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No. of Recommendations: 24
Once in a while, I will buy a very small position in a company after some quick initial research just to keep it on my radar. I know some people have watch lists for that sort of thing, but I’ve discovered that I’m far more likely to get back around to diving deeper if I actually own a little bit of the company and have to stare at it on a regular basis ;-) XPO Logistics is one of those for me, and I’ve taken this opportunity to dive a little deeper, though I’m still only barely scratching the surface in this write-up.

Today’s XPO started life in 2011 when Brad Jacobs, a very successful founder of two prior companies (more in that in a moment!), injected $150 million into Express-1 Expedited Solutions (ticker XPO) and became its CEO, Chairman, and largest shareholder with the goal of consolidating the highly fragmented transportation and logistics industry. He renamed the company to XPO Logistics and never looked back.

Before diving more into XPO itself, though, I think it’s important to understand Brad Jacobs and his history. Back in 1989, Jacobs founded United Waste Systems with the goal of consolidating small garbage collectors that had overlapping routes in rural areas. He took the company public in 1992 and, after successfully making and integrating over 200 acquisitions, the company was sold for $2 Billion in 1997 to USA Waste Services, delivering a 55% compound annualized return to its shareholders. USA Waste Services would, itself, eventually be acquired by Waste Management.

Bradley didn’t stick around when his company was acquired. In fact, one month later he grabbed 6 members of his United Waste Systems management team and founded another company, United Rentals, with the goal of consolidating the small-equipment rental industry — different industry, same strategy. United Rentals went public in December of 1997, and Jacobs focused on building a comprehensive IT platform that would integrate the company’s geographically dispersed dealers, providing a comprehensive view and allowing for more rational pricing. He also took the company online, building out a business-to-business website where customers could easily research, rent, or buy equipment. The company would go on to make over 500 acquisitions while Jacobs was CEO, and Cerberus Capital eventually agreed to buy the company for $6.6 billion (though the deal fell through as a result of the credit crisis).

And that brings us back to XPO: just as before, Jacobs is pursuing the same successful strategy of rolling up a bunch of companies in a highly fragmented industry, building economies of scale, and uniting them with a comprehensive and proprietary IT platform. As Jacobs put it, “the global transportation and logistics industry is the last large industry that’s still not consolidated but should be.”

Growth by acquisition carries many risks: paying too much for companies, struggling to integrate them, failing to realize synergies, culture clashes, baggage of legacy lawsuits and other problems, dilution of shareholders, etc. — not to mention that some companies use acquisitions to hide problems and poor performance in their traditional businesses. Excellent management is always important for any company, but especially so in my opinion for a company growing through consolidation and acquisition. So I think it’s important to note that Jacobs has very successfully executed this strategy at two other companies, and so far things are looking good at XPO as well.

Since 2011, XPO has already made over a dozen major acquisitions, plus various minor ones, establishing itself in multiple lines of business within the transportation and logistics industry (in some cases as a leader or one of the top few leaders). But what exactly is transportation and logistics, and what does XPO actually do?

XPO is primarily a 3rd-party “asset-light” transportation and logistics broker. They can manage all aspects of shipping items for a company, including selecting carriers/vessels, negotiating rates with shippers, tracking shipments, billing, and resolving disputes. The “asset-light” part means that they don’t actually own the trucks, ships, aircraft, or railroads themselves, but instead contract with 3rd-party shippers. They’re essentially a middle-man, freeing manufacturers, retailers, and other companies from having to deal with the huge headache of managing the transportation of their goods. XPO is much better and more efficient at it, and its economies of scale mean it can offer its services at very competitive rates.

XPO has many lines of business (sometimes supported by multiple business units), which offer different services under the broad umbrella of “transportation and logistics.” Here’s a brief overview of those:

Truck Brokerage, as the name implies, is arranging for shipment by truck: customers offer loads to XPO (sometimes a full truck-load of freight, called “TL”, sometimes less than a truckload, called “LTL”), and XPO takes care of contracting with appropriate trucking companies and managing the shipment end-to-end. XPO takes care of paying all of the contracted 3rd-party companies, and pockets whatever is extra after billing the customer. At the end of 2014, XPO was the 3rd-largest truck brokerage in North America, but still only served 1.5% of the total addressable market.

