The freight brokerage bubble has burst as freight markets face a long winter

On Wednesday, FreightWaves reported that Convoy was winding down operations. Earlier in the morning, I had started writing an article about the liquidity issues that some freight brokerage firms are facing or will be facing. Then news broke that one of the most popular freight brokers to emerge from the venture era of financing freight technology would fail that same morning.

Convoy was the victim of a brutal commodity industry facing one of the deepest recessions in decades and a sudden shift in investor appetite from risk to unit economics.

Although many articles will be written in the coming weeks about Convoy, unfortunately, it will not be the only important broker to suddenly shut down.

This is unusual.

After all, anyone in the trucking industry knows that asset-based carriers often face imminent failure. However, it was rare for freight brokers to suddenly close their doors. Compared to trucking fleets, freight brokers have more flexibility in their business model to adapt to changing market conditions

But we will see many large freight brokers suddenly close their doors. The reason is the significant change in the financing climate.

In an article earlier this week, I wrote about the growth and proliferation of the freight brokerage industry over the past decade. Freight brokers have gone from a small cottage industry to one of the most important forces in the shipping industry. Much of FreightWaves’ success has been driven by the growing importance that freight brokers play in the industry.

After all, freight brokers are the day traders in the freight market, and as such need up-to-date information about the freight market.

FreightWaves was created at a time when freight brokerage companies went from a small part of the industry to a dominant force. FreightWaves owes much of our success to this reality.

But much of the brokerage industry’s growth has been driven by financing structures, such as venture capital and asset-based lines of credit. The willingness to fund projects for freight brokers died down over a year ago and is partly responsible for why Convoy failed. Venture capital investors have woken up to the fact that freight brokerage is not an investable venture.

For those brokers who did not use venture capital financing but financed growth through alternative lenders, the story is different, but the results are the same. These alternative lenders are popular in the shipping market. Trucking companies use factoring companies to finance their receivables on a transactional basis. Brokers do the same thing; However, it is often not done on a per-transaction basis, but rather on a portfolio of receivables.

Receivables are pledged as collateral against lines of credit, described as an “asset-based line of credit,” or ABL, and this enables the brokerage to grow quickly without having to wait for shippers to pay.

If the market and unit economics are expanding, this is a very effective way to grow. For stock market traders, it can be compared to using margin to buy stocks.

If the value of your stock position increases, you will get a larger credit limit. The risk, of course, is using the credit line to buy more of the same stock. If this stock collapses, you are in real trouble because your losses will only accelerate on the downside.

The same thing happens in the brokerage sector. Freight brokers went out and borrowed against their real estate portfolios to fuel growth, piling up debt at cheap rates. When the Fed changed the cost of capital, that debt became more expensive. This in itself is not the problem.

But something else happened to the trucking market.

The average transaction size for loads also collapsed. Loads that generated $3,000 in revenue two years ago are now shipping for only $1,500 in revenue. Do enough of those transactions and the amount of credit facilities will start to collapse.

This is not necessarily a problem if brokers kept capital when times were good. But it becomes a problem when this capital is used for further growth or to make other purchases. For Convoy, the goal was to drive growth. For other brokers, it can be for personal uses such as homes, cars, planes, yachts, etc.

The capital has now been spent, but the debt is still there. Finance companies, aware of the risks of shipping fluctuations, tried to protect themselves by placing covenants on these lines of credit, which were often measured against margins.

As margins squeezed, covenants were broken, and financiers became nervous. Now some of them face a dilemma: whether to continue financing the line of credit or to call it. In Convoy’s case, it appears that the line of credit was called.

In recent weeks, FreightWaves has heard from sources that a number of mid-sized freight brokers are facing financial problems. One executive of a large brokerage firm who discussed potential transactions told me that the risks were most pronounced at brokerages with revenues of $50 million to $250 million.

The CEO of a major bank that deals with the trucking industry told me that he has three large brokers in bad financial shape in his portfolio, and he expects them to close in the coming months.

These companies have used receivables financing to stimulate growth. However, due to the collapse of market fundamentals, they violated their covenants.

The banks that financed these asset-based loans are trying to play the role of intermediary with some of these intermediaries, but their patience is running out.

Unfortunately, it will get worse.

The most brutal part of the cycle for a freight broker is not the soft market.

This happens when the freight market starts to open and spot rates improve, while contract rates remain compressed. This puts pressure on brokerage margins.

In other words, the spread between the spot price and the contract narrows. When that happens, it hurts freight brokers’ take rate.

A large proportion of contract prices are determined during the bidding season. If terms are favorable at the time of bidding, contract prices will decline.

The bidding season traditionally begins in mid-October and ends in February. Shipping rates have been very low all year, and there has been no improvement with the start of the show season.

Excess capacity in the market has kept spot and contract prices low – in some corridors, as low or lower than in 2019. These conditions will act as a significant drag on contract prices during the 2023-2024 bidding season. We expect contract prices to fall further as carriers realize they are “lower for longer.”

Spot rates, which are currently at levels where carriers are losing money on many of the miles they travel, are unlikely to fall further.

This will compress brokerage margins, exacerbating any financial struggles that brokerage firms may face.

Therefore, I expect we will see some frenzied freight brokerage trades happening over the next few months as healthier players take out weaker players.

I also expect those companies under significant financial pressure to go bankrupt. Bankruptcies are common in the trucking industry, but it’s usually asset-based carriers that fail.

This cycle may be the first time we have seen a number of bankruptcies impact the brokerage market.