After a very active 2018 that saw continuous deal-making in the asset-light third-party logistics (3PL) space, investment bankers told FreightWaves that they expect mergers and acquisitions to stay hot in 2019. High valuations and opportunities for scale and liquidity are driving sellers to market, while abundant capital and a target-rich environment filled with high-growth businesses are encouraging both strategic and private equity (PE) buyers.
FreightWaves spoke with Jason Bass and Frank Mountcastle, both Managing Directors and co-heads of Harris Williams’ Transportation and Logistics Group. Harris Williams is an investment bank and financial services firm based in Richmond, Virginia, offering advisory services for mergers and acquisitions (M&A). Mountcastle said that 95 percent of the business his group handles is sell-side M&A, and more than half of those deals are representing PE groups exiting their portfolio companies.
3PLs go to market for a variety of reasons. Sometimes their customers want added services that their current technology and scale can’t deliver. A freight brokerage may be trying to scale quickly to compete with larger, well-capitalized consolidators, but is hitting a wall in accelerating headcount growth, building technology or investing in modes and geographies its shipper customers need serviced. Some visionary founders are able to grow their companies to $200 million in annual revenue, but need capital and a more experienced executive team around them to sustain rapid growth.
“I don’t think there are specific dollar threshold limits that become the catalyst for a sale,” Bass said. “It’s really more company-by-company, business-model-by-business-model specific. The decision ties back into the culture of the company, the vision and the leadership, and the appetite for continued rapid growth at scale in a highly competitive market.”
Despite some uncertainty in the broader market about the Fed – Chairman Powell abruptly switched from hawkish to dovish, and investors aren’t sure it will stick – Harris Williams does not anticipate meaningfully tighter credit conditions this year.
“We continue to see the debt market open for high-quality, high-growth 3PLs,” Bass said. “Banks and non-leveraged lenders are willing to lend more in covenant-light and no-covenant situations, which continues to give PE groups the confidence to competitively pursue the best-in-class companies at high valuations. We don’t see a disruption in the pace of deal-making this year.”
“When you take available equity and available leverage,” Mountcastle added, “available capital is as good as it’s been in years. When you combine that with business models built for demonstrable organic growth and M&A available to them, that is a good formula for a PE group to want to put dollars to work at valuations that are very competitive with strategic valuations.”
One of the themes of the past few years in 3PL M&A has been the perception that private equity groups are driving up valuations and making it more difficult for strategic buyers – other brokerages and logistics providers – to execute deals at reasonable multiples.
Mountcastle explained how PE firms can afford to pay “multiples well into the double digits” for sizable, high-quality companies that have a proven track record of integrating acquisitions. Private equity groups are betting that after they’ve purchased their ‘platform’ company for a premium valuation, they can bolt-on or tuck-in smaller companies at substantially lower multiples, which drives the ratio of capital to earnings back down.
“Any time they can do add-on M&A at multiples substantially lower than entry multiple, it gives them the opportunity to average down their entry multiple,” Mountcastle explained, which makes the exit look better.
And when a private equity group wants to make its exit, it’s almost always to another PE firm or a strategic buyer, not to public markets. For the last five or six years, there has been no meaningful differential in valuations between initial public offerings (IPOs) and private sales for 3PLs. The cost of the IPO itself, plus subsequent compliance costs, have kept small and middle market companies from going public. It’s also much easier for a company’s executives to deal with one group of knowledgeable owners who have a shared vision rather than a diffuse group of institutional investors.
“All things being equal, when private equity exits, it’s cleaner and more efficient to sell to another PE or strategic buyer,” Mountcastle said. “Often there’s a desire for full liquidity. There’s no real valuation differential, at least today, between private sale valuation and IPO valuation for a 3PL.”