Forward Air’s latest deal spooks customers, investors

In addition to the throng of analysts who don’t like Forward Air’s latest acquisition, some of its core customers have concerns over how they will now fit into its new business model, which appears to position them not only as customers but as competitors.

Forward (NASDAQ: FWRD) announced on Aug. 10 it had entered into an agreement to merge with forwarder Omni Logistics in a deal that will double its size. Forward is essentially acquiring one of its forwarding customers, which has its other legacy customers concerned. In the process, it will take on a large debt load and further diversify its services portfolio, which has Wall Street concerned.

Forward’s existing customers rattled

Over the past year, Forward had begun selling directly to shippers, eliminating the intermediary in efforts to increase per-transaction revenue and improve margins. Forward’s management said in the past that removing the middleman doubles margins.

FreightWaves spoke with some of Forward’s customers on condition of anonymity as they don’t want to jeopardize their relationship with the company. The group didn’t have a real problem with Forward’s prior direct-selling efforts because the company was targeting small and midsize businesses and revenue from those efforts would likely equal just $100 million over the next few years.

However, the vertical integration of a forwarder changes that.

Omni is a direct competitor to Forward’s existing forwarding customers, generating $1.6 billion in annual revenue. All of them rely heavily on Forward’s linehaul network. The combination could potentially provide Omni with Forward’s existing customer list as well as years of account-level shipment data (lanes, pricing, tonnage, etc.), which would be detrimental during an RFP bidding process.

Forward said that wouldn’t be the case when it announced the deal.

“Forward will service our wholesale community of customers independent from Omni and will go to market with two separate sales and support teams — maintaining confidentiality and neutrality across our sales channels,” the company stated in a supplemental presentation on Aug. 13.

“Why wouldn’t Forward Air share that information because they have to unlock the value of this deal,” a CEO of a large forwarding company said. “That’s what they bought. They bought the opportunity to be able to take all of that information that they’ve gathered over a number of years and feed it to Omni and let them go direct to the shippers.”

These forwarders also see Omni competing in the market with actual assets — Forward’s linehaul network. They imagine a scenario in which they would be second in line for Forward’s capacity when the market tightens. They said the deal will also make it harder to compete on pricing against Omni.

This statement from Forward rankled some of its customers: “The acquisition removes an organization’s gross margin between shipper and destination, allowing Forward to go directly to shippers while maintaining and growing with historic wholesale customers.”

“Well, that’s exactly what the forwarders don’t want,” the source said. “They’re going to gamble 90% of their customers for 10% [Omni]. Does that make sense?”

Another forwarder CEO said their company will likely be “forced to keep working with Forward” in the interim given a dearth of wholesale linehaul capacity in the market. “[Forward is] no longer an extension of our operation; it’s now a direct competitor.”

A similar transaction occurred when forwarder Pilot Freight Services acquired American Linehaul, which was also an airport-to-airport LTL provider serving the forwarding community. Many forwarders use this option as a cheaper and sometimes faster way to position shipments that move by air.

Since then, Forward Air has acquired Land Air Express, which rolled 25 terminals under its umbrella.

“Maybe they did gamble on the fact that they would lose their top clients and the rest would have nowhere else to go,” another forwarding chief said. “They are going to be surprised at how quickly customers have pivoted and companies have moved into setting up their own linehaul network to compete.”

All of the forwarders said regional linehaul providers will see strong support from the forwarding community given Forward’s latest move but acknowledged it will take time to replicate its scale.

“You’re now starting to see collaboration [among forwarders] that wasn’t there before … being forced upon all of us because of Forward’s arrogance frankly.”

Forward describes itself as the “only national expedited LTL network” and said the deal positions the company for “long-term growth of its LTL business model for shipments of consequence by expanding the customer base to include shippers, 3PL, forwarders and airlines.”

Wall Street doesn’t like the deal either

Investors sold shares the day of the announcement, but the stock was only off 5% from the prior closing price of $110. However, as analysts began to weigh in with ratings downgrades, shares plummeted. The stock is now off 43% to $63 per share since the deal was announced, compared to the S&P 500, which is down just 1%.

Some of the pressure on Forward’s shares is due to the dilution to existing shareholders. The company will have to raise its share count by 60% to account for a 37.7% equity stake due to Omni shareholders. The rest of the deal consideration includes $150 million in cash.

Some analysts said further model diversification — this time into forwarding, customs brokerage, and warehousing and distribution services — muddies Forward’s path to being valued by investors as a provider of high-margin, premium LTL transportation services.

The company saw earnings jump 60% last year as it executed a more traditional LTL offering, focused on heavier, higher-valued shipments. The 2022 result of $194 million in net income was also more than $100 million higher than the prior cycle peak in 2018.

While noting the cost and revenue synergies gained by removing the middleman, some analysts said the Omni deal is just too expensive.

