XPO Logistics (XPO) has been one of the most transformational companies of the last two years, becoming the fastest growing company in the transportation sector via a series of acquisitions and cold starts. In previous articles I have explained thoroughly how the company has managed to achieve this feat; I have also discussed the investment upside in this company on many occasions. Therefore, I am not going to spend much time discussing the company's operational approach, but rather how investors should view and trade XPO Logistics following yet another large public offering, and also how these offerings affect the outlook for this company.
A Quick Run-Down
Back in 2011 entrepreneur Bradley Jacobs announced a $150 million equity investment into a small truck brokerage company that earned approximately $158 million in revenue the year prior. That company was Express-1 Expedited Solutions, which later became XPO Logistics. Then, with his investment Jacobs became Chairman and CEO of the company. His goal was simple: Turn XPO Logistics into a multi-billion dollar company with strategic acquisitions and a series of cold-starts.
In Jacobs' storied career, he has founded four different billion dollar companies, including United Waste and United Rentals. As an investor, I can vividly recall the day that his investment was announced, performing the research, and then speaking with Jacobs shortly after. And as a result, I then made XPO Logistics my largest position, and I have held it through thick and thin, based solely on the leadership and my opinion that Jacobs (and the team he's assembled) is a proven winner who is methodical by nature and fully capable of living up to expectations.
Thankfully, it has been a great investment thus far, as all of the company's targets have been met during the last two years, including 10 acquisitions, 23 cold-starts, and ended 2013 with a revenue-run rate in excess of $1 billion (not bad for a $158 million company just three years prior).
A New Acquisition Of Immense Opportunities
Of the 10 acquisitions that XPO Logistics has announced, not one appears more promising than its recent purchase of Pacer International (PACR).
Pacer is the third largest provider of intermodal services, which is one of the fastest growing segments of transport logistics, growing at 3-5 times the rate of GDP. The acquisition of Pacer gives XPO a solid footprint in the cross-border business between the U.S. and Mexico, along with allowing XPO to create cross-selling opportunities with it and Pacer's large customer base.
Therefore, you can see why investors such as myself loved this acquisition, and with Pacer having 12 month revenue of $1 billion, this purchase will double XPO's revenue run-rate to $2 billion once it completes. Hence, XPO just became a multi-billion dollar company!
Now, such a feat comes at a cost: XPO Logistics closed a $375 million public offering of common stock on Thursday, 15 million shares, and is still offering 2.25 million shares to underwriters in a 30-day option. This offering adds to the $543 million in convertible stock and debt offerings that XPO had already completed in the last two years, meaning that XPO is a very diluted stock, with more dilution likely to come.
Why Are Offerings Bad (& Good) For XPO Logistics?
Before bashing my largest position, I think it's imperative to understand that not one XPO long expected the company to reach its growth goals without dilution. Jacobs invested an original $150 million that was used to acquire and grow, but with large acquisitions in recent months, investors have had to cough up the dough.
With that said, let's first reassure that everyone understands what I mean by "dilution" and "stock offering". Personally, I invested for three years, and often in highly risky stocks, before I ever really understood the impact that an offering had on a stock price. But, essentially it is when a company increases its share count by selling new shares to collect the profits. Hence, it works good in a sense that it increases liquidity. So, in XPO's case it added 15 million shares to the 29.9 million shares it had as of 9/30/2013. Then, the stock price stays the same, or is traded normally. Therefore, the valuation or worth of the company rises.
Now, while my explanation of an offering or dilution may sound ridiculous to those who are experienced investors, I consider it important to newer investors who may see the selling pressure put on a stock following an offering announcement a good opportunity. Investors must realize that when a company introduces new shares to the market, and there are owners of those shares, it means that there is the potential for more sellers than buyers, at least temporarily. Basically, it creates an imbalance, and historically, such an imbalance can weigh on a stock for weeks, even months at a time.
With that said, it is a necessary evil for this company, as cash is needed to grow. So, you take the good with the bad!
When to Buy?
Currently, XPO is trading at $25.23, approximately $5.67 off its all-time high, $2.38 of which has come following the offering announcement. Yet, after closing the offering, and introducing new shares, XPO Logistics now has a market capitalization of $1.16 billion (a new high). Also, XPO has an additional 28 million fully diluted shares outstanding in preferred shares, warrants, convertible senior notes, and stock options. Yet, for the sake of argument, and to keep it simple, let's discount these shares for now, and only look at common stock with the valuation. The reason is because insiders own 41% of the total shares, including Jacobs who has not sold stock and likely will not at any point in the near future. Therefore, most of these shares are not a threat to the volatility of the stock.
