expeditors2

“Expeditors has long believed that it is a competitive advantage to focus on organic growth and to utilise an enterprise technology platform designed and built by logistics technology professionals for logistics professionals.” (Expeditors, 2018 annual report)

After Denmark’s DSV reported another set of outstanding results last month and Switzerland’s Kuehne +Nagel, unsurprisingly in my view, disappointed the market last week, Expeditors recently showed the industry where its strengths and weaknesses lie.

It is pretty tough out there for most firms, but judging by Expeditors’ operational standards and share price levels, there is a lot to like in the way it has protected its business model. Many risks could have harmed its organic, growth-driven performance over the past few years, but they didn’t; operating risks and exogenous shocks have been properly managed, while organic growth is the secret sauce – so investors should be happy, right?

One caveat is that while capital gains have far outperformed earnings per share appreciation and total shareholder returns, including dividends, have been outstanding, there remains hard evidence that Expeditors is struggling to outperform financial benchmarks on a relative basis.

This is not unusual, given its intrinsic defensive characteristics at mid/late cycle – which is where we are now, and Expeditors is penalised due to a lowly beta of 0.6 – but its relative performance leaves plenty of room to speculate about what could be next.

Relative share price (source EXPD)

Firstly, it actually doesn’t need to be a public company because it doesn’t exploit the full benefits (funding alternatives) offered by capital markets.

Secondly, cautiousness in capital deployment is common to many asset-light businesses, but to my mind this is a little crazy and reinforces the view that Expeditors is by far the best takeover target in the freight forwarding industry, particularly now following a year during which it reported record net revenue and net earnings of $2.3bn and $489m, respectively.

Financial snapshot (source: EXPD)

Admittedly, it would be an ambitious target, yet as “a perfectly oiled machine”, as one deal-maker in New York described it, it would only need to attract the investment required for a change of ownership and in four years would likely generate awesome returns to its owners – without having to do much work.

Allure

While market rumours and my banking sources continue to indicate that XPO Logistics (market cap $11.8bn) could be the next takeover target in the T&L industry, Expeditors (market cap $11.1bn) is much more attractive, as far capital arbitrage (swapping debt with equity in the capital structure) is concerned. Also, it has a free float close to 100%, and a net cash position that screams for more leverage.

Balance sheet (source: EXPD)

Core margins are typically thin in the industry, but its operating profitability is best-in-class, at about 10%. This is significantly higher than DSV’s, which is 300 basis points or so lower, and double K+N’s, while Panalpina’s is a lowly 2%.

While it is true that Apollo’s ownership of CEVA Logistics has at times been painful to watch over the past decade, Expeditors is not CEVA – it is much better run than the latter has been historically – and anyway, it seems likely that the private equity owners of CEVA will float it at a decent price this year, regardless of all the restructurings and debt problems that have hindered its performance.

How could it work

A management buyout (MBO ) of Expeditors led by existing executives and backed by a financial sponsor should command a lower amount of debt than the typical 75% as a percentage of the total purchase price by private equity – say 50% of debt in the debt-equity funding mix to finance a $15bn takeover, for an implied 36% premium. After all, Expeditors has plenty of free cash flow to play with.

Assuming it cuts buybacks and dividends to zero for the first few years under new ownership, Expeditors could churn out almost $1bn of free cash flow, once new interest expenses are considered, which means that half of the $8bn of debt supporting the take-private deal could easily be repaid by year four (assuming EBITDA grows in line with prior years’ growth rates), yielding an internal rate of return not far off 20% annually. It could be higher, though, based on my calculations.

 

 

Cash outlays dividends and buybacks (source: EXPD)

 

 

Operating income plus non-cash items such as D&A (source: EXPD)

 

Capex (source: EXPD)

By early 2022, Expeditors would carry net leverage of between 3x and 4x, and that is when its owners could comfortably look for an exit. By comparison, that range is broadly in line with XPO’s net leverage these days, while CEVA’s stands at 7.5x. A 36% premium would buy about five years of growth, assuming constant trading multiples, so it could entice shareholders.

Why now?

Expeditors is a benchmark and ranks fourth globally, just behind K+N, DHL Global Forwarding and DB Schenker, according to market data from Transport Intelligence.

It is clear that current management, spearheaded by company veteran Jeff Musser, has little or no intention of going for M&A, but private equity involvement almost certainly would represent a paradigm shift, driving a radically different corporate strategy – it would also make sense given that freight forwarders need a lot of financial engineering these days to buck the trend of possibly fast-falling share prices. Expeditors, as many others, is down 6% this year since it hit a record high on 27 February.

Of course, it could continue to focus on larger buybacks and a higher yield, but rising interest rates make this combination likely less remunerative for stakeholders. Buyouts of this size have been incredibly difficult to pull off since 2007, but a change of ownership could be supported by a jumbo buyout package that would be much smaller than the record $13.5bn debt deal put together by Blackstone and its bankers.

Annuals

There are obvious risks in the industry. Expeditors depends on a variety of asset-based service providers, including air, ocean and overland freight carriers.

