XPO – May 2015 Portfolio Review #4

Investment Analysis Clubs Saul’s Investing Discussions
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XPO – May 2015 Portfolio Review #4

XPO Logistics (XPO on the NYSE), was a new addition in November, about 6 months ago. I bought a lot at $36.25, and about a sixth more at $37.25, and little dribs and drabs on the way up, with my highest small purchase at $45.75. It closed last week at $49, up 35% in the six months since my original and major purchase. It has grown to be my sixth largest position and about 6.8% of my total. The big news has been the purchase of a large French logistics company, announced about a week ago (and extensively discussed on the board) and just today, the purchase of a drayage logistics company in the US.

As you can tell, from it being on the NYSE, XPO is a substantial company although it was just founded 2011. It’s a logistics company. What that means is that it is essentially a middleman between companies who want to ship something and the companies who own the shipping (trucks, ships, etc). Shippers contact XPO with loads to move, and XPO arranges to have the loads moved. The good news is that XPO doesn’t have to own the means of shipping. They are thus the opposite of capital intensive, and are what’s called an “asset-light” company, meaning they don’t have to own the trucks, but hire independent contractors to do the trucking, etc.

XPO keeps the spread between what it charges the shipper and what it pays to get the load shipped. Four months ago it was setting up more than 25,000 deliveries per day, mostly by truck, making it the fourth-largest truck broker in the country. Who knows how many they set up now!

The freight and shipping market is highly fragmented, with the largest player holding just a 22% market share, and there are few other large players. The rest of the market is shared by small operators: There are more than 10,000 licensed truck brokers in the U.S., but only 25 generate more than $200 million in revenue. XPO’s strategy is to grow rapidly by rolling-up smaller profitable competitors. They believe that size can convey a significant advantage in efficiency.

Typically, growth by acquisition and attempts to roll-up an industry often fail, but there are many reasons to think that XPO could succeed, and, in spite of its brief history, XPO has made huge strides toward its goals.

You have to think of both Gross Revenue and Net Revenue with this company. Gross Revenue is what they receive from the shipper, and Net Revenue is what’s left after they pay someone to deliver the goods, which makes it like Gross Margin (the way I think about it).

Gross Revenue was just $177 million for the entire year 2011, but in 2014 they had $2356 million (over $2.3 billion). That up 13x(!) in three years.

The Net Revenue is growing even faster. Here’s their Net Revenue for the past nine quarters (not years). That’s what they take home before operating expenses.
$16
$19
$35
$53
$58
$121
$175
$299

And they just announced $262 million for the first quarter, which was held back by winter weather and the West Coast port closures, but was still up 16 times from the $16 million two years ago.

NOW GET THIS: In November when they reported Sept 2014 results, they made the wild estimate that they aimed to generate

$7.5 billion in Gross Revenue
$425 million in EBITDA……. in 2017.

That was a huge step up from:
$702 million in Gross Revenue
($28 million) EBITDA loss in 2013.

Well in their earnings report today, they raised those estimates to run rates of:

$9.5 billion in Gross Revenue
$625 million in EBITDA……. Not in 2017, but by the end of this year!!!

Their EBITDA for 2014, by the way was $81.4 million.

To meet those goals, XPO is opening new offices and hiring sales talent, which it calls cold starts. Start-up requires very little capital. Thus far, it’s opened 20 or 30 new offices, though the bulk of its growth will likely come from acquisitions.

The CEO, Bradley Jacobs has an incredible track record of building businesses. (He was born in 1956, which makes him just 59 in 2014, so he’s still young enough to be motivated and enthused). He’s already built four billion-dollar enterprises from scratch. Early in his career, he apparently built a large oil brokerage company as well as an oil trading company. After that, he helped grow United Waste Systems into the fifth-largest solid-waste management company in North America and sold it to Waste Management for $2.5 billion. Then he launched United Rentals, which he developed into the largest construction equipment rental company in the world.

The COO worked with Jacobs at United Rentals and United Waste. The CFO and chief strategy officer are Wall Street veterans focused on the transportation industry, which should be especially helpful in raising capital. The leaders of both Strategic Accounts and Technology were captured from competitors. And all these insiders should be highly motivated as insiders own more than 29% of the shares.

