Two converging market forces, one secular and one cyclical, are poised to fuel another burst of merger and acquisitions activity in the transportation and logistics industry.
The first is a secular trend of increasing sums of private equity capital entering the industry to back high-growth companies and accelerate consolidation, especially in the non-asset freight brokerage space. This trend is well known; last month FreightWaves reported on private equity’s effect on the landscape of large freight brokerages.
The second is a cyclical trend where a soft freight market is cramping top line revenue and profitability for many trucking carriers and freight brokerages. Lower EBITDA and slower growth will be factored into the discounted cash flow analyses used to value companies and will result in lower valuations, encouraging buying activity on the part of companies that have the cash to do so.
Echo Global Logistics (NASDAQ: ECHO) CEO Doug Waggoner said as much in the company’s second quarter earnings call last week: valuations have come back down to earth and Echo is hunting again in a target-rich environment.
The extreme fragmentation of both the truckload carrier side and the freight brokerage side combine to create a backdrop that also makes M&A an attractive way to grow a business. Not only are there many small- and medium-sized companies in the industry, but it’s notoriously difficult to hire and retain truck drivers. Freight brokerages, too, have expensive hiring and training processes and significant churn rates. In the right business climate, buying another company can be the fastest and cheapest way to tack on revenue.
Transportation companies considering ramping their M&A activity have several strategies to choose from, and they each come with risks and opportunities. A company may make a large, transformative acquisition that fundamentally changes its profile. Those kinds of deals tend to be high-risk, high-reward, often coming with a premium paid for the target and large synergies that must be realized to justify the acquisition. Think of Knight Transportation’s 2017 merger with Swift, Maersk’s 2017 purchase of Hamburg Süd, Alaska Airlines’ 2016 purchase of Virgin America, or Echo’s 2015 purchase of Command Transportation.
Other companies may choose to make ‘selective acquisitions’, seizing obvious opportunities when they emerge but taking less risk and looking for companies that don’t have a large effect on the balance sheet.
Partners at McKinsey argued in a new article that a third approach — a ‘programmatic’ approach that systematically targets moderately-sized companies and executes a relatively high number of deals — is actually the best strategy in terms of total returns to shareholders.
“What type of M&A strategy creates the most value for large corporations?” asked McKinsey partners Jeff Rudnicki, Kate Siegel, and Andy West in a July article titled “Repeat performance: The continuing case for programmatic M&A.” “We crunched the numbers, and the answer was clear: pursue many small deals that accrue to a meaningful amount of market capitalization over multiple years instead of relying on episodic, ‘big-bang’ transactions.”
McKinsey first reached that conclusion in a study conducted in 2010 that looked at corporations’ performance between 1999 and 2010. In a new study examining a dataset of 1,000 global companies from 2007 to 2017, McKinsey found the advantages of a ‘programmatic’ approach to be “even more pronounced.”
The essential reason why companies practicing programmatic M&A perform better is because they develop an expertise in all stages of M&A, from strategy and sourcing to integration, and they build out an organizational infrastructure dedicated to managing each step of the process.
It’s difficult to transition to a programmatic M&A strategy, which McKinsey defined as “when a company makes more than two small or midsize deals in a year, with a meaningful target market capitalization acquired (median of 15 percent).” None of the companies studied by McKinsey which relied on an organic growth model were able to transition to a programmatic strategy, for instance.
To successfully execute a programmatic M&A strategy, companies must devote money, people, and time to the project. The potential buyer needs to articulate its strategy, understand its competitive advantages, and think through the capabilities it wants to acquire.
“The hard work starts with a return to first principles: the development of a blueprint for bringing strategic goals into deal-sourcing solutions,” McKinsey wrote.
After potential deals are identified, McKinsey found that companies practicing programmatic M&A typically combined due diligence and integration planning, “holding discussions far ahead of closing about how to redefine roles, combine processes, or adopt new technologies.”
McKinsey reiterated the importance of establishing a team to monitor and control the various aspects of an M&A program, for example weighing the balance of employees from the parent company and the target who would be selected for the combined team as cost synergies are pursued.
“A programmatic approach won’t work if you don’t define the program and don’t treat M&A as an enduring capability rather than a project or occasional event,” McKinsey concluded. “Our research shows that, compared with peers, programmatic acquirers often focus on building end-to-end M&A operating models with clear performance measures, incentives, and governance processes. For these companies, the devil is in the details.”