CSCMP's Supply Chain Quarterly
Finance
December 18, 2018
Finance

What private equity investments in transportation and logistics could mean for you

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A growing number of private equity (PE) firms are buying transportation and logistics companies. Here's why they're so active in this space, and what this new ownership might mean for customers and suppliers.

Private equity (PE) firms are moving into the transportation and logistics (T&L) space in a big way. Globally, PE firms were the acquirers in nearly 50 percent of the merger and acquisition (M&A) deals in transportation and logistics in 2017, up from 40 percent of such deals in 2015. That trend is continuing: As of the end of Q1 2018, PE firms were responsible for 35 of the 44 T&L acquisitions that occurred during that quarter.1 The actual number of deals that PE firms have closed has grown, too. In 2015, they acquired 94 T&L companies; in 2017, they made 135 acquisitions, a nearly 44 percent increase.2 These acquisitions include both asset-light and asset-heavy T&L companies across all modes of transportation.

There is so much interest in this industry, in fact, that T&L-focused PE firms have emerged in the United States, a trend that began in earnest four to five years ago. ATL Partners, for example, was formed in 2014 exclusively for the purpose of finding opportunities in aerospace, transportation, and logistics (hence the name "ATL"). Another firm, New Hope Capital Partners, which formed in 2013, says it focuses on supply chain and third-party logistics services. Other firms, such as Headhaul Capital Partners, Greenbriar Equity Group, and Supply Chain Equity Partners, also maintain a specific focus on the T&L space.

What is driving this increased M&A activity in transportation and logistics? More importantly, what might this mean for the industry, and how might the customers and suppliers of these acquired T&L companies capitalize on this change?

Private equity: What's it all about?

The term "private equity" is familiar to people who work in a wide range of businesses, from manufacturing to high-tech and beyond. But not everyone fully understands what private equity means, what PE firms do, and what their goals are.

PE firms traditionally are private investment funds that use institutional money to finance or buy established businesses with attractive growth prospects. The principals of private equity firms are often former entrepreneurs and finance executives with experience in the industries they are targeting. Private equity firms use a number of criteria to evaluate potential investments, and many prefer to invest in companies that have at least US$2 million in Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA). A "multiple" of EBITDA is the finance industry's standard metric when discussing a company's valuation. For example, PE professionals will say that a company "was purchased for seven times EBITDA." PE firms make their money when they sell ("exit") the acquired company, which is often five to seven years later, for either a higher multiple than they paid, or at the same multiple but with an improved EBITDA.

Generally, PE investments make a positive impact within the invested industry, but this has not been absolutely proven. A 2011 study published in the National Bureau of Economic Research looked at job creation and losses in acquired companies versus nonacquired companies (controls) and found that the gross "job creation and destruction at target firms exceed[ed] that of controls by 13 percent of employment over two years."3 A 2014 follow-up to the 2011 study also found that total factor productivity at acquired firms was higher than that at nonacquired firms.4 (Total factor productivity is the portion of output that is not explained by the amount of labor and capital used in production; it is often seen as a measure of efficient use of technology and knowledge.)5 This research isn't without its critics, however. A 2017 paper disputes the 2014 study's findings,6 and the 2014 authors are currently drafting a paper refuting that challenge.7 It's an ever-changing landscape, but PE firms continue to exist, raise money, and make acquisitions.

Why T&L is an attractive target

To better understand what changes this acquisitive trend may bring to the transportation and logistics industry, it's important to first look at the reasons why PEs are interested in the space. According to Seth Eliot Wilson, managing partner at Headhaul Capital Partners, PE firms are becoming more aware of "how integral T&L and supply chain companies are to the domestic and global economy. Nothing can get produced, manufactured, or sold without a supply chain." While this may be obvious to those within the industry, this is a key realization for PE firms as they create and develop their investment thesis. Without this understanding and acceptance, PE firms won't feel assured of their investment (and eventual return on that investment) and will put their money elsewhere.

Additionally, PEs are attracted to the fact that the market is fragmented—in other words, the industry has many participants, and no single company holds an outsized share of the market. As far back as 2012, the consulting firm PwC commented that logistics markets had become largely fragmented,8 and this hasn't changed much since. Justin Shin, a vice president at the private investment firm CriticalPoint Capital, remarks that this fragmentation makes the industry particularly "well-suited for [private equity groups] that look for [a] consolidation model." The "consolidation model" he refers to is the widely used strategy of combining two or more companies in order to cut duplicative operating costs, leverage economies of scale, and gain market share.

