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This Merger of Unequals Works by Keeping Truckers Happy

April 12, 2017
The merger of Swift and Knight will help the combined company handle a shortening of the supply chain driven by e-commerce retailers' same-day delivery promises.

Mergers of equals are rarely all that equal and Knight Transportation Inc.'s combination with Swift Transportation Co. is no exception. But the trucking tie-up is still a deal constituents on both sides can appreciate.

The all-stock transaction announced by the two companies on  April 10 implied a valuation for Swift of $22.07, or nearly $4 billion including debt and the company's class B shares, based on last week's closing prices. That modest 10% premium falls well short of the $25-plus range that Swift commanded as recently as December, a price that analysts had been predicting it would reach again on its own over the next year.

While Swift will account for about two-thirds of the combined company's EBITDA, its shareholders are getting just 54% of the equity.

On the surface of it, Knight appears to be making out like a bandit. The real payoff for Swift holders, though, is less about today's premium and more about the value created by becoming part of a stronger trucking giant. It may have been the bigger merger partner, but it wasn't necessarily better. Swift's adjusted operating ratio, a measure of profitability in which a lower number is better, stood at 92.9% last year, compared to Knight's 85.3%.

By closing that gap and making other improvements, Knight, the acquirer for accounting purposes, thinks it can double the companies' combined pre-announcement market value to about $10 billion over the next three years. It's an admittedly squishier pitch than a straight premium, but there's reason to think it just might work.

Trucking companies have been having a rough go of it lately as weak demand fails to soak up a capacity glut, limiting what carriers can charge for their services. On April 10, both Swift and Knight also said first-quarter adjusted earnings per share would fall short of guidance and lowered their forecasts for the second quarter, citing the ongoing "difficult" operating environment.

The merger can't make the truck market rebound, but old-fashioned economies of scale will go some way in helping to shore up the combined company's ability to raise prices once there is stabilization. Better purchasing power and overhead savings, meanwhile, could help it weather the current margin pinch.

One quick way to ease the overcapacity issue would be consolidation of the two companies' capabilities. But, in a twist, Knight said it intends to operate the brands separately and doesn't anticipate major terminal shutdowns. The idea is that geographic scale will help the company handle a shortening of the supply-chain driven by Inc. and other e-commerce retailers' same-day delivery promises. E-commerce has been a double-edged sword for logistics companies, with the shorter, more disparate routes pressuring profits even as the boon in shipments aids revenue.

Blanketing the country in outposts has the side benefit of making drivers' jobs more convenient by keeping them closer to home. The relative dearth of drivers amid competition from other transportation industries means prioritizing their happiness is a smart move.

But the strategy also speaks to Swift and Knight's efforts to avoid the culture clashes that have felled past mega-mergers. Knight's founders used to work for Swift before launching their own trucking company and both are based in the Phoenix area. In contrast to high-profile management struggles at cement makers Lafarge SA and Holcim Ltd. and health insurers Cigna Corp. and Anthem Inc., this appears to have been a peaceful transfer of power. Swift founder and controlling shareholder Jerry Moyes has agreed to tender his class B shares at the same exchange rate offered to minority holders and to vote his stake in favor of the deal. Swift's chief executive officer and chief financial officer are choosing to pursue different opportunities while Knight's CEO, CFO, chairman and the rest of the Knight board will continue in their roles. Swift will add four board members.

Could Swift have pushed for a bigger payout? Maybe. But there's something to be said for cultural fit in light of mega-mergers' poor success rate. The onus will now be on Knight's management team to prove it can capitalize on a significantly larger business. For now, shareholders are cheering them on.

By Brooke Sutherland

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