Too Many M&A Dollars Chasing Too Few Targets in Logistics

Although deal activity in the logistics sector started slow this year, evidence suggests that there will be greater activity on the horizon.

Thanks to shifting industry dynamics, changing investor strategies, and high valuations, it is likely there will be a noticeable consolidation in the coming quarters. Financial sponsors and strategics that capitalize on these trends, and team up with effective advisors, will be well positioned for successful investments.

Below are four current developments in the logistics industry:

Supply & Demand

The ongoing trend of significant logistics companies looking to get still larger through M&A is being stymied by a shortage of targets, but the search continues to be brisk. The goal for these larger players is to find smaller EBITDA companies that can be grafted onto the larger platform, giving the acquirer a more national base. However, as in many other industries, there remains a dearth of sellers. This, combined with a huge amount of pent-up cash with strategic buyers and pent-up equity (also cash) with financial buyers, along with excessive leverage availability, is creating historically high multiples and making it hard for a potential buyer to win at auction.

As a result, many buyers are trying other ways to find targets—networking at trade shows, hiring buy-side investment bankers in logistics, and using the CEO-centric model with a successful CEO who wants to play the PE game and has a strong network, which may include potential sellers. One of the newest trends in logistics acquisitions is in fulfillment for retailers— packaging, shipping and maintaining inventory, as the retailers are outsourcing this function and trying to stay away from Amazon. Reverse logistics has become a hotter category also, but this takes a lot of expertise and isn’t right for everyone.

Asset-based vs. Non-asset-based

Most financial buyers typically remain on the sidelines when it comes to acquiring asset-based businesses. The depreciation of assets—be they trucks, ships or otherwise—remains a primary concern, as free cash flow is the key to a target’s value. Instead, financial sponsors often seek only non-asset-based businesses, such as brokerage firms, 3PLs, warehousing and the like.

However, this reticence of financial buyers to acquire asset-based businesses may be shifting. As end customers demand more of their brokers, 3PLs, etc., we are now seeing some asset-based businesses becoming more attractive to financial buyers. In the regional short haul business of trucking, for example, cash flow can remain more plentiful as the assets do not wear out as quickly due to the short hauls.

Clearly the trend with non-asset-based focus is for the use of independent contractors—owner-operators where the logistics business does not own the assets.However, diligence in this area is critical for any buyer, as oftentimes one will find that the seller has not properly followed the appropriate procedures to guarantee that these owner-operators will be treated as independent contractors and not employees. We have seen this in many instances and in particular with express couriers or “last mile” businesses. The pre-deal diligence with an expert may yield findings that cause a buyer to walk away.

The Brokerage Business

The brokerage business remains attractive to a number of financial buyers. Although the brokerage companies have become quite consolidated, there are still many small and fragmented brokerage firms. However, recent judicial precedent has placed the broker in a more precarious position based on the carrier he hires and the carrier’s record for safety, etc., so this will raise a red flag or two with potential buyers.

Within the logistics industry itself, the biggest challenge is that of finding and retaining drivers; short haul is easy, but long dedicated hauls are not attracting young drivers, and driver education schools are not creating a wealth of new drivers. As a result, employee costs are mounting, and poaching of drivers by rival companies is a constant threat.

The Future

Looking ahead, the industry continues to grow.  Consolidation accelerates in logistics, as economies of scale are clearly advantageous in logistics.  Despite the asset-based concern relating to trucks, ships and rail, the PE world continues to expand its appetite for logistics businesses and more sophisticated PE firms are competing toe to toe against strategic buyers.  The key for any buyer is fully understanding the regulatory overlay of the business and doing significant due diligence in any acquisition process.  Having the educated advisors with them as they diligence a target is the key.