9/19/12 XPO Logistics (XPO)
$100m (+15m) sen unsec cb coming tonight from MS/DB/JEF. Terms: 5yr, 4-4.5% up 20-25%, s/c 4yr @130% (m/whole prem), full pctns. UOP = gcp/acq. Bradley Jacob’s equity play (who consolidated waste mgmt & equipment rental industries in 90s). He invested in XPO in 4Q11, currently owns 52% & did a $137m secondary stk offering in 03/12. Plans are to aggressively grow thru acq/cold starts so more funding will be required. We’d assume CCC+ & L+750. Will say it yet again, this eqty w/div so model is redundant. Brw is v v thin, small @1.5% fee. Anyone owning the stock will want to own CB, anyone wanting to own either will be Jacob believers. If you don’t believe then get sense of book. Full of long only then play for flip tomorrow.
Non-asset based, third party transportation service provided.
PF Cash $288m
PF Debt $100m
LTM EBITDA -8m
LTM FCF -10m
Leverage NA
MKT Cap $275m
XPO undergoing transformation after $72m inv by Brad Jacobs in 2011. Mr Jacobs is founder of United Waste & United Rentals & 2 other prior ventures. Excellent track record consolidating highly fragmented ind. XPO newest venture. He controls ~52% of stock. Plans significant growth thru acq, cold starts (new locations), & new tech platform. Secondary stock offer brought in $137m earlier this yr. Together w/convert proceeds have funding for the near term, but more will be needed.
L+750
UBS
Announces a $100mm 5-yr sr convert; px talk is 4-4.5s up 20-25%. 3yr hard call/2yr softcall w/ 130% trigger. Given market cap and lack of current cash flow generation, credit looks like L+1,000 or even a bit higher. At that level, model implies 24v vs. 45 90d and 51 260d historical. There is definitely more than meets the eye on this story, as we explain below, so we would expect the bonds to realize some credit volatility in the coming years as it plays out.
Closest comps we could come up with are WNC, a small cap semi-trailer truck manufacturer that priced a bond this year at L+850 and HRZ, which recently restructured its balance sheet and has 1st lien notes quoted at L+1100. Compared to WNC, XPO has higher leverage and lower fixed assets, but a slightly better liquidity profile and higher expected near-term sales growth. We also note that CCC-rated spreads averaging 950-975 right now and most recent small cap converts have been pricing credit in the 800-900 area, but mostly in healthcare/biotech, where there is more of a vol story around the regulatory process.
Company’s growth story will require substantial acquisitions over the next few years to hit analyst targets. Company had $191mm of cash at 2Q12 and is likely to burn about at least $50mm over the next 2 yrs at the current run rate. Pro forma for $100mm of the convert, that should leave about $200mm available to the company to fund acquisitions in that time. However, we think this will be about $800mm short of what we conservatively estimate the company will need.
XPO is a 3rd party logistics company that brokers commercial trucking services for its clients. Trucking is a highly volume-driven, cyclical business, though co. benefiting from a secular trend to more outsourcing of this function Company has very small mkt cap, which limits its capital markets alternatives, and will have reasonably high leverage relative to its current cash flow. As a result, interest coverage looks a bit tight next couple of years, though absolute leverage is below 50% of capital.
By its own admission, XPO is a $65mm player in a $50bn truck brokerage market, which is currently highly fragmented. However, company also wants to compete in the broader logistics market beyond independent truck broking, which it estimates is a $300bn business. Company strategy is to grow by rolling up small independent truck brokers around the US. In last 8mos, has done 2 acquisitions for a total of $12mm and opened 12 newbuild locations. Street expects revenues to grow from $191mm LTM to up to $3bn by 2015 with EBITDA margin expected to settle in at 3-4%. To achieve that level of growth, we believe company will need to execute on frequent and potentially large acquisitions. Given the low margins on this business, hard to see how this does not require taking on material leverage. Even at $3bn, EBITDA likely to be less than $150mm. Assuming about $15-20mm of interest expense (vs. $6mm today), gets you about $75-100mm/yr of op CF.
Current Street expectations seem to imply that co. needs to acquire about $2.5bn of sales over the next 3.5 years, assuming 10% organic growth/yr. If we further assume that all the acquisitions get done at an average of 0.4x sales (in line w/ XPO’s current valuation–otherwise, would have to assume dilutive deals, which probably wouldn’t be good for the stock), company will need to spend about $1bn to make the acquisitions. At 50% debt/capital, will result in $500mm of additional debt on about $30-40mm of incremental capex, which works out to leverage of 14x EBITDA. Scenario further suggests that at least $500mm of new equity will need to be issued for this to happen, since internal cash flow will not likely be nearly sufficient to fund it.
Growth targets are a stretch and plenty of execution risk inherent in this story. However, economic recovery could generate a significant tailwind that will make the growth easier. Given these dynamics, we would expect the bonds to realize some credit volatility in the coming years.