Intermodal means multiple forms of transportation are required, typically a combination of railroad and truck. It also usually includes a service called “drayage”, which is the transfer of goods over short distances, often getting them from one mode of transportation to another (between ship and rail, for example). Again, the business is asset-light, and XPO contracts with railroads, trucking companies, etc. and manages the whole process end-to-end. At the end of 2014, XPO was the 3rd-largest provider of intermodal services in North America, and a leading provider in the fast-growing cross-border Mexico sector thanks to its acquisition of Pacer.

Last Mile is the transportation of goods from a local distribution center or retail store to the end consumer’s home or business (sometimes including “white glove” services, like unpacking, installation of the new item, utility connections, take-away of an old item being replaced, etc.). Consistent and exceptional customer service is especially important in this business line, as it interacts directly with end consumers and a bad experience could damage the brand of XPO’s customers. XPO utilizes technology to collect feedback from end consumers, monitor performance of the carriers, and ensure that the end consumer has a good experience. Last Mile is a very fast growing sector, especially with the rise of e-commerce. XPO is the leading asset-light provider of Last Mile services in North America for deliveries of heavy goods.

Expedited transportation is for time-critical or high-priority freight shipments which may also have specialized handling needs. It’s often needed due to very tight supply-chain management, earlier disruptions in the supply chain, or earlier problems from an alternative mode of transportation that resulted in delays. XPO maintains an ISO 9001:2008 24/7 call center so that customers can order expedited services and get on-demand updates on the status of their time-critical and urgent shipments. XPO is the largest manager of expedited shipments in North America.

Freight Forwarding pulls everything together under a single high-touch service, especially for global shipments, where XPO essentially acts as the “carrier” even though they’re outsourcing the actual transportation to 3rd parties: they manage the retrieval of goods, arrange for any required inland transportation, consolidate loads from multiple customers into single efficient shipments to common destinations (usually via ship or aircraft), prepare shipping documents, and make sure the freight is delivered to the receiver at the end destination (including handling all of the required customs documentation, bonds, duties, classification, and clearance).

Contract Logistics services provide for long-term management of very complicated supply chains for large and medium companies when they get to be too challenging to efficiently handle in-house. These customers are very demanding, want real-time data visibility into the full chain, are often dealing with very large volumes and potentially high value products, may have specific timing requirements, and insist on superior customer service. XPO uses specialized technology and expertise it acquired when it bought New Breed to provide world class logistics services, and it’s further leveraging that technology, talent, and expertise across its various lines of businesses to give all of them an edge over competitors. This is another example of XPO recognizing the value of technology and using it to build a competitive advantage.


With that out of the way, let’s look a little more at the management’s growth strategy, which is three-pronged. The first prong, of course, is building the company through disciplined acquisition, looking for scalable and complementary businesses at a fair price. From the 10K:

When we acquire a company, we seek to integrate it with our operations by moving the acquired operations onto our technology platform that connects our broader organization. We gain more carriers, customers, lane histories and pricing histories with each acquisition, and some acquisitions add complementary services. We use these resources company-wide to buy transportation more efficiently and to cross-sell a more complete supply chain solution to customers.

Jacobs added a bit more color in a recent conference call about what sort of company they’d consider:

So [a] company that is a good company, that’s got services that customers – that our customers want, that our customers need, that our customers would value, that our customers when they would read the press release they would say, yeah, that’s great that helps me, we’re interested in that; provided we can get them at an affordable price.

So, having a wide geographic dispersion of acquisition opportunities helps with that, helps with that a lot. Because at any one point in time in the M&A world, there is a bell curve. And there’s some acquisitions that are to the right to left, and some in the middle. So, we’re trying to stay more towards the middle on valuation.


The second prong is cold-starts. That is, actually starting up new offices from scratch, which — while riskier — can obviously provide a much higher return on invested capital than an acquisition can. My impression is that XPO mostly uses this to grow existing lines of business geographically.

And the third prong is improving and optimizing the businesses it acquires: not just merely building a sum that is greater than the parts, with economies of scale and cross-selling, but actually making the parts themselves a lot better as well. Part of this is technological, part of it is cultural. For example, Chief Strategy Officer Scott Malat talked a little bit about this when discussing the recent acquisition of European company Norbert Dentressangle:

Norbert was a company that, for 36 years, was focused on giving stellar customer service.

