Diane Hess

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Yellow Defends Plan to Pay High Price for Roadway

Diane Hess

Yellow(YELL) agreed to acquire Roadway Services (ROAD) for cash and stock worth $48 a share, a 60% premium over a recently beaten-down price.

Officials at Yellow argued on a conference call with analysts that the valuation is reasonable. "It was not too long ago that Roadway was trading at $40 a share. So we think $48 a share is fair value," said William Zollars, the company's chief executive. Shares of Roadway closed Monday at $30.02, but had traded as high as $39.40 as recently as May 6. On Tuesday afternoon, the stock was up $15.43, or 51%, at $45.43.

"The industry is ripe for consolidation," said John Barnes, an analyst at Deutsche Bank. "Right now, there is too much capacity chasing too little freight. Companies are trying to put a dent in capacity." For the past year, truck companies have suffered from weak sales amid a slow economy.

In September, Consolidated Freightways filed for Chapter 11 bankruptcy protection and sold off assets. In the aftermath, Yellow and Roadway gained market share, but not enough.

Shares of Roadway dropped 17% on June 5 after the company warned that second-quarter earnings would be about half of what analysts had expected, due to a bad freight mix. At the time, the CEO of Roadway, James Staley, said "the demise of Consolidated Freightways has proven to be a double-edged sword. The business made available was welcome, but quickly absorbed due to surplus capacity."

The $966 million merger (or $1.1 billion including debt) combines two of the biggest overland freight haulers in the country, as well as two fierce rivals. They had combined revenue of about $6 billion in the 12 months to the end of March 2003.

Roadway confirmed its earnings Tuesday, saying it had net income of $6.3 million, or 33 cents a share, in the second quarter, up from $5.7 million, or 30 cents a share, during the same three months of 2002. Analysts were forecasting 33 cents, on average.

Under terms of the deal, Yellow will assume $140 million in Roadway debt, bringing its total debt to $500 million. The company expects the merger to be accretive to earnings within a year, and to create cost savings of $45 million by the end of the second year and $125 million by the end of the fifth year.

Yellow will continue to run both companies separately, however. "From an operating standpoint, there will be no change," said Zollars. "These are two of the best brands in the marketplace."

Several analysts on the conference call questioned this approach. "I wonder why there will not be more a more aggressive combination of hubs," said Mark Levin, an analyst at Davenport. "You have approximately 600 terminals and service centers. I can't imagine you need more than 350 to 400."

Yellow has no plans for significant terminal changes. "We are at a 90% capacity level," said Zollars. "If the economy recovers, that 10% can disappear very quickly."

Volumes from Yellow's manufacturing-based customers have been at economic recovery levels for the past six to eight weeks, helped by the weak dollar. Activity at Roadway has been flat, however.

Yellow expects cost savings to come from combining back-office processes, such as payroll.

One analyst asked why Yellow paid such a high price, absent the ability to deal with capacity issues.

"We are looking at three things: Income stream going forward, accretion and return on invested capital," said Zollars. "We will look at integration opportunities as they develop. The risk is too high to do that now."

Shares of Yellow were down $2.04, or 8.4%, at $22.56 Tuesday afternoon.