Jacobs to exit most of XPO the way he entered — unconventionally

Brad Jacobs didn’t build XPO Logistics Inc. (NYSE:XPO) the traditional way. He’s not taking it apart the traditional way either.

Utilizing a roll-up strategy unmatched in freight industry annals for speed, scale, and no shortage of doubters, Jacobs, the founder, chairman and CEO, took XPO in less than nine years from a $150 million domestic company with one or two revenue lines to a $17 billion international behemoth with conglomerate-like features. Now, in one fell swoop, about $13 billion of that revenue has been put on the block. Four units — each one large enough to be substantial stand-alone businesses — may be sold or spun off. The units will be offered concurrently. The time frame for full disposition is considered ambitious — perhaps as soon as six months, according to people familiar with the process.

Each unit will be offered as a whole entity. This means prospective buyers can’t cherry-pick the lines they want. For example, XPO’s North American Transportation unit, one of the four for sale, houses the brokerage, final-mile, managed transportation and intermodal businesses. A suitor would need to buy the whole thing rather than select specific subunits.

The manner in which the divestiture is being carried out, especially for a successful business that’s not under pressure to sell, is without parallel in transport history.

What will be left when the dust settles, if the company’s plans pan out, is the North American less-than-truckload (LTL) business, which clearly the company believes has the most potential because of demand trends fueled in part by e-commerce fulfillment, favorable competitive positioning in a concentrated carrier segment and hundreds of millions of IT dollars being focused on improving operational efficiency in LTL, a program that has already borne fruit through dramatic declines in the unit’s operating ratio, the ratio of revenues to expenses. Third-quarter LTL operating ratio fell to 80.9%, meaning that for every $1 dollar in revenue collected, the unit spent less than 81 cents. That is the best third-quarter ratio in the unit’s history, which dates back many decades.

The only deterrent to XPO’s plans seemingly would be if it received bids for the units that it deemed too low. Weak bids could cast doubt on the units’ value and sabotage the entire strategy, said Ravi Shanker, an analyst for Morgan Stanley & Co. However, lowballing may not become an issue given the units’ established physical North American and European networks, deep product lines and sizable client bases, all of which give buyers instant scale. Because of that, the XPO units “will not come cheap,” said Frank McGuigan, CEO of Transplace, a $2.8 billion a year third-party logistics provider (3PL) owned by TPG Capital, a private equity firm with $72 billion of assets under management.

Transplace, for its part, manages about $9 billion in annual transport spend a year, and backed by TPG’s deep pockets, is acquisitive on several fronts as it relates to non-asset-based providers, McGuigan said. The company has discussed the XPO developments internally but had not interacted with it as of Monday, he said. 

Evan Armstrong, head of 3PL consultancy Armstrong & Associates, Inc., said that XPO’s North American final-mile business would be the best fit for Transplace.

Interested bidders could be private equity firms, international transport and logistics firms looking to fill out their geographic networks and companies like Danish container shipping giant Maersk Line, which has a global presence but needs to scale up its non-ocean capabilities to support an integrated maritime and logistics network.

Would Amazon.com Inc. (NASDAQ:AMZN) jump into the fray? Typically, Amazon doesn’t spend big on major acquisitions, preferring to build large-scale capabilities from within and augment them with smaller, tuck-in acquisitions. There is also bad blood between Jacobs and Amazon Chairman and CEO Jeff Bezos over Amazon’s decision in late 2018 to pull $600 million of mostly high-margin postal induction business from XPO. Amazon, which had been XPO’s largest customer, said the move was triggered by XPO’s subpar performance, a charge that XPO hotly denied. Despite any animus, Bezos can write a big check, and XPO has a fiduciary responsibility to maximize value for its shareholders.

Analysts have significantly raised XPO’s target price to account for the additional $30 to $60 per-share value that the sales, in aggregate, are expected to generate. Deutsche Bank Analyst Amit Mehrotra said Monday that the firm is now attaching double-digit valuations — measured as 2020 estimated earnings before interest, taxes, depreciation and amortization (EBITDA) — to the non-LTL units, up from 8 times EBITDA when the announcement was first made. Mehrotra upped his target price to $125 a share from $107.

Currently, the market assigns a roughly 5 times EBITDA valuation to the non-LTL businesses. Jacobs equates that to XPO paying a perpetual “conglomerate discount” since analysts are reluctant to attach a premium to a grouping of businesses that might be harder to understand, and to value, because of the many moving parts. 

Conglomerate penalties notwithstanding, it would be impossible to say XPO shareholders have been shortchanged over the past nine years; shares rose 1,457% during the decade, making XPO the seventh-best performing stock for the period, according to data compiled by Fortune. Ironically, the sixth-best performing stock, equipment rental giant United Rentals Inc. (NYSE:URI), was also founded by Jacobs.

XPO said last week that the sale (or spin-off) process is in its early stages. Yet it has already done major spadework. It was working for weeks with its financial and legal advisers to position the units for high-end sale well before the formal announcement was made last Wednesday. Analysts who’ve met with XPO executives in recent days report that the company is more advanced in the transaction cycle than might be initially perceived.

Much still needs to be sorted out. XPO must reconcile ownership of the technology that underpins the four units; Mehrotra surmised last week that ownership will continue to reside with XPO, which will effectively license the technology to the units’ new owners. Thousands of employees will be affected, and customers may be concerned as to whether XPO can keep its eye on the execution ball while the bulk of the company is in a major transition. 

XPO has championed a cross-selling strategy ever since it completed its spate of 17 acquisitions and integrations in four years by acquiring LTL and logistics firm Con-way in September 2015. On a recent analyst call, Jacobs said that eight out of 10 customers have a need for two or more of XPO’s services, but that only four of 10 actually utilize two or more. Jacobs seemed to dampen the cross-selling mantra last week by telling FreightWaves that most of the cross-selling occurs just within the North American Transportation business unit because it has so many sub-services that could be linked. Cross-selling across business units or geographies doesn’t take place as often as some might think, he said.

Shipper demand for cross-selling models, which was respectable a decade or so ago before the advent of sophisticated technology, has faded as better platforms today give shippers fast visibility into their segments’ performance, according to McGuigan, who said this, in turn, lessens the need for an integrated suite of services from one provider with centralized IT capabilities.

For most shippers, concerns over a provider’s execution trump any real or perceived benefits generated by cross-selling a bundle of services, according to McGuigan. “You can’t assume that cross-selling will pump up a mediocre business,” he said.

Given XPO’s unprecedented expansion and subsequent integrations, which yielded a fast-growing and profitable enterprise, the conventional wisdom is that the moves of the past week represent a pivot. Not so, according to Mehrotra. Jacobs’ strategy “has been consistent all along, in our view, which is to responsibly create the most equity value in the shortest amount of time,” he said.