‘The broker wars’: Big bets pit new entrants against incumbents

Redwood Logistics' brokerage floor in Chicago.

The new competitive landscape of U.S. freight brokerage has been years in the making, but now it’s one of Wall Street’s favorite themes.

Bank of America Merrill Lynch transportation analyst Ken Hoexter published a client note on Tuesday titled “Primer: Broker Wars, Part I: Tech disruption & pricing wars shift landscape.” Hoexter focuses on the core metrics of growth, margins and tech adoption, highlighting the mobile app horse race. As Hoexter points out, it’s one thing to get carriers to download an app, but it’s quite another to drive enough operational efficiency to grow earnings on narrowing margins.

“The main near-term disruptive threat to the brokerage industry is pricing,” Hoexter wrote. “Pricing is being used by well-funded new entrants to gain scale by operating at thin or negative margins. This behavior risks triggering a race to the bottom, as established brokers, long accustomed to mid-to upper-teens net revenue margins, and mid-single digit operating margins, now see those profits at risk.”

The freight brokerage game is changing faster than ever. Uber Freight is now operating in five countries and building out a massive brokerage floor in Chicago. Convoy raised $400 million at a valuation of $2.75 billion. GlobalTranz and Nolan Transportation Group both recently entered the $1 billion revenue club. Mode Transportation bought SunTeckTTS in the largest private equity-backed merger of 2019. Redwood Logistics closed the Strive and LTX deals, launched Connect 2.0, and partnered with Truckstop.com on a new auction concept, Book it Now. Transplace made end-to-end visibility a platform-wide standard, free of charge.

On the other end of the scale, smaller brokerages are pursuing a variety of strategies to grow faster than the industry and take market share. Chattanooga, Tennessee’s Trident Transport, pursuing a tried-and-true strategy, opened new branches in Tampa, Florida, and Minneapolis. Meanwhile, Chicago’s Edge Logistics launched a digital freight-matching platform for its customers and carriers.

New venture capital-backed startups like Emerge and Turvo are democratizing access to the newest technology. Specialty services like near-shore staffing and asset-based lenders are catering directly to high-growth freight brokerages, helping them free up cash and grow even faster.

Even industry veterans are reemerging with new projects. Eddie Leshin, a veteran of American Backhaulers and Coyote, returned from private equity to lead the new Anthym Logistics, born of a merger of Atomic Transportation and Cousins Logistics. Leshin’s old partners, Jeff Silver and Paul Loeb, have founded their own software company, Mastery Logistics Systems.

But publicly traded brokerages are under increasing pressure, hence the theme of Hoexter’s note.

XPO Logistics (NYSE: XPO) is exploring a divestment of four business lines to become a pure-play less-than-truckload carrier, a divestment that presumably would include its freight brokerage business. CEO Brad Jacobs said XPO is paying a “conglomerate discount” because public markets are not correctly valuing the freight forwarding, brokerage and final-mile divisions of the company.

C.H. Robinson (NASDAQ: CHRW) struggled in the fourth quarter of 2019, its profits slashed by 45% year-over-year. Hoexter wrote that Robinson has lost market share for the past 10 quarters straight. The giant of Eden Prairie, Minnesota, is betting $1 billion over the next five years that technology investment will make its brokers productive enough to offset narrower margins.

Susquehanna’s Bascome Majors fretted about what potentially permanently higher technology and administrative spend would do to operating margins, writing “the spend is not your friend” in a post-earnings client note; Goldman Sachs’ Jordan Alliger cut his CHRW price target to $65.

Notably, Alliger did not cite competitive pressures from new entrants as a risk to Robinson’s business, instead anticipating margin compression from spot rates rising against lower contract rates.

“We remain concerned that 2020 will be tough to gain traction for the broker business — with the near term impacted by ongoing price pressure, and possible soft contract re-price environment due to competitive pressures and still soft spot volumes,” Alliger wrote.

J.B. Hunt’s (NASDAQ: JBHT) brokerage, Integrated Capacity Solutions (ICS), ran at a loss in the fourth quarter of 2019, deeper than the loss it posted in the third quarter. Hunt is investing heavily in technology to drive freight and capacity into its J.B. Hunt 360 platform, which Hoexter noted earned the highest marks in user experience and service/reliability in a survey.

At the same time, digital freight brokerages are experiencing explosive growth — also at the expense of steep losses. When UBS internet analyst Eric Sheridan initiated coverage of Uber on Tuesday, he estimated that Uber Freight would haul in revenue exceeding $2 billion in 2021. Uber Technologies (NYSE: UBER) reports fourth-quarter earnings on Feb. 6, but in the third quarter, Freight lost $81 million.

In our view, publicly traded logistics companies may be at something of a disadvantage to privately held 3PLs when it comes to growth.

While venture capitalists have reemphasized gross margins and unit economics post-WeWork, VC-backed startups are still encouraged to burn cash to grow faster. Although private equity firms care most about profit growth — as measured by earnings before interest, taxes, depreciation and amortization (EBITDA) — rich private valuations and low interest rates have made it easier to execute accretive rollups. Private equity limited partners’ capital is locked up for years, too, encouraging a long-term view of their investments.

Publicly traded logistics providers, on the other hand, have to strike a delicate balance between growth and profitability to build lasting equity value. If they lean too hard into growth during the troughs of the freight cycle, their earnings collapse, and they risk being traded like deep cyclical asset-based names.

“Freight brokerage is an extremely fragmented and competitive market,” commented Matt Pyatt, CEO of Austin, Texas-based Arrive Logistics, a private, 5-year-old brokerage that topped $525 million in 2019 revenue. “Significant investments in technology by well-capitalized companies are causing increased pressure for the entire logistics space to modernize. The opportunity continues to be with companies that innovate towards best-in-class service, technology and scale.”

For publicly traded 3PLs that have to open their books every 90 days, it’s getting harder to thread the needle.