XPO has a $3.8 billion market cap. With only $857 million in trailing Net Revenue it’s at 4.4 times Net Revenue, and it had losses over the past year, so it looks expensive. And it is losing money. However XPO is growing so quickly that trailing values seem less useful than looking forward a short way.

The current run rate, based on averaging the last two quarters, is $1.1 billion in Net Revenue per year, but this quarter’s Net Revenue was five times what it was the year before, so we can assume it will at least double in the next year. Of course, the share count will likely also rise as the company sells shares to pay for acquisitions. but even so…

Note that a major reason for investing in this company is Jacobs, and if he should leave, the company would be much less attractive.

Here is my compilation from the Mar quarter results, mostly from the press release:

Gross Revenue up 149% to $703.0 million.
Net Revenue up 349.% to $262.2 million.
Adjusted Net Loss was $9.9 million, improved from a loss of $16.7 million.
Adjusted Loss of 13 cents per share, improved from a loss of 40 cents per share.
Adjusted EBITDA was $29.2 million for the quarter, up from $0.6 million.

Acquired Bridge Terminal Transport - one of the largest asset-light drayage providers in the United States. The transaction is expected to close in the second quarter and is expected to be immediately accretive to earnings before the benefits of cross-selling and other synergies
.
The purchase price is $100 million, with no assumption of debt. BTT had revenue of $232.0 million for the last 12 months. The purchase price is 8.1 times EBITDA of $12.4 million.

In business for 33 years, BTT arranges ground transportation through a network of 28 terminals and approximately 1,300 independent owner operators. BTT has approximately 250 employees and 1,800 customers, including many multinational companies, with its top ten customers having an average tenure of 19 years with BTT. Our purchase of BTT will almost triple our drayage capacity.

Raises Full Year Financial Targets - In light of the two recent acquisitions, the company has raised its 2015 targets to an annual revenue run rate of at least $9.5 billion and an annual EBITDA run rate of at least $625 million by December 31.

CEO Comments - Our first quarter performance reflects the resilience of our diversified service offering. We generated strong results in our last mile and expedite businesses, and in our logistics segment. These gains were offset by a weak spot market for freight brokerage and the disruption of our intermodal business due to the West Coast port slowdowns. March was a more broadly favorable operating environment, with an upswing that continued into April.

In light of our recent M&A announcements, we’ve raised our 2015 targets for revenue and EBITDA. We’re now targeting a year-end revenue run rate of at least $9.5 billion, and EBITDA of at least $625 million - more than twice the EBITDA target we set just three months ago.

Rebrands All Services as XPO Logistics - The company has rebranded all its services under the single global brand of XPO Logistics.

Launches New Website at www.xpo.com

I know it’s still not profitable but I believe it will be very soon. You’ll wonder why I’m so enthusiastic about XPO, when they still have losses. First, they are growing incredibly quickly. Second, their loss this quarter was $10 million but their Gross Revenue was over $700 million, or 70 times their losses. The loss was roughly 1.4% of revenue, and easily overcome. That’s a completely different ballgame than WPRT where losses were well over 130% of revenue (as I remember). That’s almost 100 times as much loss proportionally.

Hope you find it interesting.

Best to you all

Saul

For FAQ’s and Knowledgebase
please go to Post #7972

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The CEO did an interview yesterday on Mad Money (Cramer). I thought the ticker sounded familiar!

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If you give me your money to manage for you, I’ll grow your earnings 40% per year. How? Easy – I’ll find someone next year who believes that line and take some of their money and give it to you for your 40% growth. And I’ll keep doing that until someone asks what return I’m getting on those ‘investments’.

Over a decade ago there were companies that did something like this. They had colorful CEOs who were able to grow earnings by acquiring other companies by issuing stock and borrowing. WorldCom and Tyco are two examples. The few people at the time who questioned those earnings were ignored or labeled negative. Those companies went on to not only destroy wealth but destroy people’s lives.

Three questions to ask if you are interested in XPO:

(1) Can they grow earnings without issuing more stock or borrowing?

(2) What return are they getting on their investment, and how will that change going forward?

(3) Is that Goodwill building up on the balance sheet good or bad Goodwill?

