Specialty third-party logistics providers: A busy market for transactions in 2014

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1 March 2014 A publication from PwC s Deals business Specialty third-party logistics providers: A busy market for transactions in 2014 At a glance The number of logistic transactions is on the rise and private equity and industry players continue to look for strategic purchases, particularly of specialty 3PL providers. Third-party logistics providers are becoming increasingly indispensable due to their high level of customization, service quality, or service accuracy. Because of the number of well-capitalized players and the need for this operational intelligence and sophisticated capabilities, we expect this momentum of deals to continue.

2 Introduction As the economy continues to climb out of the recession, we are seeing an uptick in M&A activity in the logistics market. This is especially striking in the case of specialty third-party logistics (3PL) providers companies that deliver complex, expertise-based services in areas ranging from fulfillment to transportation to configuration. We expect acquisitions to continue in 2014 on the part of both strategic and financial buyers. In the strategic arena, many logistics and transportation providers are looking for opportunities to differentiate their services in a crowded market via new and innovative offerings. Acquiring the specialized talent, processes, and technology of a specialty 3PL provider is one way to enhance their existing capabilities while meeting the changing needs of their clients. Specialty providers are also attractive because they can command higher margins than more commoditized traditional logistics services. Healthy margins also make specialty 3PL providers compelling targets for financial buyers. The ability to lock in customers with longer-term contracts and high switching costs adds to their allure as solid investments. With private equity firms holding back on spending during the recession, many are eager to allocate their war chests to solid investment choices, even in situations where valuations are high. An additional factor in favor of increased M&A activity for specialty 3PL providers is the fragmented nature of the industry. There are many smaller players that may be looking for a capital infusion to grow their businesses. Finally, there are a significant number of well-capitalized companies both private equity firms and industry players that are clearly in a position to go on a shopping spree. All of these factors increase the likelihood that more mergers and acquisitions are in the foreseeable future for specialty 3PL providers. 2 PwC Specialty third-party logistics providers:

3 Overview The number of strategic logistics transactions rose 50% from 8 in 2012 to 12 in 2013 for deals larger than $50M 1, and early signs indicate that this trend should continue, particularly for specialty providers. Not only has the economy improved, but the industry itself is being transformed by increased supply chain complexity and higher end-customer expectations. Specialty 3PL services are characterized by the significant degree of operational intelligence and sophisticated capabilities. These are needed to manage complex logistics tasks ranging from those with narrow delivery windows, short lead times, and last-minute change requests to those requiring a high level of customization, service quality, or service accuracy (see sidebar: Specialty 3PL providers are becoming increasingly indispensable ). Specialty 3PL solutions require high degrees of customization, something that vendors need to be particularly good at deploying. This usually requires a team of experts more akin to logistics consultants, that are capable of translating unique client requirements into custom operational and IT design plans. Cookie-cutter approaches can result in considerable trouble, as well as unexpected costs, for the logistics provider and ultimately the client. This article offers an assessment of the current M&A landscape for specialty 3PL providers and an argument for why we may see a new wave of M&A activity. 1 Thomson Reuters data, with PwC analysis Specialty third-party logistics providers are becoming increasingly indispensable Companies in industries ranging from consumer packaged goods to oil and gas to automotive are all stepping up their use of the wide variety of services specialty 3PL providers offer: Telecom Equipment: When a cell phone carrier undertakes the construction of a new cell phone tower, a specialty 3PL provider often manages the equipment deployment. This is a highly complex operation that involves coordinating with crane operators, securing permits, and confirming that the team responsible for bringing in and installing equipment is fully staffed and operational when the tower is ready to be assembled. Complex coordination and delayed configuration of equipment are two areas where specialty 3PL providers tend to excel. Food Distributor: Due to the perishable nature of their product, food distributors look for 3PL providers that can offer transport with deep frozen, refrigerated, or ambient temperatures, depending on the product. For companies moving into multiple distribution channels, 3PL knowledge of both retail and direct-to-consumer businesses can prove invaluable. Partnering with a 3PL provider can also offer a flexible cost model, because 3PL provider s business in each channel is both cyclical and dynamic. Distributors can also benefit from specialty 3PL providers warehouse management technology, which provides visibility and traceability throughout the supply chain. Automotive: Services offered by 3PL providers can reduce labor and tax costs, improve capital efficiency, and make it possible for original equipment manufacturers (OEMs) to offer more choices to customers. As build options per manufacturing line continue to rise, OEMs will need to outsource more sequencing and assembly work to specialty logistics providers. 3PL providers can also ship preassembled components, delaying configuration as long as possible. Regardless of the service they offer, what these 3PL providers have in common is specialized expertise in the form of technology, processes, and human capital and the ability to design and implement customized solutions for their clients. The rationale for outsourcing specialty 3PL services extends beyond cost reduction. Buyers also seek the knowledge, flexibility, logistics networks, and capital efficiency to solve operational problems that are not core to their business. A busy market for transactions in

