XPO Logistics (XPO -0.73%) management has been complaining about the company's valuation for more than a year now. On Dec. 2, they announced plans to do something about it.
The transportation company, cobbled together over the last decade by CEO and rollup specialist Brad Jacobs, announced plans to spin its contract logistics operations off as a separate publicly traded company.
XPO officials have long said the stock suffers from a so-called conglomerate discount, with the shares trading at a lower multiple than pure-play operators. The hope is that post-split each company will have a simpler story to tell, attracting more investor interest. It's also a chance for XPO to refinance and rework its debt, hopefully moving both businesses into investment-grade credit ratings.
Investors knew a split was possible (we predicted it was coming back in August), but should they be excited or worried about what lies ahead? Here are some thoughts about what XPO's plan means for shareholders.
A pure-play e-commerce logistics specialist
The business to be spun out would rank as the world's second largest contract logistics provider, with about 200 million square feet of warehouse space and operations in 27 countries.
Even prior to the pandemic, large businesses were increasingly outsourcing much of their warehousing and supply chains, and the COVID-related boost in e-commerce has only accelerated that trend. XPO's Direct offering attempts to help retailers compete with Amazon by providing a suite of products from warehousing to delivery.
Few retailers have the scale to compete with Amazon directly, but the combined scale of XPO Direct helps even the playing field. In the coming quarters the logistics business will also play a role in the distribution of COVID-19 vaccines.
The logistics business accounted for about 36% of XPO's $16.6 billion in 2019 revenue, but with the growth in e-commerce in 2020 it is likely the faster-growing segment of the business. It's a way for an investor to gain exposure to megatrends in retail without paying the sky-high multiples the market is currently attaching to companies like Shopify.
A tech-infused trucking company
The remaining company ranks as the third largest provider of less-than-truckload (LTL) transport in North America, and the second largest truck brokerage in the world. LTL is a difficult -- but if done right, lucrative -- part of the trucking market, requiring operators to take packages from multiple customers to multiple locations instead of simply hauling an entire load from point A to point B.
XPO became a major LTL player five years ago when it bought Con-Way, and in the years since that acquisition the company has doubled the business's earnings before interest, taxes, depreciation, and amortization (EBITDA). The operating ratio -- a measure of operating expenses compared to net sales -- has improved by about 10% since the acquisition.
Amazon has recently made headlines for trying to bring tech to truck brokerage, but XPO -- via investments of about $500 million annually in IT -- is already there. Its Connect product has proven sticky with truck drivers as an online brokerage that helps drivers fill their trucks and reduce unprofitable miles driven.
Is this the beginning of the end?
XPO is a fine company, but for a lot of shareholders Jacobs has been the focal part of the investment. The serial entrepreneur took control of what was then called Express-1 Expedited Solutions in 2011, and used a string of acquisitions to push the stock nearly 1,000% higher in a span of eight years.
Prior to XPO, he built United Waste Systems, which eventually sold to Waste Management, and United Rentals. Jacobs stayed at United Waste for eight years, and at United Rentals for ten. He's now coming up on 10 years at XPO, and that's likely to lead to some questions about how long the 64-year-old will remain at the helm.
Officially Jacobs is adding to his schedule via the spinoff, as he will serve as chairman and CEO of the trucking company and chair the logistics company's board. And the two companies are strong enough that their fortunes are not tied to one individual.
But given how highly regarded Jacobs is on Wall Street, and knowing XPO has always been a "bet on the jockey" sort of stock, the CEO's plans post-spinoff are something investors should at least monitor in the year to come.
XPO is still a buy
As a longtime XPO holder, I understand management's frustration with the valuation. XPO's businesses have consistently delivered higher growth rates and better margins than rivals, yet the company trades at a discount to those rivals. Shareholders post-split will still own the many different parts of the business, but in a de-cluttered fashion that hopefully will be more appealing to capital markets.
By simply trying to assign multiples on the two businesses in line with sector averages, trucking would be worth about $80 per share and the logistics business about $55 per share. That's combined value nearly 15% higher than XPO's share price as I write this, and if the two companies can live up to their potential, they should be assigned valuations well above the sector averages.
Jacobs, appearing on CNBC after the announcement, argued XPO shares would be 50% higher if valued comparably to its peers.
Whatever the number, the stock does look undervalued. And there is relatively little risk in this split, as shareholders will continue to own a business with strong growth potential thanks to its exposure to e-commerce, and a well-run national trucking operation.
Post-split it will be the same great businesses, with hopefully better-performing stocks.