There is also "significant waste" in the U.S. supply chain arising from the underutilization of assets, according to veteran T&L management consultant Tom Slaird, who says that the industry "need[s] to scale the use of technology" to more efficiently use its assets. The inefficient use of assets is precisely the kind of opportunity that appeals to PE firms looking to utilize their operational and technological acumen to improve a target company's efficiency and profitability. PEs will also see this "need to scale" as an opportunity to acquire technology companies that are focused on asset utilization. Like the PE firm The Jordan Company did in 2017 with its majority acquisition of Odyssey Logistics & Technology, PEs will look for acquisition targets that have positioned themselves to serve the T&L industry's needs.

PEs are also well aware of the economic tailwinds that are helping to fuel the industry's growth. The Council of Supply Chain Management Professionals' 2018 "State of Logistics Report" highlights "robust macroeconomic growth rooted in a strong labor market" as a factor boosting demand for logistics services.9 Additionally, consumer confidence and household spending remain strong; this should continue to drive demand for imports and boost inventory levels, which, in turn, will lead to increased demand for transportation and logistics services. Not only do these conditions attract PE firms to the industry, but they also provide the PEs with opportunities to grow their acquisitions and move toward their inevitable exits, which typically occur five to seven years after an acquisition, through a sale to either another, larger PE firm or to another, oftentimes larger, company within the industry that is making a strategic acquisition. An example of the former is the sale of the third-party logistics firm (3PL) Transplace by Greenbriar Equity Group to TPG Capital in 2017. An example of the latter is the global 3PL Kuehne+Nagel's purchase of ReTrans, a nonasset-based U.S. domestic logistics company, from Tailwind Capital in 2015.

PE firms are especially encouraged, as Slaird says, by "the current market rate of [EBITDA] multiples." He adds that PEs are particularly attracted to companies within the middle market because of "the increase in [EBITDA] multiples based on company size." According to GF Data, a research firm that collects and publishes M&A data for middle market companies (those with enterprise values between US$10 million to $250 million), the average EBITDA multiple in 2018 through June for middle market M&A transactions was seven times EBITDA. This was up from 6.4 times in 2014.10 In an example from the T&L industry, GF Data shows a nearly 25 percent premium in EBITDA multiples for transactions involving truck transportation (North American Industry Classification System [NAICS] code 484) companies with enterprise values between $100 million and $250 million versus those with values between $10 million and $25 million. This multiple premium carries over to trucking companies with enterprise values above $250 million as well. A recent sampling of publicly traded trucking companies with enterprise values over $250 million found that they were trading at implied valuations that average 27 percent higher than those for companies valued at less than $250 million, according to data provided by GF Data.

The reason for this premium is that there is less risk. Larger companies are generally more established within their respective industries than are middle market companies, and so there is less risk that a larger company's revenues and/or earnings will drastically change in the short term. All else being equal, buyers value companies with less risk more highly than those with more risk. PE firms, however, see the risk (and the associated lower EBITDA multiple) associated with middle market companies as an opportunity. If they can successfully help grow their acquisitions, they will subsequently be rewarded for it with a higher multiple when they sell. Given this dynamic, those most affected by M&A activity within the T&L industry will be those in the middle market.

Potential effect on customers and suppliers

As noted above, one of PE firms' most important strategies is to improve an acquired company's operations and profitability. Accordingly, they are adept at introducing systems and procedures that are specifically designed to drive margin improvements and efficiency across an organization. In addition, Brian Higgins, a senior partner at The Jordan Company, notes, PE firms can better achieve "positive investment results" by adding service offerings, expanding into new geographies, and adding new end-markets.

While it's not typically the goal for a PE firm to begin implementing changes the moment a deal closes, customers and suppliers of acquired firms should seek to establish a line of communication with the new management early in order to become aware of any possible changes, disruptions, or opportunities. Oftentimes, these can take the form of price adjustments, new technology implementation, refocused sales tactics, and management restructuring. Customers may want to pay particular attention to the transition process as it relates to customer service. Will in-house call centers be outsourced now? Will a new customer relationship management (CRM) platform be used? When might this transition occur?