“The quality and profitability of our services depend upon effective selection, management and discipline of service providers,” it said in its annual results, adding that in recent years, many “of our service providers have incurred significant operating losses and are highly leveraged with debt”.

Additionally, several ocean carriers have consolidated, and more could occur in the future.

“When the market experiences seasonal peaks or any sort of disruption, the carriers often increase their pricing suddenly. This carrier behavior creates pricing volatility that could impact Expeditors’ ability to maintain historical unitary profitability.”

Most of its revenues and operating income come from outside the United States, but I doubt an experiment as the one I recently performed with DSV would make sense, given that management is focused solely on organic growth.

Geo mix (source: EXPD)

Revenue mix (source: EXPD)

Mr Musser was appointed as president and chief executive on 19 December 2013, and since then shares have risen almost 50% after several years of stagnation, and he could be the man to shake a place that has not seriously been shaken since Peter Rose left five years ago.

COMMENTS 10


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  • michael.pruden@gmx.net

    March 05, 2018 at 6:53 pm

    Target of XPO maybe?
    XPO said they want to do some M&A this year. Currently their forwarding business is tiny compared to their other segments. Expeditors might fit in nicely.

    Reply
    • a.pasetti@yahoo.co.uk

      March 05, 2018 at 9:56 pm

      Hi Michael,

      That’s great feedback, thanks very much. Yes, XPO is nowhere close to the main players in FF, but is that the way forward? Well, I guess so, considering core margins accretion for the combined entity if XPO were to team up with EXPD. My first shot is it would have to be structured as a merger “of equals” on paper, with XPO in the driving seat, taking, say a 66-73% stake in the combo and paying out a nice special dividend to EXPD shareholders (say a lump sum of between $2bn and $4bn) to convince them a deal is in their best interest at a time when shares out are at all-time lows and buybacks are v expensive — re your comment, “might fit in nicely” with regard to any specific unit(s), in your view?

      Synergies could be minimal, IMO, in many areas of business — which plays against a XPO/EXPD tie-up, on a preliminary basis — but there could be a story of deeper vertical integration of services (EXPD’s offering/transportation services in NA would bulk up thanks to XPO’s freight brokerage, LTT, LM, FT, and there could be some obvious overlap elsewhere.)

      As I wrote on another platform, assuming a constant free cash flow yield, and based on its FCF flow guidance, XPO’s market value could more than double to $25bn by early ’19. I looked at DSV/XPO previously, but I haven’t thought of XPO/EXPD because I am inclined to believe XPO would want to fetch a significant premium (in terms of relative value) in any negotiations, which is implied in its fwd trading multiples (vs EXPD and others), and also XPO could be much more attractive as a target than a buyer. Either way, one to watch (it just hit another record high at over $101).

      Thanks again.

      Best,

      Ale

      Reply
  • Thomas Bradley

    March 09, 2018 at 11:43 pm

    Although your analysis has some technical merit, this would be the most un-Expeditors thing ever. Jeff Musser started as a messenger at Expeditors and he’s married to Peter Rose’s daughter. Simply to say, he was mentored by Peter for 3 decades essentially. He’s as firm a believer in the idea that M&A is a bad idea in this industry from a service standpoint. It’s always a bit of a disaster and the customers suffer.

    In my opinion, the chances of something like this happening are less than 5%. It’s just not in their DNA.

    Reply
    • a.pasetti@yahoo.co.uk

      March 11, 2018 at 8:27 am

      Hi Thomas, thanks much for your insight, much appreciated!

      Some marriages work, others don’t. And then who knows if Mr. Musser will be there this time next year or the year after — point being, a financial sponsor needs to retain some key existing managers, and then move on with or without Mr. Musser, although I think he could be the right man to lead EXPD under a different ownership.

      Re: “This would be the most un-Expeditors thing ever” — yes, of course, and I think I acknowledged that in the first three paragraphs of this story, as well as previously elsewhere on this platform.

      “In my opinion, the chances of something like this happening are less than 5%. It’s just not in their DNA.” — could be even lower than 5%, I agree, and this is a problem shareholders could do without. Re its DNA, see my comment above.

      “M&A is a bad idea in this industry from a service standpoint. It’s always a bit of a disaster and the customers suffer.”

      That clearly doesn’t take into consideration corporate stories where existing management teams know how to manage integration and execution risks in M&A. Are you thinking of CEVA and Toll Holdings maybe?

      How about DSV and XPO instead, who have created about $15bn of additional, combined market value in the past two years?

      I do not think this analysis has some technical merit, as you say, because this analysis clearly shows, in my humble opinion, the benefits of applying some financial engineering to boost returns (likely, and this is the best part, “without having to do much work”) after years of lagging performances, on a relative basis (see the chart 1 above). Let me also add that the FF/C environment Peter Rose lived in is very different from today’s world, and if the price is right, I understand, many EXPD shareholders would love to take the money and run!

      Best,

      Ale

      Reply
      • Charles M

        March 17, 2018 at 12:49 am

        Hello Ale,

        I am inclined to agree with Thomas Bradley above. This analysis is quite strong technically, and you very clearly state a strong case. The problem is cultural. Expeditors is not for sale. Past and current management don’t necessarily care about the stock price or the market cap. They are basically allergic to financial engineering, and will not take actions specifically designed to increase the share price.

