to share industry insights, have a need for capital to grow your transportation or logistics business, or are considering a company sale.
1. Transport Topics, June 8, 2015 & October 30, 2015
2. American Shipper, January 19, 2016
3. The Wall Street Journal, October 7, 2015
4. Transport Topics (article dated March 2, 2016
5. “Hub Group Plans Strategic Shift Toward Acquisitions,” The Wall Street Journal, January 7, 2016
6. Transport Topics (article dated February 29, 2016
7. “FedEx Settles Independent Contractor Mislabeling Case for $228 Million”, Forbes.com, June 2015
8. “Judge Awards $2.2 Million in Pacer Drayage Case,” Transport Topics, February 2, 2015; “XPO Logistics Trucking Subsidiaries Sued Over Driver Classification,” The Wall Street Journal, January 12, 2016
9. “Trucking Analyst: e-logs the main catalyst for bankruptcies,” Commercial Carriers Journal, June 26, 2014
10. Global Private Equity Report 2016, Bain & Company