An Incoming Hangover?
– Private Equity’s Challenges in the Logistics Industry
From: David Harings
The supply chain crisis during the Covid-19 pandemic and other high-profile events, such as the blockade of the Suez Canal by the container ship “Ever Given” has focused public attention on an industry whose work is often unfairly taken for granted despite its crucial role in the daily life of society — the logistics and transportation industry. But while the public’s attention was captured for a time by the prevailing supply chain bottlenecks, private equity’s interest in this highly unconsolidated industry was there long before. With the onset of the pandemic and cheap liquidity, capital inflows increased even further. While companies worldwide suffered from the disruption caused by the pandemic, the logistics sector was one of the clear winners, with regional truck operators to international freight forwarders posting record profits and valuations in the 2020–21 pandemic years.
However, with the world waking up to a post-pandemic reality, the sector and its financiers, still high from its record years, face a rude awakening in the form of a looming recession, entailing tightening monetary policy and other symptoms such as falling freight rates. Sellers in the industry now face the predicament of wanting to sell at inflated valuations, while potential buyers need help raising the necessary debt while also weighing increased uncertainty.
Looking into the future, long-term private equity investors in this sector now face a set of challenging questions ranging from finding buyers in the industry and, more crucial personal valuation growth and, lastly, whether they need to evaluate the potential of their investments, using metrics beyond the financial bottom line of the pandemic years.
Industry Overview
Logistics is widely known for coordinating and moving resources such as equipment, food, fluids, inventory, materials, and people from one location to the desired destination. The industry encompasses many different subsectors and types of companies, ranging from classic contract logistic providers, warehousing, and freight forwarders to supply chain visibility/automation providers, to name a few. In contrast to other sectors with few established players, the logistics market is highly fragmented. For instance, some of the largest third-party logistics and supply chain solution providers (3PL), such as DHL or Kuehne & Nagel, the most significant player in global freight forwarding, have respective market shares of only around 6% and 10%.
Before the pandemic, the industry benefited from several different trends, such as increased volumes of e-commerce, reverse logistics, technological innovations, and growing trade-related agreements. As a result, the global logistics market is expected to grow at a CAGR of 6.5% from 2020 to 2027.
Opportunities for Private Equity
Such levels of industry fragmentation present vast opportunities for private equity firms. Following a classic ‘buy-and-build’ strategy, PE portfolio companies can roll up smaller players. Given the global nature of the industry, there is no shortage of acquisition targets and organic growth opportunities.
Consequently, the industry experienced an increased wave of consolidation at the height of the pandemic. According to research group Armstrong & Associates, for instance, there have been hundreds of third-party logistics acquisitions worth less than $10 million in the past 18 months, while there were 25 acquisitions worth more than $100 million last year, the highest number since Armstrong & Associates began tracking such acquisitions in 1999.
For example, some of the more notable deals included the acquisition of Transplace, a technology-driven transportation management provider, by Uber Technologies Inc.’s Freight unit in a cash and stock swap valued at about $2.25 billion. Another example is the September 2022 purchase of Van Buren, a U.S.-based freight forwarder, by German freight forwarder DB Schenker in a deal valued at $435 million. Other freight forwarders, such as Denmark’s A.P. Moller-Maersk, have also gotten into the fray, buying Glen Mills for about $1.68 billion.
One deal that illustrates the exit opportunities for private equity firms is Kuehne & Nagel’s 2021 acquisition of PE-backed airfreight company Apex International Corp. from North Asia-focused private equity firm MBK Partners, valued at CHF1.1 billion.
Future Challenges
By the second half of 2022, however, Armstrong & Associates anticipate a noticeable slowdown in deal activity. Given the general cooling of the market in the face of declining shipping volumes and increasing news of a global economic downturn, sellers will face tough times. A changing macroeconomic and monetary policy environment also leads to rising interest rates deterring first-time private equity investors and drying up financing. While some of the more considerable logistics and shipping companies, such as Maersk, still have enough dry powder and appetite for transactions without having to take on debt, outside investors and sellers will feel the increased pressure in the short term.
One of the significant stumbling blocks presents the increased prices and valuations of companies post-pandemic. Gross revenue for domestic transportation management grew 52% on average last year and was up 75% YoY for international transportation management. In addition to pricing challenges, the industry faces different conditions than before the pandemic. A further rise in protectionism and increasing complexity of international trade, as currently seen with China’s zero-covid approach or the chaos witnessed at Dover post-Brexit, will shape the industry outlook over the coming years.
Given the changing environment, current and prospective private equity investors in the industry will need to reassess how they value their portfolio companies and realign their growth strategies with the current reality. While growing supply chain complexity can offer a testing new reality, it also presents an opportunity for solutions-focused firms. In the future, businesses capable of mitigating trade frictions and the other multilateral issues facing the industry will arguably both see improved performance and revenues. Consequently, investors should go beyond focusing on traditional financial metrics and increasingly evaluate their businesses more on the quality of management and their innovative capabilities to ensure their long-term success.
References
Bartman, T. et al. (2021) Unlocking the Omnichannel Opportunity in Contract Logistics, McKinsey & Company. McKinsey & Company. Available at: https://www.mckinsey.com/industries/travel-logistics-and-infrastructure/our-insights/unlocking-the-omnichannel-opportunity-in-contract-logistics.
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