Searching out deep value in US trucking
Weakness in the price?
While many freight forwarders around the globe are clutching at straws, with poor attempts at managing capital structures that are either overstretched or inefficient, XPO Logistics is leading the way in the M&A field – its results are impressive, to put it mildly.
This US group is a textbook example of a freight brokerage firm pursuing growth – sustainable growth – that allows it to take calculated risks.
Investors have fallen in love with its strategy, and rightly so: alternative investments in the sector comprise more mature, conservative businesses whose shares and bonds seem to offer little upside in a growth-free, yield-starved world.
Its latest moves have pushed up its stock, which trades on a rich forward valuation well above 10x adjusted operating cash flow. This is a remarkable achievement for a firm that reported growing net losses of about $100m in the last fiscal year, and whose core margins are still in negative territory.
The turn of tide may not be far off, however.
Investors are not bothered about economic losses and tight cash flows, and have shown faith in XPO just as they have done over time with hi-tech, loss-making firms that are worth billions on the stock exchange – think of a $47bn market-cap behemoth such as Salesforce.com, which trades at 36x forward Ebitda, but may still need a few years before being in the black!
Weakness in its stock price (-1.43%) last Thursday was the inevitable price for broader market volatility, and coincided with the announcement of the pricing of $2.2bn mid-term notes, which preceded news this week of a $1.26bn rights issue, which was priced at a discount of 7.7% to its current share price of $48.78.
XPO is hovering around record highs – its stock has risen at a compound annual growth rate of 55% since the market rally started in March 2009, for a pre-tax capital gain of 1,335% over the last six years.
(What’s next is anybody’s guess, but it could be awesome the amount of cash that you could pocket by investing in it, even at its current level.)
To beat such domestic rivals such as CH Robinson, which is finding it more difficult to deliver rapidly rising returns to shareholders, in spite of generous cash returns, XPO is pulling all the stops it has at its disposal to secure growth. The fact that it has issued equity and debt capital – the size of both offerings has surprised some observers – to the tune of $3.4bn to fund its €3.2bn purchase of Norbert Dentressangle (ND) testifies to a management team that, quite simply, knows the perils of targeting growth without having a properly balanced capital structure in place.
Surely, there are risks with this strategy, but the purchase of ND, which will also marginally be financed by cash, is well structured, and the new capital raising comprises 39% of fresh new equity, in the form of preferred and ordinary stocks, and mid-term notes, whose cost is not prohibitive at a blended rate of 6.1%.
With regard to the equity commitment, “the group includes Ontario Teachers’ Pension Plan, GIC – Singapore’s sovereign wealth fund – and Public Sector Pension Investment Board, which collectively made an initial investment of $700 million in the company in September 2014”, and who were joined by 12 institutional investors, including sovereign and university endowment funds.
Its latest announcements prove that XPO is exploiting favourable market conditions for credit, while receiving the backing of willing investors who seem to believe that in XPO there resides even more growth in months ahead.
It’s not a matter of pride: for XPO, deal-making hinges on economics (the ND deal will likely end up being accretive); financial merits (debt is cheap and its cost of equity is relatively low); and strategic merits (ND boasts a strong pool of clients). The new kid on the block, as XPO has been called in recent years, is showing financial discipline and full understanding of macroeconomic conditions – the same cannot be said for some of its rivals.
Paying up for deals
Of course, the ND acquisition is not cheap, which means that heightened execution risk must be carefully managed, keeping in mind that cross-border deals are seldom easy to pull off. At €152 a share, ND already traded 78% above its 15-year median before XPO’s takeover offer emerged – the agreed price of €217.5 per share is undoubtedly rich. The take-out price also excluded, as XPO said, a “€1.80 dividend per share to be paid prior to the close of the transaction”.
“The purchase price represents an aggregate consideration of 9.1 times consensus 2015 Ebitda of €357m. The per-share cash price represents a premium of approximately 34% compared to the closing price of Norbert Dentressangle ordinary shares on April 27, 2015,” XPO said when it announced the deal at the end of April.
In early May, we wrote: “XPO Logistics isn’t taking huge risks with ND, as the two businesses are complementary, and it grabs the accounts of the target, which boast an outstanding retention rate. That’s why XPO decided to bid up for ND’s valuable assets.”
By acquiring ND, XPO also did itself a big favour in managing expectations.
“The acquisition will more than triple XPO’s Ebitda run rate to approximately $545m, and increase its revenue to approximately $8.5bn, nearly achieving the company’s 2017 targets two years ahead of plan,” XPO added at the end of April, when its stock price rose to about $48.8 from $42.4 in the wake of the announcement.
Now, XPO has priced its equity offering at the mid-point between its pre- and post-ND deal valuation. That’s smart, and signals confidence in the stock, the firm’s prospects and the management team, regardless of broader market conditions. As you might know, freight forwarders are not exactly in a sweet spot, but it looks like XPO is shoring up its own valuation by showing investors, and competitors alike, the path forward for freight brokerage firms.
On the face of it, there’s a huge unconsolidated market to consolidate out there on a global scale.
As it continues to grow, its shares are up “only” 20% so far this year, which is not an awful performance once it is compared with industry bellwether CH Robinson (-14%), but the next big acquisition will be just as important as its latest ND deal – talking of which, XPO could pull the trigger “as soon as early 2016,” at least according to a senior banker based in New York.
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Comment on this article
John RobertsJune 29, 2015 at 2:32 pm
I read somewhere that the CEO is expecting the new combined buying power of XPO/ND to be the way they make money in future which seems a bit naive to me. Although there are obvious benefits to being bigger, with air and sea rates at their lowest for years I don’t know what huge savings are available any more to a bigger group. There’s no point promising large volumes to shipping lines to agree long term rates when the prices are already rock bottom and any average Joe can get a cheaper spot rate.
And I think the comparison to Salesforce is misleading. You can’t roll out logistics like you can do with software. For logistics, you need more staff, warehouses, expensive vehicles, equipment, etc. For software, you just need to install it.
I’m no expert but the numbers don’t add up for me. You can’t pay over the odds in logistics and expect to get away with it forever, the margins just aren’t there to cover it.
And based on the stock charts, it looks like the XPO share price turned the corner and is now heading in the wrong direction.
BrunoAugust 06, 2015 at 10:41 am
John, XPO is in a different market than sea/air to which you are referring.
Global freight is a very small part, even in the combined group.
XPO is mainly about road transport and warehousing & distribution.
What they call “freight brokerage” is about using their buying power of ROAD transport.
They buy spot vehicle capacity from smaller outfits in a very efficient way.
A bit like booking.com allows you to book a room, they offer road transport capacity.
You buy in a very fragmented market a service that is much less commoditised when compared to a container shipping from two well served ports, using one of 4 seacarrier groups.
ND has 8000 trucks in Europe and combining them with the US experience in brokerage is indeed rolling out a capability highly supported by systems.
You talk about air & sea but what you read is about road..