Based on the $110 share price, the deal was struck at a $3.2 billion enterprise value, 17.9 times trailing 12 months’ adjusted earnings before interest, taxes, depreciation and amortization. Cost and revenue synergies are expected to total a $125 million adjusted EBITDA run rate by the end of 2025, with the first $60 million being realized within six months of closing. Baking in the synergies, the initial deal valuation was 10.6x adjusted EBITDA.

However, with the stock’s recent selloff, the enterprise value has fallen to roughly $2.5 billion — 14 times adjusted EBITDA without the deal synergies, and 8 times with. The to-be-issued share count is fixed at 15.8 million and will not be adjusted to equal a certain dollar amount at closing.

Forward expects the deal to generate “meaningful cash EPS accretion” over time. It will be 5% dilutive in 2024 with accretion of 9% and 16% in 2025 and 2026, respectively.

Susquehanna Financial Group equities analyst Bascome Majors was more constructive on the transaction than most but acknowledged, “the board crossed the Rubicon on both leverage and governance to buy Omni.”

Omni generated just $8 million in EBITDA before adjustments in the first half of this year and was listed with $1.4 billion in net debt.

On the governance side, Forward will give Omni four board seats and the role of president. Also, Forward’s shareholders will not have a vote on the transaction. They will only have the option to reject a conversion of the nonvoting preferred shares offered in the deal. However, if they don’t approve the conversion to common stock following the closing, those shares would be paid a steep dividend.

The company will also leverage up to fund the deal.

Forward will refinance the debt of both companies as part of the transaction. New outstanding debt will equal $1.9 billion, and its leverage (net debt-to-trailing 12 months’ adjusted EBITDA) will jump to 3.8x at closing (3.3x including the $75 million in cost synergies). Further, EBITDA generation has slowed, potentially making the leverage metric worse if the trend holds. Adjusted EBITDA from the two companies for the first half of 2023 was less than 40% of the total generated over the past 12 months.

Forward is expected to deleverage to less than 2x within two years of the closing.

“We believe the rejection of FWRD shares in recent days is more about the board’s tactics of exhausting the company’s considerable dry powder to bet its future on an asset-light diversification and customer acquisition play, while not offering existing shareholders a voice or vote on the matter before the deal closes,” Majors said.

He maintained a “positive” rating on the stock, unlike half of the analysts who downgraded it, but acknowledged he was still “a little nervous from the fall.” He said the move into end customer (shipper) relationships versus its legacy role as a wholesaler of linehaul capacity will likely solve the company’s limited organic growth catalysts.

He expects the company to generate $522 million in adjusted EBITDA in 2024, 11% higher than the growth rate over the past 12 months.

“If the deal works, value should compound longer term,” Majors said. “If it doesn’t, FWRD could see an earlier jolt from outside agitation,” referring to existing or activist investors getting involved to change the course of the company.

Investor tells Forward to get out of the deal

A Monday open letter from ClearBridge Investments, which owns a 4% stake in Forward Air, called on the company to cancel the transaction.

“Simply put, this acquisition appears too big and too complicated. We urge the Board and management to outright cancel the transaction.”

The firm expressed concern over the potential for Forward to lose customers and questioned how integrating a forwarding operation would “lead to significant incremental traffic into Forward Air’s network.”

ClearBridge said the deal deviates from Forward’s capital allocation strategy, which has included smaller, tuck-in acquisitions and noted “substantial operating execution risk” as both Forward and Omni have recently grown meaningfully through M&A.

“The absence of shareholder approval with close to 40% of pro forma equity in the hands of Omni’s owners was poorly conceived,” the letter read. “The resultant collapse of the Forward stock (with multiple downgrades from industry analysts expressing puzzlement over the resulting complexity) is in part reaction to this feature of the transaction.”

However, insiders at Forward have doubled down on the transaction, buying up shares of Forward Air in the past week at the reduced prices. Forward Chairman, President and CEO Tom Schmitt purchased $1 million of Forward’s stock (16,000 shares) to go along with the 58,000 shares he already owned.

Omni’s shareholders plan to roll more than 90% of their ownership into Forward’s stock as well, the presentation showed.

Management’s decisions have faced scrutiny in the past

Executives and the board were publicly criticized in 2021 by an activist investor group that included Forward’s founder and former CEO, Scott Niswonger. The group was concerned with the company’s capital deployment strategy that had grown to include the acquisition of intermodal, drayage and final-mile companies. The expansion into noncore operations and away from its legacy expedited airfreight business was blamed for diluting margins and investment returns.

After acquiring a 6% ownership stake, the activist investor was able to reshape Forward’s board, which included a seat for Niswonger. However, the group has unwound its position since and the day the Omni transaction was announced, Niswonger resigned from the board.

The Omni acquisition is expected to close in the back half of this year.

Forward Air was not able to provide a comment as of publication.

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