XPO Logistics (NYSE:XPO) was one of the best performers on the stock market last decade.
Through a series of acquisitions in transportation and logistics, including Con-Way Trucking and Norbert Dentressangle in Europe, the company came out of nowhere to become a major player in logistics, building up a significant presence in areas including freight brokerage, contract logistics, less-than-truckload (LTL), and last-mile delivery.
Through the 2010s, the stock returned an impressive 1,460%, but more recently, XPO has encountered challenges that have pushed shares down significantly from the all-time highs they reached in 2018.
Since then that peak, a softening in the industrial economy and the significant piece of business from its biggest customer -- believed to be Amazon -- caused the company's sales to decline last year. As a result, in an effort to create more shareholder value, the company shifted away from its acquisition strategy to aggressively repurchase its stock.
Now the company is making yet another move to unlock shareholder value. It announced in January that it would seek to sell and spin off of all of its business units except for North American LTL, and it brought on a new CFO, David Wyshner, to help with that push. The news got a round of applause from Wall Street, which sent the stock up 15%. However, shares have given back those gains during the coronavirus sell-off.
The transformation plan
On the recent earnings call, CEO Brad Jacobs explained the logic behind the break-up, arguing that the stock is trading at a "conglomerate discount," or that the market is undervaluing it for combining a number of different businesses inside one umbrella and that it trades at a "very significant discount to the sum of our parts as well as to the valuation of our peers."
Jacobs defended the company's current model and called the potential that it remains whole an "excellent Plan B," but he said the company made the decision to split up because it wasn't being valued appropriately by Wall Street. That was a reality that management had come to accept, and he added, "Don't fight with reality, because reality always wins."
After making several acquisitions over the last decade, XPO has become a diversified, complex, and unique logistics company. It has no true peer to which Wall Street can anchor its valuation. The LTL subsector, on the other hand, has several pure-play providers, including Old Dominon Freight Line (NASDAQ:ODFL), the provider often considered to be best-in-class, and Saia (NASDAQ:SAIA).
On an EV/EBITDA basis, XPO currently trades at ratio of just 7.2. That compares to Old Dominion Freight Line at 14, while Saia trades at an EV/EBITDA of 8.9.
XPO also trades at a discount compared to other logistics operators such as C.H. Robinson, Expeditors International, UPS, and FedEx.
It's impossible to know what kind of valuation XPO might fetch as a pure-play LTL provider, but the company's LTL division is growing quickly even with the slowdown in the industrial economy. Last year, adjusted operating income in North American LTL grew 25.4% to $656 million even as revenue rose just 1%. The company was able to do that by bringing down its adjusted operating ratio, or the percent of revenue that goes to operating expenses, by 350 basis points to 82.7%. That's not far from the 80.1% operating ratio that Old Dominion posted last year. By comparison, Saia had a much higher operating ratio of 91.5%, meaning Old Dominion is likely a more accurate comparison for how XPO might be valued as a pure-play LTL company.
XPO is also targeting $1 billion in adjusted EBITDA from LTL by the end of 2021, up from $883 million in 2019, and the company has steadily grown profitability in the business from investments in technology. In other words, if the company is able to execute its plan, selling off its other businesses so that it becomes a stand-alone LTL operator, it would likely be able to pay most, if not all, of the $5 billion in debt it has on its balance sheet. By comparison, XPO paid $3 billion in 2015 for Con-Way, a diversified logistics company, which had $528 million in Adjusted EBITDA at the time. The non-LTL components of its business generated about $800 million in Adjusted EBITDA last year. In an interview with Bloomberg, Jacobs explained the timing by arguing that the credit and M&A markets are favorable to such a deal.
If it was able to sell its four other units, that could put the stock in a position to double from its current market cap around $7 billion to $14 billion if it was afforded a similar valuation as Old Dominion.
In any case, that seems to be the way Jacobs and his team are looking at it. A lot has to happen between now then for that goal to come to fruition, and XPO would also benefit from an improvement in the industrial economy, which seems less likely after the coronavirus scare for now. However, the path is there if the company can find buyers for its other businesses. Wall Street clearly likes the idea of the break-up based on its reaction in January.