Logistics – “The process of planning, implementing and controlling the efficient, effective flow and storage of goods, services and related information from point of origin to point of consumption for the purpose of conforming to customer requirements.”
Small and/or mid-sized businesses often do not have the ability to dedicate time or resources to extensively plan the shipment of goods from their factory to the myriad customers or geographies in their order books. In these circumstances what is required is a cost effective way of outsourcing this task to a reliable company whose specialism is in making this logistical nightmare disappear. Logistics is a mission critical service to a business: late delivery is as bad as no delivery and so manufacturers really do place their reputation in the hands of their logistical providers.
The Business – Radiant Logistics (RLGT – $1.40)
Radiant Logistics is a micro-cap franchise non-asset based third party logistic (3PL) provider. Radiant Logistics, Inc. (NYSE:RLGT) negotiates with transportation providers who offer them favourable and priority rates due to their large purchasing power on behalf of clients. The non-asset based part means that they limit their investments in facilities and transportation equipment. Radiant Logistics, Inc. (NYSE:RLGT)’s average shipment size is considerably larger than might be dealt with by FedEx Corporation (NYSE:FDX) or United Parcel Service, Inc. (NYSE:UPS). Radiant Logistics, Inc. (NYSE:RLGT) provides a turnkey solution for the movement of goods customised to the customers’ needs and taking account of factors such as speed of delivery, special handling requirements and transportation mode.
RLGT’s operations involve obtaining and arranging transport of customers’ freight from point of origin to point of consumption/destination through their network of agent locations. These logistic solutions include inter alia domestic and international freight forwarding and door-to-door delivery services using a wide range of transportation modes (including air, ocean and truck).
RLGT was started with $5m of seed capital by CEO Bohn Crain. Crain raised this capital by doing the rounds with a PowerPoint presentation and a good idea. Crain was actually approached by Private Equity firms to execute this plan but he walked away and did it solo as he didn’t feel they allowed him enough equity participation – he wanted the upside for himself. Although there is an element of organic growth through additional customers and servicing larger shares of existing customers’ logistical needs, the real growth story is one of industry consolidation via acquisition and expansion. RLGT is still of a size where adding small private companies to its network can have a significant impact. Yet it is still large enough to be achieve significant economies of scale and operational leverage. There is a decade long runway for multiplying the current revenue and earnings. The following factors (expanded upon later) below explain why this strategy could work:
- The industry is extremely fragmented;
- Increased profitability as a result of centralised functions reducing costs and new agents;
- RLGT’s global reach may enhance the breadth of offering and improve the pricing that agents can offer to existing client base and;
- “The Gray Tail”
RLGT and how it works in practice:
Ryan O’Connor, at Above Average Odds, believes that
“There are essentially two businesses at work: a franchisor and a freight forwarding business.
For the franchisor, Radiant provides network support through industry leading freight logistics platforms, outsourced back office services (billings and collections, accounting, HR etc) and, most importantly, freight buying power. Franchisees keep 70% of their revenue, the rest goes to Radiant. Interestingly, Radiant withholds 6-8% of franchisees cut to account for bad debt. Franchisees are in a first lost position for bad debts.
Currently, the franchisor role is the biggest piece of what Radiant actually does (though they do have several corporate owned stations). According to CEO Bohn Crain, the corporate overhead is now at a size and operational standing where it can add significantly more franchisors and franchisees without adding any incremental overhead. New agents offer near 100% contribution margins.
Bohn describes Radiant’s freight forwarding business as “freight travel agents.” They buy blocks of transportation services from a wide array of truck, rail, air and shipping providers. They sell this block and provide logistics services to customers needing to ship goods. Domestically these services generate 35% gross margins. Internationally they generate 20% gross margins. The margin is a fixed percent of sales price. While changes in freight costs and shipping inputs indirectly affect margins, it is not a direct impact. Reviewing the business historically, the margins appear to be quite stable at 30%.
Customers generally do not have contracts. Bohn has likened the relationship to any other business service (lawyer, auditor etc) where you have a preferred provider based on a relationship and the customer has an ongoing understanding of what the cost of service is. While he could not quote retention rates off hand, he said they are very high and customer counts are growing (comparing their growth to the industry I buy this).”
RLGT has been acquiring non asset-based freight forwarding franchises. Over the coming years they expect to acquire the underlying franchisee businesses as well and this process has slowly begun. The growth of revenue comes from the addition of new franchisees to the platform and by increasing sales at their franchisees and at the growing number of corporate owned stores. As RLGT grows the network effects of the platform will become more evident and more attractive to new franchisees. For example, when RLGT bought Airgroup they managed to grow sales by 100% in the first year- almost entirely on the back of the addition of new agents.
3PL’s create their advantage by (i) pooling their customers’ orders to create scale and (ii) by eliminating “deadhead” (i.e finding more cargo to ship “back” on the return journey after the first delivery). This process is, in reality, very complicated due to differing (i) starting locations and (ii) timescales for delivery; but it vastly reduces the share of total transportation costs which each manufacturer/customer must pay. The 3PL pays the transporting company directly and then collects from the manufacturers (plus a brokering fee). The industry standard income statement measures are reported as follows:
Revenue (re-sale price of transportation services to customers)
Cost of Transportation (the cost of purchasing the transportation from the carriers)
Net Revenues (the difference between the two from which RLGT then can deduct their costs)
Top-line growth is important but as the bulk purchasing power begins to kick in it will be net revenues that are key.
The Issue of Scale
It is ironic that the 3PL industry has great advantages to scale, and yet, it is one of the most fragmented which I have ever encountered. The largest US based 3PL is C.H. Robinson Worldwide, Inc. (NASDAQ:CHRW) which commands around 2% of the market and has a $10bn market cap. The fragmentation is a reflection of the fragmented industry which they serve – there are more than 1.2m trucking companies (incredible statistic!) in the US and 90% of them operate with six or fewer trucks.
These big players have (i) much lower average fixed costs (IT/administration divided across higher sales) and (ii) wider distribution networks. The foregoing enables them to: earn higher margins, higher ROE, generate cash and command earnings multiples of high-quality and high-growth businesses in at least 10x current year EV/EBITDA.
EBITDA is a good metric for this industry because (i) it approximates free cash flow to the firm and (ii) its most relevant for acquisitions because typically businesses in this sector will be asset light and therefore their depreciation and amortisation are insignificant. If you take that premise and then include interest payments then this means that you can compare companies allowing for their differing capital structures.
The “industry pie” has been growing for the last 15 years at a compound growth rate of around 10%.
The main drivers for this growth rate were described by Torin Eastburn (who, incidentally, alerted me to this opportunity via his phenomenal body of work on 3PL’s) founder at Monte Sol Capital:
“The U.S. 3PL industry was more or less born out of the Motor Carrier Act of 1980. This act deregulated trucking, morphing it from a concentrated and somewhat cozy industry into an extremely fragmented and price-competitive one. The result was an explosion in the number of trucking carriers: there were less than 20,000 in 1980, but there are 1.2 million today. This explosion necessitated a middle man to help the customer navigate the multitude of new trucking options. 3PLs were born, many in the form of truck brokers.
Then came China. Economic initiatives implemented there in 1990 quickly turned the country into the global epicentre of low-cost manufacturing. This made almost all finished goods and components cheaper, but it also added great complexity to global supply chains. Sourcing goods and components, shipping them, storing them, and keeping track of them became something companies no longer wanted (or could) do on their own, so they started hiring 3PLs. In 2001 only 46% of Fortune 500 companies used 3PLs, but today about 85% do.
Finally came computers and the internet. Software has enabled great advances in the efficiency of logistics and distribution.”