From time to time we analyze the viability of doing an LBO deal in a specific industry sector.
Because this week we’ve been focused on why military training makes for great dealmakers…
And because the military is great at operations and logistics, i.e., moving materials and troops from one place to another…
Today I thought I’d discuss the transportation sector — i.e., businesses that get paid to move products or people (bus coach or charter business.)
To be clear, this is just one of MANY sectors that makes for great LBO deals regardless of whether you’re ex-military or not.
I myself have owned both types of transportation businesses in the past.
Here’s how these deals work and what to look for…
Advantages & Opportunities
The transportation sector is large and fragmented. Because apart from needing a transportation license and qualified drivers, there aren’t any major barriers to entry.
Most transportation businesses have a strong asset base. They’ll often have lots of vehicles and sometimes warehousing facilities where they’ll store products on behalf of customers.
When it comes to their human assets, the employee base for the most part is comprised of a ready supply of low- to medium-skilled employees. You should easily be able to scale your workforce as you win new business.
Another point of note, this industry doesn’t compete solely on price. Service and reliability are very important, often more so than cost. This is why customers are loyal to trusted providers with strong levels of service.
My own transportation business served Rolls Royce. When they were pressing up against a production deadline, they would pay us astronomical amounts of money to move small components between sites simply because they trusted we would deliver everything safely and on time.
Most businesses in this sector tend to be owned by older people. Those sellers tend to be more concerned about preserving their legacy and safeguarding their employees than cash. (the opposite to say a technology business). Understanding this psychology will prove valuable when it comes time to negotiate deal structure.
Best of all, if you’re looking for a sector you can quickly scale, transportation businesses are GREAT for doing roll-ups. Or, if you already own one, you can easily look to grow your empire through bolt-on acquisitions.
And because of the overall low barriers to entry, you can offer lower acquisition multiples than you would for other sectors.
Disadvantages & Potential Pitfalls
Unfortunately, low barriers to entry means unlimited competition. And because customer relationships tend to be sticky, it can be hard to grow market share organically.
Fixed price contracts with clients are an industry standard. If your overhead increases — say, because the price of fuel rises — profit margins can be suppressed.
This hurt me in the past with a coach business I owned. All our contracts were fixed for a minimum of 12 months. But in 2012, the price of diesel in the U.K. went up by 50% in a short span of time. Because diesel was a major overhead in the business, it killed us.
When it comes to the vehicles, they tend to be heavily depreciated for tax reasons. There is also a tendency — especially in the U.K. — for these types of businesses to hold onto their assets as long as possible, so you may find many of the vehicles have little to no financing value.
The people transportation business can be highly seasonal. Earlier this year, Adam and I passed on a tour coach business just before the U.K. was locked down in COVID-19. We could have acquired the business late 2019 but decided to delay closing at the start of the busy season (May–October) so we could receive all the cash flow.
The business ending up getting decimated by COVID-19, so it was fortunate we passed on it when we did.
Every sector has advantages and disadvantages to running the business, and there’s a lot to think about with transportation deals. But at the end of the day, they make for excellent LBOs deals under the right circumstances.
Sample Valuation
Now, let’s look at the deal math…
Revenue = $2,000,000
Margin = 15% (typical for a transportation business)
Profit = $300,000
Multiple = 2.5X (avg. for transportation deal this size)
Enterprise Value (EV) = $750,000
And here’s the sample balance sheet:
Assets
Cash = $200,000
Fixed Assets = $300,000
Inventory = $0
AR = $500,000 (avg. 90 days payment terms)
Total Assets = $1,000,000
Liabilities
Accounts payable = $400,000
Non-Trading Liabilities = $200,000
Total Liabilities = $600,000
Net Asset Value = $400,000
There’s no surplus cash in this deal, so let’s calculate the value for 100% equity, which is:
EV ($750K) + Surplus Cash ($0) + Real Estate ($0)– Non-Trading Liabilities ($200K) = $550K
(We don’t adjust for the accounts payable since we’re inheriting the AR for financing.)
So $550K is the value of the shares in the business.
So, how do we finance this?
We will likely see a 50% loan-to-value (L2V) on the fixed assets (trucks), or $150K.
AR financing will likely see an 80% L2V, or $400K.
So we’re looking at $550K in financing for 100% of the value. But we still need to cover closing costs and a small top-up in working capital. Plus, you as the buyer may also want to take a deal fee.
Let’s assume in total that’s another $100K, so the net financing for a closing payment will be $450K.
My opening offer would be $500,000 split between $250K at closing and $250K seller financing ($50K per year for five years).
Assuming the seller decides to negotiate, I would have my offer sequence ready to build up to a maximum offer of:
In summary, transportation businesses can be great LBO deals thanks to their asset-heavy composition and average margins. There are lots of positives that outweigh the negatives, many of which can be averted anyway.
If the transportation sector is in your lane (pun intended!), go close some deals!
I will see you soon with another sector deep-dive soon.
Until next time, bye for now.