We’ll keep that strong focus on the customer while accelerating our sales efforts and driving growth. We see a lot of opportunity to scale up our European operations by adding more salespeople, adjusting incentive compensation and giving our employees the benefit of a common CRM technology. We’re excited about our e-fulfillment business that’s taking off in Europe and we’ll install our proprietary Freight Optimizer technology to build on the more than €1 billion of brokerage business that we currently serve.


To date, XPO is largely a tale of acquisition, integration, and optimization. I think it’s worth going through the acquisition history to get a sense of how the company has become what it is today, but all of that is found in the 10K and it’s kind of silly to just reproduce it here. However, I’d be remiss in not talking a little bit about the company’s most recent acquisition of French company Norbert Dentressangle, mentioned above.

Announced in April and concluded in June, the $3.5B all-cash deal is the largest of Jacobs’ career and more-or-less triples XPO’s revenue and EBITDA run rates, essentially meeting financial goals the company had set for 2017 two years ahead of schedule. XPO has now set new financial goals for 2019, discussed in a bit. The acquisition also immediately makes XPO a major player in Europe (and a top ten player globally), which is obviously nice from a geographic expansion and scale standpoint, but is also interesting because the transportation industry in Europe is less developed than the U.S. market in some ways, and Norbert now provides a platform from which XPO can launch services that are taken for granted in the U.S. Chief Strategy Officer Scott Malat again:

Many of our European customers are interested in high-quality last mile logistics. Europe hasn’t developed its heavy goods home delivery as much as North America has, and there is a lot of room to improve customer satisfaction levels. It’s a fragmented landscape with a lot of regional providers. There is a concrete opportunity for us to apply our technology and expertise and develop the last-mile sector for heavy goods in Europe.

Furthermore, many large customers — and Norbert serves a lot of blue chips and multi-nationals that are new to XPO — want to deal with someone with global reach, leading to immediate new growth opportunities beyond the standard cross-selling. Scott Malat again:

Even though the Norbert acquisition is just eight weeks old, we’ve already had our first big cross-selling win between North America and Europe. We’ll be opening an important e-commerce facility in Pennsylvania to serve the U.S. footprint of an international fashion retailer. This is a company that’s a top 10 customers of ours in Europe where they have a big presence and they’ve been growing quickly in the U.S. market. This is just one example of many opportunities where we can leverage the strong track records of both our European and our North American operations.

The Norbert acquisition is interesting in another way, in that Norbert actually owns most of its trucks: 7700, with another 3,200 contracted through independent owner-operators, so XPO is a bit less asset-light on a global basis. During lean times, this could potentially hurt (especially as those trucks are in Europe, where labor laws are less flexible), but in good times they will provide more leverage and access to a dedicated fleet of trucks instead of having to compete for the same 3rd-party ones everyone else wants to use (a positive negotiating point for some large customers). So it’s a balance, and it’ll be interesting to see how that aspect of the business develops over the next few years.

So where is XPO going from here? I’ll let Jacobs answer that question ;-)

Let’s back up for a second and start with who we are and then what we’re evolving into. So who are we in respect to the questions you asked are, we’re roughly 50% of our profit come – when I say profit, I’m talking about EBITDA, coming from North America; roughly 50% of our EBITDA coming from Europe, plus or minus. We’re roughly half of our EBITDA coming from contract logistics. We’re roughly half of our EBITDA coming from transportation. And we break our transportation comprised of last mile, intermodal, truck, expedite. So, we have a fairly balanced mix right now both geographically and service line.

Now long-term, to answer your question, I think we will be having business mix that is more reflective as we get into the tens and tens of billions of dollars of the end markets. So, when you look at those different end markets, some are much larger than others. The contract logistics is a much, much bigger market than, say, expedite for example. So, you would expect us to be much bigger in contract logistics than expedite when we’re at $20 billion, $30 billion, and $40 billion…



The great thing about the next great next thing is, I don’t know what will be next. I know what will be long-term, but we’re going to be opportunistic. We’re going to be agile. We’re going to be nimble to react to opportunities that make sense that have and a compelling logic to do them in that sequence.

But long-term, to answer your question, we want to go deeper in contract logistics. That is the field that is the most stable. It’s the most recurring revenue that you can add the most value to the customer, long five year plus contracts. It’s just – that’s a business we want to absolutely go much, much, much, much deeper in.

