Merger Mania

July 1, 1999
LAST year at this time, tank truck carriers seemingly were changing hands right and left, and the industry experienced its first purely strategic buyup.

LAST year at this time, tank truck carriers seemingly were changing hands right and left, and the industry experienced its first purely strategic buyup. This year has been eerily quiet, so far.

A few deals have been announced in 1999 but none on the scale of those the previous year. A couple of the bigger deals this year were initiated by Liquid Transport Corp, Greenfield, Indiana, which bought Mississippi Transport Inc, a $9.3 million carrier in Stillwater, Minnesota, and by Bulkmatic Transport, Griffith, Indiana, which acquired Butler and Company, a $13.7 million dry bulk fleet in Vernon, Alabama.

Is this the calm before the next acquisition storm, or has merger mania run its course in the tank truck industry? Will we see efforts to build more mega mergers like the one in which Apollo Management LP combined MTL Inc and Chemical Leaman Tank Lines to form Quality Distribution Inc, a $620.2 million tank truck operation?

Certainly the Apollo rollup was the monster merger of 1998 for the tank truck industry, but there were plenty of other big deals during the third year of what appears to have been a three-year cycle. By Modern Bulk Transporter's estimate, at least $1 billion worth of tank truck carriers changed hands during the past three years, with 1998 accounting for the highest single-year total.

The seeds of the merger wave of the past three years were planted 18 years ago with deregulation of the trucking industry, according to Richard T Lewis, president of Superior Carriers Inc. "We've seen the same sort of consolidation in other deregulated industries, such as banking, airlines, and railroads," he says. "Gradual consolidation of the tank truck industry has been occurring for about 15 years now."

All indications are that there is a lot more merger activity to come. An important driving factor has been the tremendous amount of consolidation that has occurred in the petroleum and chemical industries-two key sectors served by tank truck carriers.

Among chemical manufacturers, approximately 70 deals were announced in 1998, more than the previous year. According to Chemical Week magazine research, chemical deals with disclosed values totaled almost $350 billion.

The biggest strictly chemical deals include Degussa's $7 billion merger with Huls; Lyondell's $6.5 billion union with Arco Chemical; Akzo Nobel's $3.8 billion acquisition of Courtaulds; Hercules' $3.1 billion takeover of BetzDearborn; and KoSa's $3 billion purchase of Hoechst's global polyester business.

In the petroleum industry, Exxon announced in December 1998 that it was purchasing Mobil Corp for a record $75.6 billion. Earlier, Amoco Corp had agreed to be acquired by British Petroleum Co Plc for $55 billion, creating a $100-billion oil and petrochemicals giant.

With all of the activity in the chemical and energy sectors, it's not surprising that 1998 was a record year for acquisitions valued at $1 billion and above. Total acquisitions of all sizes for the year added up to $1.13 trillion.

Worldwide competition has fueled much of the merger and acquisition (M&A) activity among petroleum and chemical companies. Executives believe their companies must get bigger to gain critical mass in the market place. In addition, there is a tendency to play follow the leader when big deals are unveiled.

Tank truck carrier executives also have been trying to gain critical mass with their companies. Despite all of the M&A activity over the past three years, the level of industry fragmentation remains virtually unchanged. In 1995, before the merger wave began, the 25 largest carriers in the Modern Bulk Transporter Gross Revenue Report accounted for 58% of the total. By 1998, they were up to 61% of the total, just a 3% change.

Consolidation in the tank truck industry was inevitable, says Lee P Shaffer, president of Kenan Transport Company, Chapel Hill, North Carolina. Over thepast two years, Kenan Transport made two large acquisitions-Transport South and Petro-Chemical Transport-as well as several petroleum marketer fleets.

"We got bigger so we could provide nationwide service to the gasoline marketing sector," he says. "We felt that we had to buy those carriers because a competitor would have if we hadn't. Acquisition offers one of the best avenues for growth in petroleum hauling, and I think you'd hear the same reasons from chemical carriers. The main objective today is to provide customers with total service.

"As a consequence of the big mergers last year, $500 million gross revenue may now be the base for attracting equity financing in this industry. In addition, $100 million is becoming the minimum revenue needed to attract and keep top management and fund adequate levels of training."

Agreement comes from Charles J O'Brien Jr, president and chief executive officer of Quality Distribution Inc, the company created by the MTL Inc/Chemical Leaman Tank Lines merger. "Without question, much of the consolidation among chemical haulers has been driven by the merger trend in the chemical industry," he says. "The trend toward core carriers will continue in the chemical sector, and that will drive more carrier mergers. It is becoming more expensive to be a major transportation player. Carriers need deep pockets to meet customer requirements."

Lewis points to shippers as a major motivation for getting bigger. "They want to deal with fewer suppliers, and that favors big carriers," he says. "In addition, today's carriers must be able to fund larger management teams and new technology. They have to be flexible and be able to meet the special requirements of customers."

Chemical shippers in particular seem to favor bigger tank truck carriers, but that doesn't mean the shippers are strong proponents of tank truck industry consolidation. Shippers are beginning to express greater concern about the levels of M&A activity in the trucking industry.

"Leverage shifts with consolidation, and shippers look for alternatives," says Fred Stephenson, associate professor of distribution at the University of Georgia's Terry College of Business. "The Union Pacific/Southern Pacific Railroad merger taught them that they don't want to put all of their eggs in one basket. We'll never see a day when shippers advocate a significant reduction in the number of tank truck carriers. It's simply not in their best interest."

While the push to get bigger will continue, the tank truck industry is not likely to see many more giant mergers like the one that combined MTL Inc and Chemical Leaman Tank Lines. The key reason is that the industry is just too small, probably totaling no more than $6 billion.