        You state that this aversion to financial engineering is “a problem shareholders could do without”. I’m not sure EXPD management gives a hoot what shareholders care about. The focus is 100% on their people, their customers, and their market share. Market cap is a byproduct, not a goal. Management is compensated more with cash profit-share payouts than stock options. They have been explicit about this for years, and Wall Street just refuses to take them at their word.

        Reply
        • a.pasetti@yahoo.co.uk

          March 19, 2018 at 12:05 pm

          Thanks Charles, your feedback is much appreciated.

          You are thinking of it as a corporate man, rather than a finance guy, so I think your premise is debatable because you are looking at a different side of the story.

          Re: “Expeditors is not for sale.”

          All public companies can be sold (look at the ~ 100% free float), by definition. It’s just a matter of price and how many years of growth any proposal would buy. Five years will be enough for EXPD, assuming constant trading multiples. The market cap, in isolation, is a somewhat meaningless metric (even more so with EXPD, given that it’s bought back stock at a fast pace in recent years).

          Re: “They are basically allergic to financial engineering, and will not take actions specifically designed to increase the share price.” I’d personally add “until shareholders are no longer happy with that”.

          But overall, what you’ve written is not accurate, because management has used a lot of financial engineering to boost EPS artificially via buybacks in the past decade or so (wasting millions during certain periods of time under Rose).

          https://tradingeconomics.com/expd:us:common-shares-outstanding

          So, I think we agree EXPD is a public company (fact), owned by its shareholders (fact), and if it receives an offer the board will have to acknowledge it (fact), given its fiduciary duties (fact), right?

          Then the board can say “no way”, and then, I imagine, the suitor could turn hostile and go directly to the shareholders, and EXPD will be sold.

          You need a different corporate structure to prevent a takeover, it’s as simple as that.

          Is a change of ownership going to happen? I don’t know.

          Would it be in the best interest of shareholders if its CEO were involved? Yes.

          But PE firms do not need Mr Musser, so he might be out of work sooner rather than later if a traditional LBO (rather than an MBO) emerges.

          My 2 cents.

          Thanks very much for your comment.

          Best regards,

          Ale

          Reply
        • Jacob Smith

          March 21, 2018 at 11:43 pm

          I strongly agree with the Charles and Bradley. In the end, the only way this ever happens starts with a hostile takeover. Anyone who truly knows Expeditors knows the leadership understands their legacy will be forever tarnished if this happened under their watch. They have way too much pride to go down that path voluntarily. Almost all of the leadership has been with the company well over 20 years, most over 30. Many of them have children/family that also work for Expeditors. Short of a hostile takeover, there is 0.00001% chance this happens. Anyone who disagrees with this assessment simply doesn’t know Expeditors. 10 years from now? Who knows?

          Reply
          • a.pasetti@yahoo.co.uk

            March 22, 2018 at 10:09 am

            Jacob,

            I think you remember the headlines in 2014, right?

            “Rose quits as Expeditors chairman amid signs of investor unrest”

            https://www.seattletimes.com/business/rose-quits-as-expeditors-chairman-amid-signs-of-investor-unrest/

            I have covered EXPD for years, so I understand your point — loud and clear. However, what you should also acknowledge is that shareholders are in the driving seat, not management. And Mr Musser has a great opportunity to be part of the changes that I foresee, or he can just retire happy and rich.

            A decade? Ah, it might take less than three years to witness significant changes in the board and shareholder structure, so I guess we’ll talk then.

            Best,

            Ale

            (PS: how did you come up with that 0.00001% chance of a takeover happening?)

          • jsmith2611@gmail.com

            March 22, 2018 at 4:07 pm

            Ha ha… 0.0000001% is a mathematical way of saying “nada”. The problem with a takeover is that there’s probably about 15-20 top level people (if not more) who are more than rich enough to not hang around. Then what do you have? Other LSP’s don’t have this “problem”. Basically, a takeover would effectively end Expeditors in the sense they’d become just another forwarder.

            I also remember something Peter Rose told us investors as well — “…Rose replied, “What hostile takeover? We would be about as easy for an outsider to digest as a porcupine.”

            Btw, I truly appreciate your feedback and responses.

          • a.pasetti@yahoo.co.uk

            March 22, 2018 at 5:14 pm

            Jacob,

            I really appreciate your comments and insight and I am glad I reached the same conclusions about that 0.0000001% rate!

            Good quote, too — that is the reason why I believe the involvement of existing management is necessary. We’ll see how it goes… Goldman recently pointed out that option prices indicate that CHRW could be another target (same applies to XPO), so there is plenty of speculation in the marketplace about a possible change of ownership for some of the market leaders in the supply chain in the US (possibly also driven, I am told, by e-tailers).

            I’ve been on calls over the past two weeks and the feedback I received was inspirational, so I’ll have some more thoughts coming on the EXPD story either before or after Easter. I’ll make sure I’ll incorporate your take, as well as Charles’ and Thomas’.

            Hope you’ll find the time to share your views again on my upcoming story.

            Thanks again.

            Best,

            Ale