It’s a fact that merger and acquisition activity in the third-party logistics (3PL) space has cooled this year. It’s harder for freight brokerages to achieve robust organic revenue growth because paper and spot trucking rates have been trending downward for a year.
At the Armstrong & Associates 3PL Value Creation Summit in Chicago, industry executives, investment bankers and private equity (PE) partners talked about the reasons why fewer companies are going to market, multiples are falling back to earth, and what kinds of companies are most attractive in a slowing macro environment.
Most PE firms have fairly standard holding periods of four to five years between the purchase and sale of an operating company. PE firms need time to make organizational changes and improve the business they’ve purchased, but holding it for too long will cause the fund’s internal rate of return – measured on an annual basis – to fall below an acceptable level.
That relative inflexibility causes earnings before interest, tax, depreciation and amortization (EBITDA) multiples paid for companies to be bid up when times are good and capital must be deployed, and can force the same multiples downward when a recession is looming.
“We’re expecting a recession and modeling it in our base case,” said Kyle Stage, a director at Credit Suisse. Stage explained that PE groups have to meet a 25% internal rate of return with a recession in the model and that drives down the price they can afford to pay for a company.
“There’s a bid-ask spread in the market today,” Stage said, referring to the difference between the prices sought by sellers and the prices offered by buyers.
Current conditions are quite different from the transportation and logistics bull run of 2017 and 2018, recalled Jason Bass, managing director and co-head of Harris Williams’ transportation and logistics group. Harris Williams participated in the sales of Transportation Insight and Nolan Transportation Group to Gryphon Partners, and helped sell GlobalTranz to The Jordan Company and then back to Providence Equity.
“Through the balance of ‘17 and ‘18,” Bass said, “there was tremendous interest, and more money than good ideas, but some really good companies that came to market. Those deals seem to start trading at higher and higher multiples. 3PLs traded on the run, each deal trying to top the last one.
No question that the pace and trajectory of valuation has slowed down. There’s more discipline on the part of the lenders in today’s market than we’ve seen in the past.”
Nowadays, lenders focus more closely on add-backs – the adjustments companies make when calculating EBITDA – and current run rates as opposed to trailing 12-month figures, than they did in prior years, Bass said.
“There are a lot more variables and uncertainty,” added Hugh Rabb, managing director at Jefferies. “That’s not as conducive for prolific M&A at huge multiples.”
Angel Pu, vice president of Warburg Pincus’ technology, media and telecommunications practice, said that Warburg plays in a different part of the industry, offering young, high-quality logistics companies with strong technology growth equity at multiples very different from typical middle-market M&A. Warburg invested in Coyote Logistics and sold it to UPS in 2015; now Warburg owns BlueGrace Logistics, a high-growth brokerage based in Tampa, Florida.
Pu said that Warburg, for example, has invested in companies at multiples of revenue as well as earnings, and has at times come in at double-digit revenue multiples.
“In our approach to investments in general, we know that companies we want to own in the sector for the next few years have a very high quality threshold, strong organic runaway, management, and business model,” Pu said. “Whether they trade today or five years from now, they will command a high multiple. We don’t see a meaningful impact on valuation multiples that we would be expected to pay.”
Disparate comments on liquidity for leveraged buyouts of mature companies compared to growth investments in hyper-growth shed light on a bifurcation in credit markets.
“There’s more B3 paper being held than there ever has been – a historical high,” Bass said. “And there’s some indigestion in that market. A lot of investors are going to be risk off: more focus on adjustments, less tolerant of synergies; they want good hard traditional cash flow. There’s less leverage and wider spreads – more expensive money.”
B3 debt is toward the lower end of quality in high yield bonds; Moody’s, for instance, defines B3 as “high credit risk.” In a downturn, companies with B3 ratings will have a higher risk of financial stress and default on their debt obligations; in anticipation of a material slowdown in the macroeconomy, lenders are starting to be more cautious and are pulling back from risky investments.
But Pu said that on her end of the market, which leans toward a risk profile more characteristic of venture capital than private equity, investors are as aggressive as ever.
“We’re seeing very robust debt activity,” Pu said. “Companies are increasingly willing to lend on revenue as opposed to EBITDA. On one recent acquisition, they had no EBITDA and funded it with a 3x multiple on revenue with deferred interest payments and very attractive interest rates.”