Shareholders of Echo Global Logistics (NASDAQ: ECHO), a leading Chicago-based third-party logistics provider, will gather Friday for an extraordinary meeting to vote on the 3PL’s acquisition by private equity firm The Jordan Company for $48.25 per share.
Echo’s management team is proud of the deal they struck with Jordan — $48.25/share represented a premium in excess of 50% of the company’s stock price when the deal was announced — and considers it a win for shareholders. But more than the return to shareholders, Echo Chief Executive Officer Doug Waggoner is keenly anticipating what being a private company will allow him to do that was more difficult in the public markets.
As a private company, Echo will gain two big advantages, Waggoner explained: long-term ownership and favorable valuation arbitrage dynamics.
The first advantage comes from the fact that management teams of publicly traded companies are constrained by the need to meet or exceed Wall Street’s quarterly earnings expectations. A significant amount of time is spent on investor relations to manage those expectations and then the company’s operations are adjusted and carefully weighed to hit very precise profitability targets. Narrowly missing sell-side analysts’ consensus expectations for earnings per share in a given 90-day period can send the stock price tumbling.
“We won’t have to worry about a couple pennies of EPS — we can think longer term than that,” Waggoner said in an interview with FreightWaves. “Say we wanted to spend an extra $20 million on technology next year just to move faster. We already have a vision and road map, but we want to accelerate the pace. As a public company, we might want to throttle it back a little bit. As a private company, as long as we can convince our one shareholder of the [return on investment], they may say, ‘Go for it, run faster.’”
In a 3PL and freight brokerage industry that has taken on an enormous amount of private investment to drive innovation — and which remains populated with hypercompetitive incumbents stacked with talent and deep expertise — it’s plausible that the public markets, constrained as they are by a degree of Wall Street short-termism, may not be the best operating environment for a leading company.
Waggoner suggested that the mandate to consistently deliver growing profits to shareholders who may be trading in and out of the stock based on shifting investor sentiments has actually slowed Echo’s progress relative to private companies with more flexibility.
“My ask to The Jordan Company is: ‘Let me run faster,’” Waggoner emphasized.
The other important advantage that Echo will have as a private company is a renewed ability to conduct mergers and acquisitions and pursue inorganic growth. The abundance of private capital — global dry powder hit a record $2.9 trillion in 2020 according to Bain & Company — has driven up valuation multiples and made private companies in many cases more expensive relative to public companies.
Relative valuation multiples matter in M&A transactions because they can either generate a quick return for the acquirer or needlessly destroy capital. To give a simplified example, a company with $2 million in revenue that’s valued at 2x revenue (or valued at $4 million) might buy a company with $1 million in revenue valued at 1x revenue (or $1 million). When the new company’s revenue is added to the acquirer’s revenue, the acquirer now has $3 million of revenue worth $6 million (remember, it’s valued at 2x revenue). The acquirer spent $1 million on its acquisition but added $2 million to the value of the company — a quick 100% return on its investment. That riskless valuation arbitrage is the financial logic that underlies so many deals and fuels corporate buying sprees.
But the math can work in reverse too, making M&A difficult to execute and generally unattractive. What if the acquirer has $2 million in revenue and is worth 1x revenue but wants to buy a company valued at 2x its $1 million revenue? The acquirer spends $2 million to buy the target company, but when the $1 million in new revenue is added to the acquirer’s revenue, it’s revalued at 1x, or $1 million. The acquirer spent $2 million to add $1 million in enterprise value, instantly destroying capital.
The reality of mergers and acquisitions is a bit more complicated than that because valuation is typically based on a multiple of earnings before interest, taxes, depreciation and amortization, which more closely tracks a company’s ability to pay off debt from a leveraged buyout, but the same dynamic holds true. That’s why Waggoner anticipates that taking Echo private at a higher valuation than it was able to achieve in the public markets will unlock many new M&A opportunities.
“Echo did 21 deals,” Waggoner recalled. “In recent years it’s been harder to do those deals. Small tuck-ins don’t move the needle at our current size and to do larger deals as a small cap public company, it’s hard to get financing. So it’s been harder to do meaningful M&A; as a private company we can be a lot more aggressive and strategic and if it’s accretive to our business, we can pull the trigger on it.”
Waggoner said that The Jordan Company’s particular expertise in executing M&A transactions would be a boon to his management team and allow them to focus on operating the business.
“We will now have partners that are experts in M&A,” Waggoner explained. “We had to do all those deals in-house. When you’re doing diligence on a company, you’re spending money on professional services and distracting the attention of your people who have a regular job, and often you do all that work and don’t even get the deal. Having a partner in The Jordan Company could be a tremendous benefit to us. Jordan is much better at acquisitions than we are because that’s all they do.”
Waggoner also said that The Jordan Company is an experienced investor in transportation and logistics companies — it currently owns Capstone Logistics and previously owned GlobalTranz — and understands the freight cycle’s impact on brokerage profitability.
“Jordan can come in with eyes wide open and help us grow the business,” Waggoner said.
As for 2022, given the high freight volume levels, congestion and higher levels of infrastructure spending by the U.S. government, Waggoner thinks that business conditions for 3PLs will remain favorable.
“It’s reasonable to assume tight market conditions and elevated rates certainly though 2022 and possibly beyond,” Waggoner said. “The ‘normal freight cycle’ may be an historical artifact. In 2020, we saw an entire cycle in three months; now we’re in an extended tight portion in the cycle with no end in sight.”