Is logistics seen merely as a commodity service: necessary-evil, non-valuable, and uninteresting? All the attention on M&A activity and the future of private capital investments in logistics outsourcing say it's more than that.
The logistics outsourcing industry consolidation has taken on new momentum, not only because large service provider firms are merging or acquiring other service providers, but because the private equity world has sprung a seemingly insatiable interest in logistic operating companies like 3PLs or logistics service providers (LSPs). They are especially interested in those that are non-asset or asset-light.
Private equity companies and those orchestrating financial deals have significantly increased the interest in, and the amount of capital available for, 3PL investments.
This outlook on 3PL uses extensive interviews with private equity companies, 3PL CEOs, and specialty investment banking firms. In following the money, we analyze what investors are doing and why, and look at what 3PL CEOs need to do to position their company to take advantage of, or avoid, these movements.
Private equity firms, especially those that have invested in learning about logistics, have a piqued interest in investing in logistics outsourcing companies for several reasons including but not limited to:
Demand-driven supply chains exacerbated by outsourced manufacturing and globalization are much more complex to run. At the same time, the industry needs more mature service providers to step up.
The logistics industry consists of an over-abundance of small, entrepreneurial, owner-operator companies, most of which are narrowly specialized niche players operating in a limited geographic region; that is, the industry is highly fragmented.
The rise of offshore, low-cost labor firms that are successfully outsourcing non-core back-office functions raised awareness and, frankly, new levels of acceptance of business process outsourcing (BPO) in general.
Logistics outsourcing average annual growth rate is 15%. The best companies are doubling that and more. Early entry investors have shown examples of 20% gains for return on capital in logistics investments in three to five years.
Consolidation and investment activity is rampant. M&As' in the industry have accelerated dramatically the past three to five years. Consider the following transactions:
1. Schenker bought BAX Global for $1.2B.
2. Deutsche Post/DHL bought Exel Logistics for $6.6B.
3. SembCorp Logistics was acquired by Australian transportation giant, Toll Holdings.
4. PWC merged with GeoLogistics and is now known as Agility Logistics.
And here's a sampling of what just a few of the private equity firms have done:
1. Apollo Management acquired TNT's Logistics group and branded it CEVA. It then turned around and won a contested bid for the acquisition of EGL Global Logistics over a management buyout orchestrated by CEO Jim Crane, who was being backed by private equity firms Centerbridge Partners and Woodbridge Co. (got that?).
2. Fenway Partners created Big Wheel Partners, which invested in and has already sold Greatwide Logistics and also created RoadLink USA via the merger of several independent regional intermodal companies.
3. GTCR Golder Rauner invested to form Golden Gate Logistics.
4. Wilpak sold to Jacobson Companies with the help of investment banking firm BG Strategic Advisors. Subsequently Oak Hill Capital Partners bought Jacobson from Norwest Equity Partners to merge it with its existing portfolio logistics company, Arnold Logistics.
Lake Capital Partners invested to expand presence and capabilities of NAL Worldwide.
Logistics certainly appears to be popular, at least to some segment of the capital community, but the early entry advantage, most say, has certainly passed. Some of the early entry private equity firms and investment bankers have been at this for almost a decade. They are seeing a multitude of other equity firms chasing a smaller number of true quality deals. The fervor has driven prices up (but not necessarily valuations), making for a cautious field for potential investors.
However, according to the equity players, plenty of hot opportunities are still out there because debt is still incredibly attractive. Moreover, a multitude of logistics companies are still available due to the highly fragmented state of the industry, and interest in the sector is still growing because logistics complexity and awareness is at an all-time high. Those hoping to get in the game still have a three-to-five year window.
As highlighted above, the large existing LSP firms are acquiring at a blinding pace. These companies are looking to expand their reach with new services, add additional geographic coverage or specialty, and increase customers (read: revenues). Expanding the customer base through acquisition is naturally more prevalent in the lower margin outsourcing categories--warehousing, transportation management, and freight forwarding--where you simply need bigger numbers to create more value.
Because of the fragmentation, many companies are looking to become proficient in one category or another. Rare is the company that is equally as good in more than one of these categories today, even among the mega-players. Of course, expansion of service coverage to more areas is a very common goal as well. The vision of the integrated, consistently performing, global 3PL is still just that: a vision. Maturity will occur slowly and the emergence of the truly global provider will occur, just not tomorrow.
While it may appear that capital firms are just rolling up companies or simply smashing companies together to obtain financial engineering results, such scenarios are actually the exception rather than the rule.
