|Just nine years ago, XPO Logistics Inc. (NYSE:XPO) was a $150 million-a-year expeditor whose new owner, Brad Jacobs, had designs to dominate the freight brokerage sector. Yet as Jacobs became comfortable with the freight industry, he realized his ambitions were too modest. So XPO expanded into contract logistics, last mile, intermodal, Europe and, finally less-than-truckload (LTL). By the end of the decade, XPO was a $17 billion, multi-modal giant whose main value proposition lay in cross-selling its many capabilities to big customers.
Now Jacobs and XPO have pivoted again. By exploring the sale of the entire company save its North American LTL business, Jacobs, the board and management have signaled that XPO’s days of being what amounted to a transport and logistics conglomerate are over. Its future, which Jacobs plans to guide no matter how it plays out, lies exclusively with a $42 billion LTL industry that itself may operate quite differently two to three years from now.
XPO cautioned that there is no timetable to accomplish any asset sales or spinoffs, and that no deals may ever be consummated. There are also risks. The company is expected to run its business and serve its customers all the while executing a significant change to its corporate structure. It must work to allay concerns of employees, customers and suppliers. If any or multiple units fail to sell, XPO may be stuck with businesses perceived by the market as damaged or unsellable, thus harming the logic behind the breakup, said Ravi Shanker, transport analyst at Morgan Stanley & Co. (NYSE:MS). Customers might ask, perhaps validly, how a breakup would affect their cross-selling programs. (XPO has said most cross-selling activity occurs within the two transportation units and any respective new owners could continue the programs.)
Risks aside, the company has begun courting offers for its four non-LTL units: North American Transportation and Supply Chain, and European Transportation and Supply Chain, which combined account for about 70% of XPO’s revenue. The sale process will be conducted concurrently, said Cowen & Co. Analyst Jason Seidl, who spoke with XPO management after the announcement. There are “many strategic and financial buyers” for all four units, Seidl said.
Deutsche Bank Analyst Amit Mehrotra said in a Thursday afternoon note that XPO management is “further along” in the breakup process than most market players believe. Mehrotra, who also spoke to XPO post-announcement, said it is aware that the announcement could be a distraction that could disrupt the day-to-day business. XPO is also assessing how to divide the intellectual property (IP) that has come from its substantial IT investments, Mehrotra said. He said that most of the IP will likely reside within XPO and will be licensed to acquirers of the units, if any are found.
None of this would be happening had Wall Street accorded XPO the valuation, and the stock price, that its board and management thought it deserved. XPO shares currently trade at 9.3 times earnings before interest, taxes, depreciation and amortization (EBITDA). By contrast, a pure LTL provider like Old Dominion Freight Line Inc. (NASDAQ:ODFL) trades at 13.5 times EBITDA, a level that also reflects Old Dominion’s long-running status as the segment’s best operator. A cluster of third-party logistics providers also trade at higher valuations than does XPO.
By breaking up the company, Jacobs believes it can free the relatively depressed valuations of each unit, creating enormous shareholder value should they all be sold. (Estimates Thursday ranged from an additional $30 to $60 per share if all four are sold.) XPO’s $13 billion non-LTL business trades at 4.25 times EBITDA, according to Deutsche Bank estimates. That is well below the eight times EBITDA figure considered acceptable for a business with solid growth prospects and low capital investment, Mehrotra said.
“This step had not been in my mind before,” Jacobs said in an email Thursday. “Our plan was to continue to grow the company, both organically and through acquisitions.” However, investors continued to value the portfolio at a discount to the “sum of its parts” and to its pure-play peers, Jacobs said. Facing the reality that the status quo might never change, the board and management decided to act, he said. “This was not a snap decision,” he added. Jacobs said in a separate interview that a “conglomerate discount” had been attached to the business because analysts found it harder to get a clear read on its many moving parts. By contrast, pure-play providers are easier to understand and analyze, and can thus be rewarded with premium valuations.
An LTL-centric XPO, Jacobs said — sounding to all the world like a man who wants no other scenario — will have little or no debt, loads of capital from the various transactions, and compete in a carrier-concentrated market where the top 10 carriers control more than 70% of the business, and can raise rates without much resistance from shippers.
The LTL segment might also see a major demand spike as e-commerce demand leads to the development of more warehouses, and shorter-haul, middle-mile runs that LTL carriers excel at will become more commonplace.
XPO has revived a once-inefficient LTL operation. Today, the unit’s operating ratio — the ratio of expenses to revenues — sits at its best levels in decades. It also spends nearly $600 million a year on technology, a large chunk of which on LTL, typically a backwater of IT innovation and where much low-hanging efficiency fruit hangs. Jacobs is “much more aggressive on tech enhancements than any other carrier, and there’s a lot more room to improve,” said Lance Healy, founder of Banyan Technology, a software solutions provider to the LTL sector.
XPO also owns its capacity and “therefore its own destiny relative to margin management,” Healy added.