4 Demand for advanced outsourced logistics solutions is on the rise PwC s analysis indicates that specialty logistics services are on course to exceed 8% CAGR between 2012 and First, industries that are the primary consumers of these services, such as technology, automotive, and healthcare, are all growing at a vigorous pace. Second, savvy supply chain managers have come to the realization that they need to outsource more than basic transportation and logistics in order to meet customer expectations while continually reducing costs. Until fairly recently it could take days for companies to aggregate customer demand information from multiple points of sale so that they could make appropriate adjustments to product mix. Today IT solutions deliver this information within hours, and companies are looking for ways to respond quickly to near-real-time market signals. For example, in order to leverage increased demand visibility more effectively, OEMs are developing platforms that allow products to be configured locally and therefore closer to the demand source. Delaying configuration makes it possible to tweak products in response to changes in demand, lowering production costs, improving fill rates, reducing excess and obsolete inventory charges, and above all, creating shorter lead times. Specialty 3PL providers play an important role in delivering inventory visibility, configuration services, and fulfillment. For example, 3PL service providers can sequence and even sub-assemble auto parts from suppliers to feed manufacturing plants that are building a higher mix of cars into their assembly lines. For IT equipment vendors, 3PL's can hold raw materials and configure them in almost real time to demand signals and therefore avoid shortages and excesses that occur with supply and demand mismatches. Medical device manufacturers that require complex coordination of technical, civil, and hospital resources for installation, can also rely on 3PL's to coordinate and execute the job seamlessly, especially when they are already supplying healthcare institutions in a particular geographic area. Retailers and OEMs also view specialty logistics services as a means of enhancing customer intimacy. As they strive for ways to deliver a seamless experience to customers across all purchasing channels, the ability of specialty 3PL providers to offer supply chain visibility and coordination is invaluable. Specialty 3PL providers also offer many of the services that help build customer loyalty, including customer support, troubleshooting and repair services, rapid order fulfillment, and recycling. Companies that fail to offer these services risk losing customers to companies that do. Specialty 3PL providers offer transportation and logistics companies a way to differentiate their service offerings Logistics companies that hope to deliver the best possible experience to their customers will increasingly look to specialty 3PL providers for their deep knowledge of specific services. Acquisitions offer a mechanism to add new or shore up existing talent and capabilities, strengthen customer relationships, and penetrate new markets. Specialty 3PL providers serve advanced customer needs using their engineering design capabilities, IT know-how, specialized processes, and operational management skills to develop solutions that are customized to an individual company and geography. These companies use a highly consultative approach and design process to define all aspects of the assignment, including scope of work, pricing, key performance indicators, incentives, remediation, and penalties. Continuous improvement and cost-reduction targets are usually written into specialty 3PL contracts. Due to the sophisticated skill requirements for specialty 3PL solutions, margins for these services tend to be substantially higher than the bread and butter services offered by large transportation and logistics providers. This alone has sparked the interest of potential acquirers. Specialty logistics assignments generally involve significant upfront set-up costs to cover IT integration and customization, training of both 3PL providers and client staff on new processes, and securing and configuring facilities. Contracts are therefore commonly three to five years in length, as opposed to basic transportation contracts, which are tendered yearly. When specialty 3PL providers are able to deliver on the terms of their contracts, customers tend to rely on them for these mission-critical services and renew their contracts rather than switch to another provider and risk a supply chain disruption and additional set-up costs and learning curves. The ability to increase the stickiness of customer relationships is another reason transportation and logistics companies view specialty 3PL providers as attractive acquisition targets. Not only can large providers cross-sell specialty services as part of an overall logistics contract, but they can leverage resulting customer relationships for the benefit of their core business. 4 PwC Specialty third-party logistics providers:

5 An improved economy should fuel more buying Strategic buying among logistics companies tends to increase as the economy improves (see Figure 1). Since 2000, larger strategic transactions (greater than or equal to $50 million) for logistics providers have closely tracked world output. With the International Monetary Fund forecasting an acceleration in world output in 2014 to 3.6% annual growth (up from 2.9% in 2013), it seems likely we will see more industry investment activity, with a particular focus on specialty 3PL providers. A slow loosening of credit and a continuation of low-interest rates should further support a healthy buying environment. Figure 1: Strategic Deals GTE $50M vs. World Output¹ % 5.0% % 4.0% % 8 3.0% 2.5% 6 2.0% 1.5% 4 1.0% 2 0.5% 0.0% 0-0.5% Transactions led by strategic buyers closely follow World Output¹ The IMF forecasts accelerated growth of world output in 2014 to 3.6% p.a. from 2.9% in Credit availability and low interest environments will likely continue to favor transactions Based on our analysis, we have identified a number of transportation and logistics companies that have both relatively low debt and sufficient equity to fund both organic growth and strategic acquisitions (see Figure 2). Companies in the upper left quadrant with total enterprise values over $9B are well positioned to acquire one or more specialty 3PL provider. Figure 2: A number of transportation and logistics companies have debt and equity dry powder to finance both organic and inorganic growth Low debt TEV/EBITDA (x) LTM High value Avg. 19% 38x 14x 12x 10x 8x 6x 4x 2x 0x 0% 5% 10% 15% 20% 25% 30% 35% 40% 60% 65% 90% Debt/TEV (%) LTM TEV > US$9.4B TEV < US$6.9B Source: S&P Capital IQ Low debt Low value High debt High value Avg. 11.9x High debt Low value World Output Projected World Output # Deals Source: Thomson Reuters data, with PwC analysis A busy market for transactions in

6 Fragmentation in the industry favors consolidation The specialty 3PL provider market is made up of a large number of relatively small players that focus on specific services or geographic areas. Of the 137 specialty providers in North America, 130 (95%) have revenues of less than $1 billion, and 104 (89%) have revenues of between $20 and $500 million (see Figure 3). This high industry fragmentation translates into multiple attractive acquisition candidates. For well-capitalized companies, the opportunity to supplement their capabilities through strategic purchases of specialized industry players is significant. Figure 3: Revenue of N. American 3PL Service Providers 1, % of North American 3PLs have less than $1B in annual revenue = $18B Opportunity $30B North American 3PL Revenue <$500M Rev 100% 90% 80% 700 $25B 122 3PLs 28% 70% Revenue $M $20B $15B $10B $13B > $500M Rev <$1B 8 3PLs $5B >$1B Rev 72% 60% 50% 40% % of Revenue 300 $5B 7 3PLs % of Revenue 30% 200 $B $12B 20% % companies with revenue between $20 and $500M account for $13B in revenue Amstrong & Associates, Inc. Global 3PLs Who's Who 0% Conclusion: Let the buying and selling begin As increasing supply chain complexity and customer expectations place pressure on OEMs and retailers, demand for specialty logistics services is likely to intensify. 3PL providers with high switching costs that offer niche services should see healthy revenues for the near future, particularly as the economy improves, making them attractive acquisition targets. For private equity firms that have delayed purchases during the recession, this is an optimal time to add a specialty 3PL provider to their portfolios before valuations become too steep. Likewise, strategic buyers with the capital to spend have an opportunity to boost their capabilities, expand their offerings, and increase their profit margins. Specialty 3PL service providers looking to recapitalize for growth should expect to find more willing investors than in recent years. Finally, 3PL customers should expect to see a rise in acquisitions and consider how that might affect their choice of provider. Regardless of the specific deals that get done, one thing is clear: 2014 should be an exciting year for specialty 3PL M&A. 6 PwC Specialty third-party logistics providers:

7 Acknowledgements We would like to thank Julien Didi, Paul Lockhart Korris, Sean Gaffney, Ronald W. Andrews, David Mann, Kelly S. Anderson, Sreedhar Vangavolu, and Nenad Milicevic for their contribution to this publication. Authors Daniel Mekler Director, M&A Strategy For a deeper discussion on deal considerations, please contact one of our practice leaders or your local Deals partner: Roger Wery Principal, Strategy Competency Leader [email protected] Brett Cayot Principal, Transportation and Logistics [email protected] Martyn Curragh Principal, US Deals Leader [email protected] Chris Lederer Principal, M&A Strategy [email protected] Dietmar Ostermann Principal, Global Automotive Advisory Leader [email protected] Bernard Student Principal, Advisory Healthcare [email protected] Patrick Gordon Principal, Advisory Technology [email protected] Peter Wietfeldt Principal, Advisory Retail and Consumer [email protected] About PwC Deals business PwC s Deals practitioners help corporate and private equity executives navigate transactions to increase value and returns. In today s increasingly daunting economic and regulatory environment, experienced M&A specialists assist clients on a range of transactions from smaller and mid-sized deals to the most complex transactions, including domestic and cross border acquisitions, divestitures and spin-offs, capital events such as IPOs and debt offerings, and bankruptcies and other business reorganizations. First we help clients with strategic planning around their growth and investment agendas and then advise on the business-wide risks and value drivers in their transactions for more empowered negotiations, decision making and execution. Clients can then expedite their deals, reduce their risks, capture and deliver value to their stakeholders, and quickly return to business as usual. Our local and global deal strength is derived from over 1,600 deal professionals in 35 cities in the US and over 13,300 deal professionals across a global network of firms in over 120 countries. In addition, our network firm PwC Corporate Finance can provide investment banking services within the US. A busy market for transactions in

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