Freight Brokerage Bubble Bursting As Shipping Markets Face Long Winter

By Craig Fuller of FreightWaves

On Wednesday, FreightWaves reported that Convoy was winding down operations. Earlier in the morning, I had started writing an article about liquidity issues that some freight brokerages are having or will have. Then the news broke that one of the most iconic freight brokers to come out of the venture era of freight tech funding would fail on the same morning.

Convoy was a victim of a violent commoditized industry that is facing one of its deepest recessions in decades and a sudden change in investor appetite from risk to unit economics.

While many articles will be written in the coming weeks about Convoy, unfortunately, it won’t be the only significant broker to suddenly shut down.

This is unusual.

After all, anyone who has been in trucking knows that asset-based carriers face imminent failure frequently. However, it has been rare for freight brokers to suddenly shutter. Compared to trucking fleets, freight brokers have a lot more flexibility in their business model to adjust to changing market conditions

But we will see many more sizable freight brokers shut down suddenly. And the reason is a 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 moved from a small cottage industry to one of the most important forces in freight. A large part of FreightWaves’ success has been driven by the increasing importance that freight brokers play in the industry.

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

FreightWaves was created at a time when freight brokerages morphed from a small part of the industry to a dominant force. FreightWaves owes a lot of our success to this reality.

But much of the brokerage industry’s growth has been fueled by financing structures, such as venture capital (VC) and asset-based lines of credit. The appetite for venture funding of freight brokerages has been dead for over a year and is partially responsible for the reason Convoy has failed. VC investors have woken to the reality that freight brokerage is not venture-investible.

For those brokers that didn’t use VC funding but financed growth through alternative lenders, the story is different, but the results are the same. These alternative lenders are common across the freight market. Trucking companies use factoring companies to finance their receivables on a transactional basis. Brokers do the same; however, it is often not 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 a brokerage to grow quickly without having to wait for shippers to pay.

If the market and unit economics are expanding, it’s a very efficient way to grow. For traders in the stock market, it can be compared to using  margin to purchase stocks.

If a stock position is increasing in value, you gain a bigger line of credit. The danger, of course, is if you use the line of credit to buy more of the same stock. If that stock collapses, you are in real trouble because your losses will only accelerate on the downside.

The same thing is happening in the brokerage sector. Freight brokers went out and borrowed against their AR portfolios to fuel growth, racking up debt at cheap rates. When the Fed changed the cost of capital, that debt became more expensive. That in and of itself isn’t the problem.

But something else happened to the trucking market.

The average transaction size of loads also collapsed. Loads that  generated $3,000 in revenue two years ago now ship for only $1,500 in revenue. Do enough of those transactions and the size of the credit facility starts to collapse.

That isn’t necessarily a problem if brokers had held onto the capital when times were good. But it does become a problem when that capital is used for more growth or to make other purchases. For Convoy, it was to fuel growth. For other brokers, it could be for personal uses like homes, cars, airplanes, yachts, etc.

The capital is now spent, but the debt is still there. And finance companies, aware of the risks of freight volatility, tried to protect themselves by placing covenants into these lines of credit, often benchmarked against margins.

As margins compressed, the covenants were violated, and the financiers became nervous. Now some of them are facing a dilemma: continue to fund the line of credit or call it in. In Convoy’s case, it appears the line of credit was called in.

In recent weeks, FreightWaves has been hearing from sources that a number of midsize freight brokers are in financial trouble. One CEO of a large broker that had discussed potential transactions told me the risk was most pronounced in brokerages that generate $50 million to $250 million in revenues.

A CEO of a major bank with exposure to trucking told me he had three large brokers that are in dire financial shape in their portfolio and he expects them to shutter in the coming months.

These firms have used receivables funding to fuel growth. However, due to collapsing market fundamentals, they have breached their covenants.

The banks that financed these asset-based loans have been trying to play matchmaker for some of these brokers, but their patience is starting to wear thin.

Unfortunately, it will get worse.

The most brutal part of the cycle for a freight broker isn’t a soft market.

It’s when the freight market starts to turn up and spot rates improve, while contract rates remain pressured. This squeezes brokerage margins.

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

A large percentage of contract rates get established during bid season. If conditions are soft at the time of bids, contract rates will fall.

Bid season traditionally starts in mid-October and ends in February. Freight rates have been very soft all year, and there has been no improvement as bid season gets underway.

The overcapacity in the market has kept both spot and contract rates low — on some lanes, as low or lower than in 2019. These conditions will be a significant drag on contract rates during the 2023-2024  bid season. We foresee contract rates dropping further as carriers realize “it’s lower for longer.”

Spot rates, currently at levels where carriers lose money on many of the miles they run, are unlikely to fall much further.

This will compress brokerage margins, exacerbating any financial struggles that brokerages may have.

Therefore, I expect we will see some frantic deals in freight brokerage happen over the next few months as healthier players take out the weaker ones.

I also expect bankruptcies for those firms that are under significant financial stress. Bankruptcies are common in trucking, but it’s usually asset-based carriers that go under.

This cycle could be the first time we see a number of bankruptcies impact the brokerage market.