Both customers and suppliers should also focus on their contracts with the acquired company and how they might change as a result of the acquisition. An acquisition can usually be made in one of two ways: an asset purchase or a stock purchase. In a stock purchase, contracts are often part of the transaction, and they will stay in place through the transaction. In an asset purchase, however, contracts typically need to be signed anew. As such, customers and suppliers should be aware of the transaction's structure and, if it is an asset purchase, be prepared to sign a new contract. Even with a stock purchase, though, contracts may still need to be revisited. Many contracts have a "change of control" provision in them, which typically provides various protections to one party should the other be bought. It's important to know whether there is a "change of control" provision in a contract, since it can be used to cancel the contract or amend the terms and price, if necessary.

With this said, however, Mike Raue, partner at Clarendon Group, a PE firm that focuses exclusively on the T&L space, notes that he and his colleagues "have never observed a materially negative change in a firm's relationship with customers post-transaction." He stresses that most investors who are seasoned enough are "very careful not to disrupt such very important relationships." The same applies for supplier relationships, especially strategic supplier relationships.

In many cases, both customers and suppliers may benefit from the changes implemented by the new owners. For example, they can take advantage of the "process improvement" stage of a PE firm's ownership by watching for any best practices that they might be able to implement themselves, such as centralization and standardization of processes and operations. PEs tend to have experience in many industries, and if they've found a strategy or tool that worked in one industry, they'll use it in another. Cybersecurity measures often lend themselves well to this broad, cross-industry approach.

Suppliers and customers can also inquire as to what tools a PE firm has implemented to monitor resource allocation and company performance. PEs consider performance metrics and similar tools to be invaluable for monitoring growth and progress toward strategic objectives. They also allow for the creation of strong financial incentives for leadership teams. Suppliers and customers should be able to adopt many, if not most, of these tactics within their own organizations to help drive improvement and growth.

While implementing change in order to grow is a natural progression for any company, it should be noted that both change and the resulting growth are likely to be experienced at a faster-than-usual pace within a PE-owned company. This is partly driven by the fact that a PE's typical holding period for investments is five to seven years, so these firms are working with a constrained timeline. The holding period can vary greatly, however; both longer and considerably shorter holding periods are commonly seen. For instance, one of Slaird's 3PL clients has been owned by three different PE firms in the last eight or so years.

Such short holding periods, according to Slaird, can lead to short-sightedness and an ambivalence toward longer-term industry trends. As an example, he cites the increased use of "Uber-like" owner-operators to handle the last-mile delivery component of the supply chain. He suggests that this model appeals to PE firms because it allows them to minimize capital expenditures. But he believes this practice could hurt the industry in the long run, as these owner-operators have a tendency to underprice their services to get the initial business, which then leaves them financially strapped, unable to service their vehicles or purchase additional vehicles to meet demand. Slaird cautions that this is the exact type of short-term thinking that could lead to long-term industry problems.

In an effort to accelerate growth within the holding period, PE-backed transportation and logistics companies will also often make acquisitions of their own, referred to as "add-on" acquisitions, where the PE finds additional T&L companies that can be acquired and then simply added to the main "platform" company. Here's a recent example. In mid-2017, Higgins' firm, The Jordan Company, backed the acquisition of Unitrans International Corporation. The ultimate purpose of the acquisition was to combine Unitrans with another of the firm's acquisitions, Q International Courier. This type of strategy, at its most basic, is intended to boost the income statement. But PE firms also utilize this "add-on" strategy to create something that's greater than its parts—a combined entity with increased efficiencies of scale, more services and capabilities, a wider geographic reach, and a stronger industry presence. In Unitrans' case, customers continue to experience the same level of service but with an expanded set of offerings, according to Higgins. Ideally, he adds, customer/supplier relationships should stay the same or improve after the acquisition. Expanding and/or improving services through add-ons can even help to drive down customers' costs, he notes.

Raue's viewpoint regarding add-on acquisitions is similar. He believes that add-ons are "generally engineered to improve the company's ability to better serve existing customers and new customers alike." Although it is "certainly conceivable" that integration complexities might temporarily derail a company's focus on customer service, this has not been his experience, he asserts.

It is possible, though, that add-ons, while providing the PE-backed company with the capability to provide better service, may also cause it to start focusing on larger, more impactful customers in order to maintain the target growth rates for the company. The smallest customers of these PE-backed companies should be mindful of this possibility. Customer rationalization, the purposeful process of focusing on only those customers that are most profitable and/or have the greatest impact on the company's business, doesn't typically occur the moment an acquisition closes, as a PE firm needs time to learn about and fully understand the newly acquired company's business before it can develop a strategy for add-on acquisitions. Nevertheless, customer rationalization does occur, so again, it's important that customers start and maintain a dialogue with the acquired T&L company early to understand the new owner's strategy, or as much of it as the company is willing to discuss.