With that said, XPO is trading at two times trailing 12 month sales versus 0.63 times sales for the industry-leader CH Robinson (CHRW) and 0.50 times sales for a smaller peer like Echo Global Logistics (ECHO). Therefore, XPO Logistics trades at a high premium, as investors are betting on the future, not necessarily investing for today.
If we look at valuations from a run-rate perspective, using analyst expectations for the full-year, then XPO Logistics is trading at 0.58 times future sales with growth around 150%. Echo is expected to grow 17% this year and CH Robinson has a 6.6% growth outlook. Thus, sales might be the best metric to compare XPO Logistics to its peers, as it's not yet profitable due to focusing on growth, expecting to announce its first quarter of positive EBITDA during the Jacobs era for the fourth quarter.
With that said, if we compare XPO from a valuation perspective to its peers with the understanding that high-growth companies are often awarded premium multiples then you could likely buy XPO Logistics today, hold it, and return very large gains over a course of several years. However, investors must also realize that with each period of dilution XPO Logistics is taking potential gains from investors, inflating the company's valuation, and creating an unstable mix of buyers and sellers, with more of the latter.
Therefore, to find a good buying price for investors wanting to maximize the return on their investment - given the additional 15 million shares that have been introduced to the market - let's look back to August 2013, which is when XPO completed its last secondary offering of 8 million shares.
Between the July 13 and September 13 period you can see where XPO's stock peaks, then falls. You can also see in the volume chart where the number of shares traded increased significantly: It is at this point where XPO's 8 million share secondary occurred.
Now, there are a couple key points from XPO's last secondary offering. First, XPO peaked over $25 on August 2 before the offering until falling below $22 on August 16. Then, XPO recovered to $23.5 by the end of August. However, the following two months were rough, as XPO shares fell to $19.50 in early November, and it was this price action that is a good reflection of how dilution weighs on a stock over a short period of time.
Granted, XPO then recovered to reach all-time highs in excess of $30, which might be a good example of what to expect when investing in this company. Maybe we will continue to see large acquisitions followed by dilution that creates highs and lows. And while this has been a lucrative strategy the last two years, at some point XPO Logistics has to find other ways to create cash, such as raising more debt, or operate in a more responsible way where profits are at least visible in the foreseeable future.
With all things considered, XPO has already recovered from post-offering lows of $24 to now trade at $26. But, if we use history as a guide, and pay close attention to the trend of the stock following XPO's 8 million share offering, then I don't think we've seen the lows yet. I think we could still see a one-two month period of rough trading, where, like last time, XPO's stock could fall well below its initial post-offering lows of $24. In other words, $21 to $22 shouldn't be unexpected over the next eight weeks, as this offering is twice the size of the last one, meaning a lot of new investors owning this stock. Who knows, it may even drop below $20!
Conclusion (What Does This Mean?)
The more that XPO dilutes its shares the harder it will be to fundamentally support its price. However, as of now with this latest round of dilution, XPO is still a long-term buy.
The company has proven its strategy to be effective and has met every target that the company has set in the last 24 months. And with a $2 billion revenue run-rate, I think the company's long-term goal of $4-$6 billion in revenue by 2016 is highly probable. Then, with growth that exceeds the industry, it is worthy of a premium, and eventually, will produce the same operating margins of 3% to 6% that's seen with industry peers.
So, what does this mean for the stock's long-term price target? If we assume that XPO will reach $6 billion in annual revenue by 2016 then I think it will also carry a market capitalization of $6 billion based on a growth premium of one times sales. If XPO Logistics can achieve operating margins of 5% (below CH Robinson's 5.71%) then this would have XPO trading at a 20 times operating profits, which isn't unprecedented.
Furthermore, if we use the current shares outstanding, then XPO could see a stock price of near $130 by the end of 2016. But, if the company offers another 15 million shares, then that price could drop to $100, showing the full impact of such dilution. Lastly, despite this most recent dilution, XPO Logistics might very well have a breakout year in 2014.
For many, XPO has remained under-the-radar, and now that it's operating at a $2 billion run-rate, momentum and growth investors might very well be attracted to the company. Also, XPO Logistics' net loss of $50 million over the last 12 months was a significant overhang. And with the fourth quarter producing positive EBITDA, it begs to reason that XPO will see major operational improvements this year, which could drive significant gains. As a result, I wouldn't be surprised in the least bit to see $50 to $60 a share by the end of this year, but to conclude, investors should still expect a rough patch while the market adjusts to the presence of 15 million new shares.