"At most, we may see one or two more attempts to build very large tank truck operations," Lewis says. "Other strategic buyers have looked, but they haven't done anything. The next big rollups will be more challenging because the buyers will have to include quite a few medium-sized carriers. That makes it more time-consuming and expensive."

These strategic buyers are attracted by several factors. For one, they believe trucking has been undermanaged, and they see opportunities to achieve improved economies by implementing tighter fiscal accountability. In addition, transport companies are asset-rich, which helps attract capital.

It may be awhile before the next large-scale merger takes shape. Industry experts speculate that the parties most likely to be involved in the next big round of buyups have paused to see how the Apollo rollup works out.

"It will probably take two to three years before we know how successful Apollo has been," Lewis says. "This is a whole new situation for the industry. Strategic buyers like Apollo want to do a rollup and then take the merged company public or sell it to another buyer. "In contrast, the financial buyers that have been traditionally active in our industry purchase a company to operate it, either independently or as a part of another fleet."

Smaller buyers also appear to be taking a breather. That can be attributed to several reasons, according to Richard Jackim, president of Chapman Associates, a merger and acquisition specialist that focuses on transportation companies.

"Buyers (typically fleets acquiring other fleets) took a breath at about the same time as the stock market correction in late 1998," Jackim says. "This was especially true for those buying properties in the $25 million to $50 million range."

Price may have become somewhat of a chilling factor as the year unfolded. Some in the industry suggest that prices soared too high during last year's merger frenzy. In its 1998 annual report, Trimac Corporation, parent company of Trimac Transportation System, stated that unrealistic price expectations were created by the Apollo rollup.

Rollups are likely to continue, though on a smaller scale. There is still plenty of money available, and lenders are anxious to make deals. Demand for motor carriers in virtually all sectors remains high.

"Consolidation will continue at relatively high levels," Jackim says. "We expect to see more buyers enter the market to do rollups of five to six smaller companies. The buyers are typically two to three times the size of the acquisitions. The buyer's objective is to build an operation with critical mass.

"The biggest question is: can they put these rollups together and keep them going? It's a high-stakes game, and the buyers are taking some big risks."

Another question is: will return on equity and return on investment be improved through M&A activity? Shaffer points out that tank truck carriers achieved an average return on equity of 14.8% in 1997. Average return on investment was 9.3%. "The industry is barely earning the cost of capital," he says.

With the stakes so high, it's crucial that tank fleet managers give careful thought to the role their company will play. Do they want to be a buyer or seller? Do they want to get big or remain a small niche player? Can they meet market needs through alternative arrangements, such as strategic alliances?

Whatever the decision, carriers must have a plan. There is little room for tank truck carriers with management teams that are undecided about where they want to go. Lewis says many acquisitions and mergers will make sense and will prove beneficial for the buyers. The bad deals will become obvious soon enough.

Jackim adds that the current M&A market gives aging owners of tank fleets an opportunity to obtain the equity from their companies for retirement. In a 1998 survey of M&A activity in the trucking industry, 40% of active sellers said they were motivated by a desire to retire. "Selling to another company is the only practical option for many of these people," Jackim says. "Their children don't want the businesses. They have become doctors or lawyers, and they don't want to get their fingers dirty."

Motivations for selling abound, and tank fleet buyers far outnumber sellers, according to the Chapman Associates survey. The highest demand is for companies generating annual revenues between $1 million and $10 million.

However, smaller companies don't need to feel that they have to sell out or find a merger partner. A place for the smaller niche carrier will remain, according to Stephenson.

"Small and mid-sized carriers probably have no reason to be concerned by the consolidation that is taking place," he says. "It's more important to provide good service and focus on satisfying customer needs. Not all customers want the same thing. There are benefits in being a high-value provider.

"The riskiest position is the one held by tank truck carriers in the gray middle. These are mid-sized companies that aren't clearly differentiated in anything they do."

Agreement comes from Lewis, who says there will always be a place for the smaller carriers that are niche players. "These companies provide superb service to a specific customer," he adds. "Once a company reaches $25 million to $30 million, though, the operational complexity starts to build. Top executives must understand where the company is going."

Companies that decide to grow through mergers or acquisitions must tread carefully. "The acquired company must bring something to make the buyer better," Stephenson says. "It's important to watch out for incompatibilities that could distract managers for several years. Brand equity must be protected."

A recent study shows that nearly 60% of all mergers fail to meet expectations and result in lower-than-average returns, according to James Vetter, a principal with Environmental Resources Management (ERM). He directs ERM's new Global Merger & Acquisition Advisory Services.

Along with traditional business drivers, environmental matters can have a material effect on future earnings and business operations if not properly assessed and accounted for during the negotiations. One fleet owner says it's incredible that so many deals are finalized after only a cursory review of environmental liabilities.

ERM recommends an integrated M&A review process, using what it calls a four-step value chain. The process starts with pre-M&A planning to ensure that the foundation is properly laid for future post-acquisition integration and performance.

M&A assessment is the core phase and involves the rapid collection and communication of information to transaction stakeholders to facilitate and close the deal. Equally important, the assessment phase is one in which information is collected that will ensure both smooth integration of the purchased company and the elimination of gaps that will inhibit future performance.

The third phase, post-M&A integration, helps ensure rapid assimilation of the acquired company's environmental, health, and safety functions. The final phase is ongoing operations. As the two companies are put together, the corporate culture is adjusted and modified.

Despite the pitfalls, the quest for growth through mergers and acquisitions will go on. The objective for all acquiring companies is to eventually achieve a reduction in the total number of carriers, providing more leverage for the remaining companies. It's a goal that will be difficult, if not impossible, to achieve.

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MBT staff