Tuesday, July 24, 2007

Con-way and CFI: Ego Trumps Logic

To the credit of both companies, no one saw this deal coming; an apt tribute to their respective low key styles. Publicly traded Con-way, Inc. born of the legendary and now defunct Consolidated Freightways quietly outfoxed the Teamsters back in the 90’s to emerge as a leading non-union LTL carrier. Privately held CFI grew from two trailers in 1951 into a truckload powerhouse. This company understood the power and privilege of private equity years before anyone on Wall Street ever heard of the concept.

So we have two companies that play their cards close to the vest. A good cultural start, but does anything else about this deal make sense? In a nutshell: no. Let us start with the $750 million price tag. Con-way overpaid by close to $350 million. Reasonable estimates place CFI’s revenues at $450 million with an 88% operating ratio. That gives them a bottom line before taxes of roughly $54 million and an after tax (figure FIT at 35%) profit of $35 million. Con-way’s stock presently sells for an after tax PE of 11.65. That makes the value of CFI’s incremental earnings closer to $400 million. At $750 million CFI generates a PE of 21. Classic merger theory calls for the acquiring company to target a candidate with a lower PE to its own. That way the purchased earnings cost less in a relative sense to the value the market assigns to internally generated profit. In this case Con-way has paid considerably more than the cost of internal earnings. And it has done so in the midst of a very difficult truckload market. Rates are falling. Freight has become harder to find. These factors could adversely affect CFI’s earnings over the near term making this deal even more expensive for Con-way.

Let us then examine the potential for cost savings. Perhaps this deal still makes sense from that standpoint? Not. Aside from plans to close Con-way’s relatively small truckload division in Memphis, there is no potential for cost savings. Sure we hear talk about how Con-way accounts for 6% of CFI’s business and the synergy to come in offering one stop shopping to shippers. On the surface it sounds good, but at the core this deal consists of an LTL carrier buying a TL carrier. They’re both in the trucking business, but unlike say a retail banking merger the operations do not overlap. This acquisition amounts to a classic horizontal combination at a time when global economic forces dictate the exact opposite strategy. You do not see too many companies (think U.S. automotive) snapping up their suppliers at premium prices these days. Generalization is out. Specialization is in.

Con-way’s management has placed a huge bet on squeezing more blood out of the CFI turnip. This bet looks shakey. CFI already performs better than the average truckload carrier. Con-way will have to drill pretty deep to pump out an additional $350 million in value for its shareholders. Unfortunately for them, this deal seems more driven by managerial ego than logic. Time will tell.

Thanks for checking in…

Ed Campbell, III