Thanks,
Ears

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Hey Ears, interesting points. Saul outlined the CEO’s history above, so the guy has a track record, and he hasn’t seemed like a scammer in the past.

How would you tell if XPO is a Tyco or the real deal?

Karen

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Is that Goodwill building up on the balance sheet good or bad Goodwill?

Hi Ears, Here’s what TMF EnochRoot wrote in response to that issue about Goodwill in relation to XPO. I’ll let him speak for me:

"The poster is pointing out the accounting impact of acquisitions. Yes, acquisitions of profitable businesses worth more than book value creates goodwill, and a highly acquisitive company buying decent businesses will therefore have increasing amounts of goodwill on the balance sheet. I do not view this as a good or bad thing, nor do I see any obvious ‘perils’ to goodwill - price paid versus value received is what matters, not price paid versus tangible assets received.

Berkshire Hathaway’s goodwill+intangibles rose from ~37 billion to ~72 billion in the last 5 years. I don’t view anything perilous about that either."

By the way, as I pointed out, I’m up about 36.5% now in six months on this investment where they are “destroying value”. It’s hard to imagine what “creating value” would look like.

Saul

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Yes, acquisitions of profitable businesses worth more than book value creates goodwill, and a highly acquisitive company buying decent businesses will therefore have increasing amounts of goodwill on the balance sheet.

The way to think about this is that any successful business worth acquiring will sell for more than its book value. In other words its actual value will be more than its book value. So, when you acquire it, the accounting gods have decreed that you have to designate that inevitable difference between what you pay for it and its book value as “Goodwill”. Thus, as TMF EnochRoot pointed out, goodwill is neither good nor bad, it’s just there and rather meaningless (unless you made a really terrible acquisition, which none of XPO’s have seemed to be).

Saul

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So, when you acquire it, the accounting gods have decreed that you have to designate that inevitable difference between what you pay for it and its book value as “Goodwill”.

Goodwill is a double-entry bookkeeping necessity created by GAAP, the right side has to match the left.


**Concept                           Debit      Credit**
Book value (of acquired firm*)  100,000
Cash (price paid)                           150,000
Goodwill                         50,000
                               --------    --------
Total                           150,000     150,000
                               ========    ========
  • The book value would be distributed to various asset and liability classes including cash, securities, account receivable and payable, plant and equipment, debt, etc. What GAAP does not allow you to do is to distribute the difference between the purchase price and the book value of the acquired company so it winds up as goodwill.

Now consider this: Microsoft expenses the R&D that goes into Windows. Windows is not capitalized like a smelter at a steel mill. But even if Windows is worth ZERO on the books, surely in the real world it is worth something, after all, it has made more than a handful of millionaires and a few billionaires. Now suppose ABC Software buys Microsoft. The value of Windows is not reflected in the books but surely it is in the purchase price. The value of Windows winds up in the goodwill account of ABC Software.

But even more interesting, at Microsoft Windows was not capitalized but at ABC Software it is – DISGUISED AS goodwill. How is that for GAAP standardizing the accounting?

Denny Schlesinger

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But even more interesting, at Microsoft Windows was not capitalized but at ABC Software it is – DISGUISED AS goodwill. How is that for GAAP standardizing the accounting?

Except, its not, really. The goodwill is everything about Microsoft which made it worth more than the purchase price. The capital investment to create Windows isn’t all of that by any means or even is it the important part. The reason it is worth paying more for Microsoft than the book value is because of the established market for Windows. That is really what the goodwill represents. Otherwise, the amount a company had spent developing their product would be the value of the company and that clearly isn’t the case. With a steel mill, there is a residual capital value in the equipment. With Windows, the value only exists to the extent that people are still buying it. If everyone converts to Android or Linux or whatever, then all those billions they spent developing Windows is worthless.

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Except, its not, really. The goodwill is everything about Microsoft which made it worth more than the purchase price. The capital investment to create Windows isn’t all of that by any means or even is it the important part.

It’s counterproductive to get bogged down in details when discussing the principle of a thing. :wink:

Denny Schlesinger

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Except I think this is core to the principle. If one buys MSFT for 2X market cap meaning that 1X market caps goes to goodwill, one had better be right that that much money is really worth the established market. If one did that when there were already signs of a mass exodus to Android or Linux or whatever, then one would have massively overpaid and writing down that goodwill would be the penalty one had to pay. If, conversely, the real value of an acquisition turns out to be much more than the goodwill, then one has bought well … not necessarily underpaid because the value can go up over time.

