Value Investors Club / DASEKE INC (DSKE)

Description

Daseke, Inc. (pronounced DAAS-kee) has never been written up on VIC and offers investors a unique opportunity to make 50% (with multi-bagger potential over the next few years), as a well-regarded mgmt team executes the Brad Jacobs XPO playbook in a small but interesting niche of the transportation market.

The stock is down 35% in 2018 due to a botched follow-on offering in February followed by a mildly soft Q4 print. I think shares are conservatively worth ~$14 (+50%) today with additional upside as the company continues to scale and becomes an actionable investment for larger institutional investors.

Key investment considerations:

1) industry leader with a unique opportunity to consolidate a highly fragmented industry in desperate need of consolidation

2) regulatory environment is becoming increasingly favorable to players with scale

3) industry fundamentals continue to inflect positively after a rough 2016

4) exploiting a meaningful public / private market arbitrage opportunity

5) Daseke's status as the preferred buyer in transactions

6) strong insider alignment / SPAC sponsor with a good pedigree

7) attractive valuation

8) reasons for mispricing are clear

Daseke, founded in 2008 by Don Daseke, is N. America’s largest pure-play open deck carrier. For those unfamiliar with this niche of the transportation market, the open deck niche is just what it sounds like: loads secured atop trailer decks without sides or a roof. The specialized nature of the loads typically hauled by open-deck carriers requires handling expertise and familiarity with special permitting requirements for such loads. As a result, shippers are generally less sensitive to price when shipping these products compared with shippers sending more traditional items in Dry Vans / Reefers. The end-market revenue mix is well-diversified and no individual customer represents more than 10% of sales. The 10 largest customers represent 30% of sales and have 20+-year relationships with Daseke.

Recognizing the consolidation opportunity in front of him, Don Daseke has taken the company from $30m revenue and $6m in Ebitda in 2009 to $1.3B in revenue and $140m in Ebitda currently by methodically rolling up the industry (17 deals since 2009). In Feb 2017, Daseke went public via a SPAC with Hennessy Capital in an effort to accelerate the pace of the roll up. All went according to plan and the stock traded above $14/share as recently as 10 weeks ago, but a botched equity offering and a mildly soft Q4 print sent the relatively illiquid stock down over 40% to the low $8s.

Though the stock has begun to recover after this week's Q1 print, I believe the stock is still meaningfully undervalued and lay out the investment case below. First, some simple background. The business comprises two segments: 1) Flatbed Solutions (43% of sales), which offers transportation and logistical solutions for traditional flat-bed products and 2) Specialized Solutions (57% of sales), which focuses on non-commoditized, time-sensitive, high-value, super heavy haul, over-dimensional items (think airplane wings, oil sands vessels, etc.). Daseke's sales are roughly split between asset-based activities (company-owned trucks/trailers) at 49% and asset-light offerings (brokerage, owner operator) at 51%. This "asset right" mix enables Daseke to retain control over equipment quality/availability and consistency in service levels, while also retaining flexibility in managing demand fluctuations and expanding capacity when necessary with minimal incremental investment. The asset-based business offers higher margin potential that comes with a larger fixed cost base, while asset-light operations offer a higher ROIC, given minimal incremental capital required. Asset-based and asset-light operations are both roughly 50% of sales, though they are not broken out separately within the two reported segments. Finally, it is worth noting that given that open-deck trucking is an outdoor sport, there is more seasonality in DSKE’s business than in other transportation niches, with Q2/Q3 typically the strongest quarters.

1) Unique consolidation Opportunity

The open-deck flat-bed US market is estimated to be $133B and growing at ~9% annually, but despite being an industry leader, DSKE currently has <1% share. The open deck market niche is served primarily by private, mom-and-pop, sub-scale operators. To give some context, over 99% of players (that's 50,000+ companies) operate a fleet of fewer than 100 trucks, compared with Daseke's 5,000+ tractors and 11,000+ specialized trailers. I struggle to come up with other industry leaders with such insignificant market share.

2) Regulatory environment leaves DSKE ideally suited to consolidate

Sub-scale operators are suffering under an increasingly unfriendly operating environment. Ever more safety and environmental regulations have created a powerful incentive for the "little guys" to sell:

a) Mandated ELDs:

Mandated Electronic Logging Devices went into effect for the industry in December of 2017. These devices will replace the paper logbooks many truckers have used to document compliance with Hours of Service (HOS) requirements. Going forward, ELDs will cripple the ability of truckers to operate outside of prescribed limits on driving hours, which was a source of meaningful profit on which many of the smaller trucking outfits have historically relied. Industry analysts expect ELDs to take 3% out of industry capacity, which bodes well for industry pricing but increases costs for sub-scale operators. Most of Daseke's fleet is already equipped with these devices.

b) Scaled carriers offer significant advantages over the competition:

1) Customer demands: national customers strongly prefer working with national carriers.

2) Insurance: cost of large liability coverage is particularly cumbersome for smaller carriers with a small fleet

3) Greater capacity leads to higher levels of service

4) Stronger purchasing power

5) Better positioned to deal with future safety/environmental regulations

6) Receive more favorable terms for capital and enjoy better access to public markets

7) No customer concentration issues (a particularly heavy burden for sub-scale carriers)

With the walls closing in on smaller operators, there is a strong incentive to sell before it’s too late.

3) Industry fundamentals inflecting positively

2016 was a challenging year for tricking fundamentals, as weak energy markets reduced demand for the transportation of energy-related goods. Since 2017, according to dat.com, spot pricing has grown steadily and is expected to remain strong, especially in light of the capacity restricting regulations impacting the industry (ELDs).

source: dat.com

Additionally, flatbed load-to-truck ratios have surged in 2018, reflecting strong industry demand.

source: dat.com

While the vast majority of Daseke's pricing is contracted, roughly 90% of the business reprices annually (typically 60% in 1H), so spot rates serve as a good leading indicator for Daseke's contract pricing. We saw this effect starting to take hold in Q1 and strong spot rates should continue to drive organic growth for the remainder of the year.

