DSV

“Is DSV a target for private equity?”

I skipped the small talk and went straight to the point with investors and bankers with whom I have talked since the turn of the year.

Many of them seemed to think I have become overly ambitious when it came to trying to predict consolidation and strategic trends among freight forwarders, although some argued strongly that capital arbitrage and solid growth rates made the Danish freight forwarder palatable.

A change of ownership may not be not imminent, I countered, but there are a few compelling reasons to look at DSV as a takeover target: in particular, a sale to a financial sponsor could be reasonable once the benefits stemming from the integration of UTi Wordlwide become less effective and all restructuring costs are absorbed.

DSV Restructuring Costs (source DSV)

DSV Restructuring Costs (source DSV)

Prey or predator?

That was another obvious question that sprang to mind, and I found consensus among my sources: DSV will continue to buy rather than build.

DSV, too, stated last week it would continue to be acquisitive to deliver shareholder value. Where will it bulk up, though?

One debt investor in London kindly flashed a Bloomberg headline on Friday, which read: “DSV CEO may be interested in US road M&A once UTi is digested.”

While road trends there are encouraging, DSV has also been sniffing around some air and ocean assets in recent times, chasing UTi-like deals, albeit on a smaller scale, I have heard. And this is another reason why capital arbitrageurs could team up with existing managers, attracted to the idea of taking it private, while growing it inorganically over a typical three-to-five-year holding period for private equity.

Its latest results, published on 10 February, confirm that the executive team is doing a great job, which means a management buyout (MBO), backed by a couple of financial sponsors, could make a lot of sense, with each PE house committing $1.2bn, based on my assumptions.

Cash flow

DSV has become a mildly leveraged entity since it bought UTi, and seems to continue to reap the benefits of more profitable accounts than those of its rivals, shrugging off cyclical headwinds.

Unexpectedly – to me, at least – its managers are not in a hurry to cut operating costs, particularly the headcount, the biggest expense of all. But that, again, is something that private equity would be pleased to look at if a deal were hammered out.

Assuming a 30% premium to current levels, for an implied take-out value of almost $12bn for its equity, a buyout financed up to 80% by debt could deliver awesome returns, in terms of so-called “IRR” – or internal rate of return, against which private equity’s performance is measured – over a five-year horizon (2018-2022), while net leverage would pose little problem.

Value and growth

A skyrocketing valuation conjures against a change of ownership, as DSV stock trades at 25x earnings for 2017.

But if managers keep delivering as they have since UTi was snapped up, those multiples will likely fall rapidly – hence its equity might become significantly cheaper, based on a constant share price.

On Friday, it hit a record high of Dkr343, while in early trading yesterday its stock rose again to a new high of Dkr348, and today it changed hands at Dkr355. However, value creation from this level, in my opinion, remains very challenging unless it surprises investors with some other meaningful M&A-related action.

I am less inclined to suggest a trade sale to a competitor by 2018 , although recently debated dynamics that might challenge freight forwarders could certainly help speed up consolidation among the top 20 logistics service providers, where CEVA stands out as the most likely target, followed by Panalpina and Expeditors.

Results

Its shares struggled to find direction when DSV reported its trading update last week, ending up 1% on Friday, which was below the record high it recorded intraday.

Market reaction was less enthusiastic than in many other previous occasions on the day of the quarterly announcement, and its performance in air and sea – the core revenue driver with Dkr32bn of annual sale – is partly to blame, in my view, due to a “temporary margin squeeze” in the fourth quarter.

DSV Air and Sea (source DSV)

DSV Air and Sea (source DSV)

Its road activities experienced some pressure on gross margins, while profitability figures were acceptable in its smaller solutions unit, as the two tables below show.

DSV Road (source DSV)

DSV Road (source DSV)

DSV Solutions (source DSV)

DSV Solutions (source DSV)

These metrics matter a lot, because returns need expanding margins to rise, among other things, as well as a wise capital allocation strategy, of which DSV management is proving capable, although the short-term pain shows in its bottom line, conversion ratio and operating margin.

DSV P&L and financial ratios (source DSV)

DSV P&L and financial ratios (source DSV)

However, adjusted cash flows and debt metrics look strong, while projections for 2017 are truly enticing, as the two following excerpts indicate.

DSV debt and cash flows (source DSV)

DSV debt and cash flows (source DSV)

DSV Outlook (source DSV)

DSV Outlook (source DSV)

On this basis, DSV ought to be considered as a must-have, asset-light company in any private equity portfolio.

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