Supply Chain Company Valuations – Part 3

Previously we examined T&L company valuations from several different perspectives. We learned SCCs weathered the storm better than most and recuperated more rapidly than all other T&L segments. Today, SCCs are poised at relatively high valuation metrics compared with their past. In this last article, we examine what it will take for the valuation metrics to go even higher.

Valuation Basics
Are even higher multiples are likely? Let’s look at the basics first. For higher multiples, companies need to produce faster, sustainable earnings and EBITDA growth with a lower cost of capital. This requires companies to do one or more of the following:

• Increase their growth rates (e.g. through market growth, share gains, new segments, price adjustments)

• Improve operating margins (e.g. by leveraging fixed costs, reducing and streamlining operating costs, exiting high cost segments or customers)

• Reduce their cost of capital (e.g. by increasing or refinancing debt)

• Limit their capital expenditures

These items are not totally controlled by the companies. For example, a debt crisis could easily raise the cost of debt substantially, raise the cost of capital, and reduce valuation multiples. Tax rates and depreciation policies also are examples of things beyond manager’s control but which could significantly affect depreciation, amortization, and costs of equity that all could change likely multiples.

Looking at the SCCs, this industry segment could increase the cash flows available at an above average rate. The companies have grown revenues and EBITDA through this period. With a return to a more normal market, growth at an above average rate is quite possible. In fact, supply chains are an increasingly critical strategic component to many. Operating margins could increase as the demand for incremental and new services outstrips the fixed costs and more SaaS (Systems As A Solution) applications are added to their service mix. Unfortunately, capital costs are unlikely to be reduced, with interest rates more likely to increase. Adding debt to reduce costs is possible given the sectors low relative debt, particularly if operating margins remain stable or increase and are not to volatile. Finally, capital expenditures are not a major factor except for acquisitions which add revenues and opportunities for earning growth. Therefore, it is quite possible that multiples could go higher barring another broad recession or a significant increase in interest rates as the economy grapples with US debt repayments and the budget.

Supply Chain Company Valuation Outlook
Looking to the next year or two, sellers and buyers will likely have some diverging interests that could result in above average deal closings. From the sellers’ position, multiples have returned and capital is still limited, and competition continues to demand more investment and resources to defend market shares and enhance competitive positioning. And, within the next 18 months the Bush tax policies will likely be changed and are likely to reduce the value of corporate earnings and equity making sales more attractive before the changes take place.

Buyers need growth beyond what the slow recovery offers to enhance their valuations. Supply chain management is still in its growth phase, hence companies offering solutions to better manage supply chains and their components should remain in demand. SCCs will need to add services and products to expand their market share and be more relevant to customers. Volume through acquisitions provides revenue as well as cost reduction opportunities and will likely be a key part of their longer term strategies. Virtually all of the SCCs closing deals in the first quarter were software companies, often times in niche specialty services or segments of the industry. Time will tell if this is a new starting point for supply chain M&A activity, but all the signs suggest activity will remain high for the foreseeable future in the absence of a double dip recession.

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