Trucking M&A activity marked by selective buyers

   Celadon Group’s recent acquisition of Frozen Food Express Industries’ dry van fleet and interest in fellow truckload carrier USA Truck are examples of how new economic pressures could lead to greater consolidation of the fragmented U.S. trucking industry.
    In early October, FFE announced it was exiting the dry van transportation business to focus on refrigerated freight and putting 435 trailers and 290 tractors up for sale. Within days, Celadon bought most of the assets for less than $15.5 million in what it characterized as a capacity play to secure experienced drivers, who are in short supply these days for a number of demographic and economic reasons.
FFE said it would use the proceeds to reduce debt.
   About the same, Indianapolis-based Celadon also bought a 6 percent share of publicly traded USA Truck and has made no secret that it wants to merge with its competitor, which is in the midst of a management restructuring after losing $6.4 million in the first nine months of the year.
   “We certainly see a tremendous amount of interest in acquisitions, but not merger for the sake of merger, or just to get larger. Companies are looking for specific lanes, specific customers or specific types of shipments,” Lana Batts, president of Transport Capital Partners said during an Oct. 12 conference call hosted by financial services firm Stifel Nicolaus to update clients about the trucking industry.
   In the case of Celadon, executives say they are looking at acquisition targets primarily as a way to get drivers as well as a foot in the door with customers in need of a new carrier.
   As freight volumes pick up, shippers are having more difficulty finding trucks to move their goods in a timely manner because carriers unloaded excess capacity during the recession and the pipeline of younger drivers entering the business has been shrinking for years. Compounding the negative trends related to driver supply is a new safety monitoring system (Compliance Safety Accountability) implemented by the Department of Transportation’s Federal Motor Carrier Safety Administration that experts say could end up purging 5 to 8 percent of the existing driver base.
   That’s because for the first time driving violations, warnings, and vehicle maintenance shortcomings are now being included in a centralized database and drivers with high scores on their safety performance get a red flag. Carriers are also being scored in various safety categories and the driver scores are a component of the ultimate score received by a carrier. Carriers, now accountable for the driving records of drivers on their watch even after a driver leaves their employment, have an incentive to select safe drivers because shippers have access to the generic scores and increasingly are factoring potential liability risk into procurement decisions.
   Although trucking companies aren’t willing to expand their fleets given the economic uncertainty and what they perceive as unsatisfactory rates, they are refreshing equipment to retain drivers. Commercial vehicle drivers with good records are gradually commanding more leverage and one of their primary desires is for modern equipment that won’t break down, and limit their earning potential on a trip. They also don’t want to get a poor score under CSA for having a poorly maintained truck.
   In the past drivers were rarely held responsible for maintenance issues even though they are supposed to do pre-trip inspections.
   During the economic downturn, many motor carriers extended their normal vehicle replacement cycles to preserve cash.
   Analysts say the confluence of increased regulatory compliance costs, tight credit and the high price of new trucks with engines that meet federal emissions requirements is making it difficult for small and mid-sized trucking companies to stay in business.
   Celadon’s strategy involves quickly selling the used trucks obtained through any acquisition and providing the drivers with new trucks.
   Companies acquired by Celadon have fleets of 300 to 400 units, most of which are five to nine years old, Celadon Chairman and CEO Stephen Russell said during an earnings call with analysts last week.
   “They can’t survive because the drivers are upset they can get bad CSA scores in the vehicle maintenance category, they can’t buy a new truck because a new truck is $130,000, and if they’re trading in a five-year-old truck it’s probably worth $20,000 and they can’t get mortgages on $110,000.
   “So what they’re doing is trading two or three or four trucks to buy one, and therefore they’re shrinking. And that’s what’s creating the capacity shortage. And so we believe the capacity shortage is going to change the industry in the next five years,” he said.
   FFE is a large trucking company, but faces some of the same pressures.
   CEO Russell Stubs said in the Oct. 5 divestiture announcement that FFE would also trade in an additional 240 of its oldest tractors for new ones.
   “The cost to maintain an aged fleet has seriously deteriorated our operating results in 2011 and had to be addressed. Due to higher maintenance costs, loss of warranty and reduced fuel efficiency, older model tractors cost considerably more to operate than newer models. Additionally, a younger fleet significantly improves driver morale and retention, which is an industry-wide challenge,” he said.
   Transport Capital Partner conducts a survey of trucking executives every few months to gauge their expectations for the industry. The number of carriers thinking of selling their companies in the next 18 months increased slightly to 28 percent in August from 25 percent in May, marking the highest percentage the consulting firm has seen since it started asking the question in May 2009, Batts said.
   Exiting the business is on their mind because the future looks so cloudy and “they are getting higher used equipment valuations, which means that some carriers now have a positive equipment margin over their debt on trucks, so they’re saying, ‘Let’s get out while we can.’ ”
   A third of smaller carriers were interested in selling versus 23 percent of the larger carriers in the survey.
Batts, a former president of the Truckload Carriers Association and vice president of government affairs for the American Trucking Associations, said many potential deals are falling apart because “buyers are extremely selective and picky.”
   Those seeking to make acquisitions frequently have an unrealistic outlook, she noted.
  “Buyers are looking at the last three years of earnings and saying, ‘My God, you didn’t do very well,’ and offering very low prices. Sellers, on the other hand, are saying, ‘My God, I survived the Great Recession and I’m not going to give this company away,” Batts said.
   Whether carriers reinvested in tractors and trailers, or didn’t, is being used against them by prospective buyers, said Batts, whose firm provides advice to clients on mergers and acquisitions.
Sellers will tout their good operating profit, “but the buyer will come in and say, “Yeah, but look at the capital expenditure I’m going to have to spend because I’m going to have to buy this fleet twice.’ So that slows down the negotiations,” she said.
   “On the other hand if the seller has kept his fleet relatively young, then the buyer comes in and says, ‘Oh My God. Look at all this debt.’
   “Well you can’t have it both ways. So that’s kind of where the disconnect is taking place,” the trucking industry veteran said.
   And she was critical of financial buyers who only want to buy non-asset based companies that rely on independent contractors.
   Owner-operators are most at risk from the rising costs of equipment, fuel, insurance and compliance and their numbers are decreasing. Depending on subcontractors to provide capacity when capacity is leaving the industry doesn’t make sense, Batts said.
  “I think you’re going to spend a whole lot of time looking and going to kiss a whole lot of frogs before you ever find anybody in that market that is going to be willing to sell,” she said. – Eric Kulisch