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Except I think this is core to the principle. If one buys MSFT for 2X market cap meaning that 1X market caps goes to goodwill, one had better be right that that much money is really worth the established market.

Goodwill has NOTHING to do with Market CAP! It is the price paid vs. the book value.

Denny Schlesinger

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Sorry, misspoke. But, the remarks apply equally either way.

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Hi Karen,

You asked: How would you tell if XPO is a Tyco or the real deal?

Unless you’re a forensic accountant with access to XPO’s books, you really can’t tell. For example, see: http://www.scu.edu/ethics/dialogue/candc/cases/worldcom.html…

What you can do is look for symptoms – large amount of Goodwill in relation to Total Assets, negative or low return on investment, poor quality earnings, etc. Those areas become your target for further research until you feel comfortable one way or the other. One way to make it easy on yourself is to look for companies with as few red flags as possible – in other words, look for one-foot hurdles not ten-foot hurdles.

Hi Saul,

You said: I’m up about 36.5% now in six months on this investment where they are “destroying value”. It’s hard to imagine what “creating value” would look like.

The stock price can do anything in the short term (short term meaning even a few years). Enron, and WorldCom and others had rising stock prices for quite a while. In fact they were the darlings of Wall Street.

Thus, as TMF EnochRoot pointed out, goodwill is neither good nor bad, it’s just there and rather meaningless (unless you made a really terrible acquisition, which none of XPO’s have seemed to be).

Just a difference of opinion.

Berkshire’s Goodwill & Intangibles are about 11% of Total Assets. Anything over 20% is a red flag. XPO’s Goodwill & Intangibles is about 46% of Total Assets, and about to get larger with the new acquisitions. We don’t know yet if XPO overpaid for their purchases. We won’t know that for a while. But with that much goodwill on the balance sheet it’s a potential time bomb if things don’t go well with the integration. I can tell you from personal experience that corporate acquisitions are a minefield.

I’m not saying XPO is a bad investment. I’m saying there are enough red flags with XPO to make it a much more difficult business to research than some of your other choices, like Skyworks for example.

Again, just .02, and appreciate your comments.

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The other possible red flag is a transition from a broker role to owning the actual delivery vehicles and staff. Not really the same issue. Vertical integration can be a plus, but is also a risk.

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The goodwill question is terribly important. Pointing to your own returns as proof it was as a good investment is no different than pointing to a winning lottery ticket as proof that you are good at guessing. It will be hard for Saul to lose money on his trade, given his results. The same is not necessarily true for someone who enters the trade today.

This isn’t to say XPO is a bad investment. I really have no idea.

But to wave off the concerns that surround a company whose top line growth is coming through MA is uninformed, at best.

If you don’t like the examples of companies who defrauded their shareholders by misrepresenting the actual risks associated with owning them, how about the example of two stalwarts and the largest goodwill write-off to date.

AOL’s acquisition of Time Warner was a $147B deal that contained as much as $128B of goodwill. Ultimately the write-off ended up being about $100B, while shareholder value dropped from a high of $200B to about $20B. AOL now has a market cap of $3B while Time Warner has recovered to $69B.

The numbers don’t matter so much as the lesson. These were two companies with visionary leaders who (correctly) saw the future in high speed digital media and still managed to reduce their owners’ equity by 90% because other than a vision, one of the two “equals” was virtually valueless, despite the greater market cap.

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The goodwill question is terribly important. Pointing to your own returns as proof it was as a good investment is no different than pointing to a winning lottery ticket as proof that you are good at guessing. It will be hard for Saul to lose money on his trade, given his results. The same is not necessarily true for someone who enters the trade today.

I agree entirely. The point of my earlier post is that GAAP accounting is not helpful in evaluating M&A transactions, you have to figure out what the Goodwill number really means, not an easy task for novice investors or even for more seasoned ones. In the AOL/TW deal it is now clear that the buyer overpaid. In the hypothetical takeover of Microsoft, Windows would be a hidden asset included in Goodwill and a large number need not be a red flag.

Denny Schlesinger

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