Finally, a strong ISM manufacturing index thus far in 2018 indicates additional industry improvement.

4) Public / private multiple arbitrage

Daseke currently trades for 7x forward EBITDA but typically purchases companies for ~5x on a pre-synergy basis. The most recent transactions have been at slightly higher multiples, but they have been more asset-light businesses that typically trade at higher multiples and, again, do not reflect expected synergies. For example, the most recent transaction (Aveda) has a headline multiple of 8.1x ttm EBITDA, but Aveda's Q1 EBITDA (disclosed with the transaction announcement) puts the Q1 run-rate multiple at 7.1x, and management indicated on the call that Aveda is seeing consistent sequential growth in EBITDA, a NTM multiple would be more like 6x, and that they ultimately expect the synergized multiple to be 5x.

5) DSKE as preferred buyer

As the only public company actively rolling up the open deck industry, DSKE’s scale and access to capital markets make it a logical choice for buyers. With an effectively endless pipeline of acquisition opportunities in front of it, Daseke does not participate in competitive auctions, and the management teams at the acquired companies stay on at Daseke in virtually every deal. In many cases, the management teams recognize that becoming a part of the Daseke organization ensures survival, as Daseke’s scale provides a powerful buffer against regulatory constraints. As such, Daseke's transactions are frequently the result of sellers who have reached out to them.

Daseke management has also demonstrated its capable of integrating their acquisitions quickly and effectively. With 17 deals since 2009, Daseke has generated organic EBITDA growth of its acquired companies of 20% on average within 24 months of closing. Daseke does this via a combination of rate optimization, purchase consolidation, and customer extension across the platform.

6) Strong management / insider alignment

There is unusually strong shareholder / management alignment relative to typical SPACs:

a) Don Daseke sold no shares in IPO and owns roughly 30% of the company.

b) Lock-up: as part of the deal, Don agreed to a 3-year lock-up on his shares. 2 years currently remain.

c) Unique earnout structure: DSKE management is entitled to receive an additional 15m shares of common stock providing the company meets certain adjusted EBITDA growth targets and certain share price thresholds. Specifically, the stock price must trade at $12/share in 2017, $14/share in 2018, and $16/share in 2019 (for any 20 days within any consecutive 30 period during such year).

d) Hennessy Capital, the SPAC sponsor, has a solid track record (they took BLBD public and it was 2015's best performing SPAC).

7) Attractive valuation

Daseke currently trades at 7x pro-forma 2018 EBITDA, which I feel is too low for a company with such a consolidation opportunity in front of it and better organic growth than most of its peers. Some investors prefer to compare the multiples of Daseke's asset-heavy and asset-light peers and arrive at a valuation using a blended multiple based on Daseke's asset mix. I prefer not to use this method, as it feels like a lot of false precision and there are significant differences between Daseke and its peers. Daseke's products are less commoditized than those of the TL and LTL operators, and despite the fact that it is an industry leader and value-add consolidator that has already achieved scale, it is still in the very early innings of executing on a sustainable growth opportunity. Daseke will likely be a multi-billion dollar company in 3-5 years, and as it increases its scale advantages, the multiple should only grind higher. 7x simply feels far too low.

Another forward-looking approach to valuation is as follows, and assumes organic growth of 5% annually and that Daseke does $400m worth of M&A each year for the next three years, paying an average multiple of 6x TTM EBITDA. It also assumes ZERO margin improvement post-acquisition.

A note on the slightly complicated capital structure: I am using 63m shares and net debt of $610m, arrived at as follows:

8. Why does this opportunity exist?

- SPACs are a fairly ignored market segment

- It's a small cap stock

- In a post-VRX world roll-up stories are viewed with extra skepticism

- Botched follow-on offering in February

Risks:

1) Integration risk

Always a risk with M&A, but the continuity of previous management minimizes integration risk. The proof is in the pudding, as Daseke has proven quite capable on this front over the past several years.

2) Cyclicality

Daseke's business is certainly prone to general macro weakness, but recent industry data trends are all quite positive and this risk is easily hedged out. I'd also add that Daseke's end markets will only become further diversified with time.

3) Driver wage inflation

The shortage of drivers is a perennial problem in the trucking industry, as millenials prefer the life of a barista to life on the road (and I can't say I blame them). Wage inflation is a hot topic, and Daseke is actively exploring ways to solve it. One idea they are currently testing is the idea of "pay leveling." Drivers are typically paid on a per-mile basis, leading to very lumpy pay checks. Daseke's theory is that a consistent pay check with true-up provisions will be more attractive to many drivers as the cadence of their earnings will be smoothed out.

4) Key man risk

Hard to quantify but Don has been the engine room of the company since its founding. As Daseke increases scale and deepens its bench, I think this concern dissipates.

Conclusion:

Daseke has all the trappings of a "mini-XPO" in the very early innings of a powerful and sustainable consolidation opportunity, operating in an industry with healthy fundamentals and an experienced management team strongly aligned with shareholders. February's dislocation has provided a great opportunity for shareholders to buy this business at an attractive valuation, with nice compounding potential over the next few years as Daseke continues executing on its plan.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) contract repricings throughout the year

2) more accretive deals

3) increased liquidity from future follow-ons

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			2018	2019
Price:	9.35	EPS	0	0
Shares Out. (in M):	63	P/E	0	0
Market Cap (in $M):	588	P/FCF	0	0
Net Debt (in $M):	610	EBIT	0	0
TEV (in $M):	1,198	TEV/EBIT	0	0