Last mile is a business that we want to continue to capitalize on the industry-leading position. We’ve got North America and transplant that over to Europe. I really do feel, based on my customer visits, that the customers are yearning for this in Europe. The customers are wanting a real strong high-quality last mile solution that is all across the continent and England, not just a regional and – variable in terms of customer satisfaction solution. So, we’ll build that one.

Intermodal. We’ll grow that business, we’ll absolutely grow that business and that will grow depending on how fast the conversion from over-the-road to rail is, and that will depend on a number of factors that are completely outside of our control.

Truck brokerage is a big industry, tens of billions of dollars of size inside a trucking industry that’s hundreds of billions of dollars. So, that’s a big market that we’ll continue to grow in; that’s something that our customers use and value and need all the time. So, we’ll absolutely keep growing on that.

Expedite; we got the number one position on that. We just renewed a contract with important customer and we have high, high levels of customer satisfaction, near 100% on time pick-up and delivery in expedite. It’s a really, really great franchise we have there. That’s something we also want to be transplanting over to Europe.

And then in Europe, we look at it as two sections. Of course, freight forwarding overlapped all of this. In freight forwarding, we’re not a big player yet. We’re a few hundred million euros in size on that globally, but we’re continuing to grow it.

And in Europe, on the transportation side, we have a big trucking company. I mean, we have a big trucking company here too, but it’s non-asset. We have more than 6,400 owner-operators in our fleet. It’s a big calling card to many customers. In Europe, we’ve got 7,000 some odd trucks that we own. We got another few thousand trucks that are owner-operators. We’re going to keep developing that fleet and keep using that to be tied in with the customer.

So, business line, all of them are going to grow; geographically, ultimately, but that’s – it comes back to my first comment about what’s next is eventually but probably not right away. Eventually have to be in Asia. Our customers are global; they’re in Asia also. We’ll have to be in Asia in due course.



Ratings

So what’s XPO worth, and do shares represent a good buy today? Despite now being a top player globally, the reality is that XPO still only reaches a tiny fraction of the market. In a recent call, Jacobs emphasized this point:

Now that we’ve achieved critical mass on a global scale we have a huge opportunity to grow business not just organically but also by acquiring complementary companies. Today, at $9 billion, we have a tiny piece of the transportation and logistics pie. And even when we’re a $23 billion company four years from now, we’ll still have a small share of the global spend.

Management has blown by its 2017 financial goals with its acquisition of Norbert, and it has now set new financial goals of $23 billion in revenue and $1.5 billion of EBITDA in 2019. But today, the company isn’t yet profitable.

I personally don’t like to get into the weeds with valuation, as I think there are just way too many assumptions that go into it: my inclination is more towards trying to be “generally right” rather than “precisely wrong.” So here’s one back-of-the-envelope way to look at it: XPO just bought out Norbert Dentressangle for about 9 times 2015 EBITDA, which I’ve seen a TMF analyst call a “reasonable” price. So if one were to assume the market will value XPO at that level, that would give a market cap of 9 x $1.5B = $13.5B in 4 years if you believe management can meet its EBITDA goal. The market cap today is just under $3.7B, so that’d translate into about 38% annualized appreciation in share price if management hits its targets and the number of fully diluted shares remained constant (they obviously won’t, but management has said their 2019 estimates do not depend on additional equity raises). So apply a reasonable discount to account for additional shares and one’s degree of confidence in management’s estimates.

I’ve also seen a TMF analyst roughly estimate that the company, if it were valued in line with peers, might have a market cap of about 80% of revenues (and indeed, that’s about what competitor CH Robinson is priced at). Using that rule of thumb with management’s goal of $23B of revenue in 2019, one would arrive at a market cap of around $18B. That makes me think there’s some margin of safety in the above estimate of $13.5B.

But again, this all depends on how much confidence one has in management and their ability to meet their stated goals. And that brings us back to Jacobs and his track record of success with this business model across multiple industries, along with his success to date in this one: in many ways, a bet on XPO is a bet on Jacobs. My own personal conclusion is that today’s price is reasonable if the company can come close to achieving its goals.

My hypothetical real-money portfolio rating: 4 stars (out of 5 possible).

My CAPS call: thumbs up (outperforms the market over 5+ years)


Neil
Long XPO
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