Concurrently with customer rationalization, a PE-backed company will examine its suppliers and how each one aligns with its growth plans. Suppliers will be expected to keep up with the company's increasing demands. This may be difficult for those that haven't invested in, or prepared for, additional capacity requirements, but this change, like customer rationalization, won't happen overnight. If suppliers maintain an open dialogue with PE-backed companies as to their growth plans, the additional demand won't catch them by surprise, and they can invest wisely in the necessary resources to meet their customers' growing needs.

Be prepared for change

It's likely that we'll see more acquisitions in the transportation and logistics space. Private equity firms have amassed a record amount of capital; as of the middle of 2018, the amount of committed capital they had available to them globally was US$1.1 trillion.11 Not all of those funds are earmarked for investment in T&L companies, of course, but given the industry's positive attributes, a sizable portion of this capital will be spent there.

Overall, as PE firms continue to march into the T&L space, any disruptions they may bring, such as employee turnover or customer/supplier rationalization, should be relatively muted. There will be change, however: New ownership. New practices. New growth. Consolidation. That much is guaranteed, but the PEs have a vested interest in keeping business disruptions to a minimum. After all, their short-term investment horizons almost require them to minimize significant disruptions, since they don't have the time to recover from such problems. They're incentivized to become more efficient, strengthen their customer/supplier relationships, and, most critically, grow. Nevertheless, customers and suppliers should carefully monitor merger and acquisition activity, start dialogues with PEs where appropriate, and position themselves to take advantage of whatever changes may come their way.

Notes:

1. PwC, "PwC Deals: Global Transportation and Logistics Deals Insights-Q1 2018," https://www.pwc.com/ca/en/transportation-logistics/publications/transportation-and-logistics-q1-2018.pdf

2. PwC, "PwC Deals: Global Transportation and Logistics Deals Insights-Year-end 2017," https://www.pwc.com/ca/en/transportation-logistics/publications/transportation-and-logistics-q4-2017.pdf

3. Steven J. Davis, John C. Haltiwanger, Ron S. Jarmin, Josh Lerner, and Javier Miranda, "Private Equity and Employment," National Bureau of Economic Research working paper (September 2011), http://www.nber.org/papers/w17399.pdf

4. Steven J. Davis, John C. Haltiwanger, Kyle Handley, Ron S. Jarmin, Josh Lerner, and Javier Miranda, "Private Equity, Jobs, and Productivity," Chicago Booth Research Paper No. 14-16 (April 24, 2014), https://ssrn.com/abstract=2460790

5. Accounting Tools, https://www.accountingtools.com/articles/2017/5/15/total-factor-productivity

6. Brian Ayash and Mahdi Rastad, "Private Equity, Jobs, and Productivity: A Comment" (October 11, 2017; revised September 6, 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3050984

7. Steven J. Davis, John C. Haltiwanger, Kyle Handley, Ron S. Jarmin, Josh Lerner, and Javier Miranda,"Private Equity, Jobs, and Productivity: Reply to Ayash and Prastad," Harvard Business School Entrepreneurial Management Working paper No. 18-074 (January 31, 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3113272

8. PwC, "Intersections: First-quarter 2012 transportation and logistics industry mergers and acquisitionsanalysis," https://www.pwc.ru/en/transportation-logistics/assets/1q_2012_tl_ma_full_report1.pdf

9. Council of Supply Chain Management Professionals (CSCMP) and A.T. Kearney, "29th Annual State of Logistics Report: Steep Grade Ahead" (June 19, 2018), https://cscmp.org/store/SearchResults.aspx?Category=SOL

10. GF Data: Reported multiples from transactions completed in the $10 million-$250 million enterprise value range across various industries.

11. Data reported by Preqin in Ben Eisen, "Why a $1 Trillion Mountain of Private-Equity Cash Matters," The Wall Street Journal online (July 10, 2018), https://blogs.wsj.com/moneybeat/2018/07/10/why-a-1-trillion-mountain-of-private-equity-cash-matters/

Adam S. Palmer (apalmer@aethlon.com) is an associate with the Minneapolis, Minnesota-based investment bank Aethlon Capital LLC

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