The baseball legend Yogi Berra once said that “when you get to the fork in the road, take it.” The analogy is far from perfect, but that may be the situation that Brad Jacobs eventually finds himself in.
With word out over the weekend that XPO Logistics, Inc. (NYSE:XPO), the company Jacobs founded less than a decade ago, had put out feelers for its European supply chain business, the debate has begun over the best way for Jacobs and his board to maximize shareholder value. Should XPO sell the unit, which might fetch $4 billion to $4.5 billion, according to a report appearing late Friday on Bloomberg’s website? Should this be the first of the company’s four units to go on the block? Or should the company remain intact and build long-term shareholder wealth through organic growth?
There is little doubt that XPO’s business today touches many elements of transportation and logistics on two continents. Jacobs and his team acquired and integrated 17 companies over a four-year period, an unprecedented feat in an industry where integrating even one or two acquisitions is an arduous and sometimes unprofitable task. The question now is if a transaction goes forward — and there is no guarantee that it will — where XPO will go from here.
Jacobs told an industry conference last month that breaking up XPO would not be his first choice. However, he said the company needs to be valued at levels well above where it currently trades. XPO currently sells at about 10 times estimated 2020 earnings before interest, taxes, depreciation and amortization (EBITDA), Jacobs’ preferred metric. The valuation levels are unacceptable to Jacobs, who has said Wall Street attaches a “conglomerate discount” to XPO shares because the company’s complexities make it difficult for analysts and investors to assess its true worth.
“We are very, very undervalued,” he told the conference. XPO executives declined comment for this story.
By way of comparison, a $4 billion to $4.5 billion price tag on the European logistics business would value the unit at 15 times EBITDA, based on Deutsche Bank’s 2020 estimates of $290 million EBITDA for the business. This could trigger a virtuous cycle where investors begin to revalue all of XPO’s businesses higher, said Amit Mehrotra, Deutsche Bank’s lead transport analyst.
Mehrotra has a $122 per share price target on XPO if the total business is valued at what he considers a reasonable 11.5 times 2021 EBITDA. XPO shares closed Monday at $93.43, up more than 8.3% on the day.
The European supply chain unit is the most difficult of XPO’s businesses for investors to value, Mehrotra said in a note Sunday. Yet it’s where much of the potential lies due to the exponential growth of e-commerce, where XPO is a major last-mile heavy-goods delivery provider, he said.
What’s more, finding able and interested buyers, either in private equity or from industry, shouldn’t be difficult given the unit’s strong competitive positioning on the continent, and the secular trend toward e-commerce deliveries and logistics outsourcing in general. Benjamin Gordon, head of BG Strategic Advisors, a transport and logistics M&A firm, said a European divestiture makes sense because Jacobs has signaled his intent to focus on the North American business. “The European business could be more valuable in the hands of the right buyer,” Gordon said Monday. “I would expect strategic acquirers in European logistics to be very competitive.”
XPO’s European transportation unit would also be in high demand should that business also go on the block, Gordon said.
Jason Seidl, transport analyst at Cowen & Co., said in a Monday note that XPO will likely “pursue strategic alternatives” should markets continue to undervalue the total enterprise. The company is performing well, and is strongly exposed to such positive themes as outsourcing, near-shoring, e-commerce and automation, Seidl said. Meanwhile, Seidl said that XPO’s “valuation gap” with less-than-truckload (LTL) and non-asset-based peers has actually widened since January, when the company planned to put its North American and European transport and supply chain businesses up for sale, while retaining its North American LTL operation. The initiative was scrapped in March due to the outbreak of the novel coronavirus.
Seidl expects the LTL business to report solid third-quarter results after a subpar second quarter. Post-pandemic e-commerce trends are benefiting XPO’s last-mile business, while its intermodal operation should gain from near-record tightness in truckload capacity, he added. XPO is Seidl’s top pick, with a price target of $119 per share.
Now, wait a minute! …
Not everyone is sold on an XPO divestiture strategy. Ravi Shanker, transport analyst at Morgan Stanley & Co., said the company will generate more value by staying intact than selling off its parts. “While we believe the mathematical logic of [a European supply chain sale] seems clear, the strategic logic may be harder to understand,” Shanker said in a Monday note. Breaking up the company would be a distraction to day-to-day operations, and “hurt its ability to grow organically if customers believe they are selling off the business,” he said.
XPO has as clear a runway to organic growth as at any time in its history, Shanker said. There are no M&A distractions, the contract logistics climate remains robust despite the pandemic, the heavy hiccups surrounding Amazon.com Inc.’s (NASDAQ:AMZN) 2018-19 withdrawal of $600 million in business is behind it, and Jacobs has fully filled out XPO’s C-suite with the appointments of a CFO, a chief transformation officer and a chief diversity officer, he said.
Evan Armstrong, president of Armstrong & Associates Inc., a transport and logistics consultancy that focuses on the global third-party logistics (3PL) industry, said XPO would be headed down the wrong path if it sold its European logistics business. In an email, Armstrong said the company has seemingly “adopted a strategy of domestic retrenchment for short-term shareholder gain.” In addition, XPO would be betting against a normalization of global trade by scaling back global supply chain solutions to multinational customers, he said.
The problem, according to Armstrong, is that the “smaller the network scale in third-party logistics, the more competition, and that it looks like this is where XPO is headed.”
Armstrong also questioned XPO’s fancy for the LTL business, especially if it comes at the expense of its last-mile operations, which he labeled the jewel in the crown. While XPO’s North American LTL unit is performing well financially, it is a business-to-business operation with limited cross-selling potential, Armstrong said. By contrast, its last-mile business is well-positioned to capitalize on surging e-commerce growth with its highly integrated hub-and-spoke network and deep last-mile contract carrier relationships, he said.
According to Armstrong data, U.S. 3PL e-commerce revenues will reach $53.3 billion in 2020 due to sharply higher business-to-consumer activity during the pandemic. That translates into a 28% compound annual growth rate (CAGR) from 2017 to the 2020 estimates, according to Armstrong. The U.S. last-mile delivery market should grow to $50.4 billion this year, which would equate to a 17.3% CAGR from 2017 to the 2020 estimates, based on Armstrong data.
“Our advice would be [for XPO] to spin off its domestic LTL operations to generate cash, and get back to being a global supply chain management 3PL,” Armstrong said.