The best investors are building an operating company around a solid expansion strategy. All of the equity managers in our research were looking to invest in a platform: a company or set of companies upon which to build further acquisitions. Platforms might focus on a particular logistics category, a region or lane, an industry, a mode, or any of several other distinctions. The purpose is to find a strategy and the right companies that will create value.
Value creation is the sole mission of the investment firm post acquisition. Primarily, the firm expects value to come from three areas:
1. Cost reduction and/or margin improvement--Through operating efficiency (from cleaning up the companies), possibly introducing stronger professional management
2. Organic revenue growth (sales)--Recognizing, however, it is hard (impossible) to get the three-times multiples on money invested that private equity wants with organic growth
3. Acquisitive growth--Adding customers and revenues; expanding services, geographical coverage, and capabilities (vertically and horizontally); gaining scale to spread fixed costs more economically, all along the platform strategy
Of course, in the best of worlds, the investment firm finds a niche platform and grows it through piecemeal acquisition of low-cost add-ons that fit strategically. The aim is for one of those magical, elusive situations we always describe that fit the one-plus-one-equals-three formula. Some have seen it; others are still waiting.
Realizing gains comes from three strategies:
1. Take the new entity public and get money out at the IPO
2. Sell the new higher-value entity to another, probably larger, logistics company that needs that niche platform
3. Get bought out by another private equity firm that wants to start with this entity as its platform for a bigger play
The past few years have seen the last two options pay off significant returns for those we interviewed.
However, since the purpose for the acquisitions is strategic and not just picking up bargains, not all acquisitions can be had for one low price. This, in turn, affects the ultimate multiple on capital expended. Most spoke about costing down the average multiple by looking for great buys to counterbalance investments where they had to pay more than what they originally designed. The aggregate entity becomes more worthwhile but by using this costing down strategy, the private equity firm tries to retain the economics for the magical equation to be true.
Logistics is exceptionally broad, so be careful not to underestimate the breadth and complexity. You must understand what you want to accomplish with your investment strategy and how specifically you expect to achieve that across the diversity of the segment.
High fragmentation leads to a variety of niche companies with different specialties and business models. What focus do you want to have? In which categories, industries, and/or geographies are you interested? Which combination of investments will lead to the fastest, or most sound, value creation?
When seeking out investor candidates:
1. Look for those funds that have taken time to learn the logistics sector, there are several.
2. Engage an investment-banking firm that specializes in the logistics sector such as BG Strategic Advisors or Eve Partners. These firms have invested years in researching and grooming the private equity sources that are interested in the sector. They will help navigate to the funds that are right for the situation and that have an appetite for the particular platform opportunity.
3. Don't just chase the dollar and end up with the wrong partner.
Another way to leverage capital is to seek a partial investment; that is, sell a stake in the company. Some companies seek outside money to support a faster growth strategy. Sometimes an owner/entrepreneur takes on investors to cash out a part of what they've built up and continue on with new ownership structure. Just remember, the equity investors want value creation to support that 3-to-5 year exit strategy of their own. And of course, you lose some or all control depending upon how much of the company you put out for investment.
Focus your company within a niche where you can be outwardly recognized as a standout. Category leaders--the top three--are more attractive from a sale standpoint and they command better terms.
Scale is important, with larger deals getting higher multiples. Private equity firms tend to like to use greater capital because the multiples are higher and smaller deals take approximately the same amount of effort as larger deals.
Many companies, especially smaller ones, develop around a founder or an entrepreneur. But most private equity firms are hesitant to invest in a single person, although a strong CEO is critical to their decision. Their advice--Create a strong functional management team and you'll be more attractive to investment. If you are a founder, have a decent operating company in a good niche, and want to get out completely, the interest likely changes diametrically.
Create a strategy with a 5-year horizon and be articulate about how the company will position itself for uniqueness and leadership. By doing so, the argument for capital investment will likely be very apparent and the anticipated results clear.
Finally, scale through expansion so that you can serve more customers in more regions. Larger scale economics makes it easier to grow value, especially in lower-margin services because fixed costs can be spread. Investors are also weary when a provider firm is too dependent on too few customers. Try to de-couple the company from too much reliance on particular customers.
Private equity firms want to dispel their sometimes-negative perception: They are not villains. They don't believe they are smarter than the operation's management. They are just people that have a different perspective on the issues. Their perspectives and strengths need to be aligned with strong management that has an undying focus on driving the value growth private equity investors want to help accelerate.
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