RXO Logistics - A Spin-Off is Named (RXO)
XPO Logistics names its next spin-off and we summarize the advantages imbedded in the brokerage business model.
Listen to the Special Situation Investing Podcast on Apple Podcasts, on the website, or wherever you listen to podcasts.
Welcome to Episode 34 of Special Situation Investing.
On the 12th of July XPO logistics updated their brokerage spin-off plan by announcing the, soon to be spun-out, companies name. The newly spun-out company will go by RXO logistics and already has a landing page where curious investors can register to receive email updates detailing the progress of the spin-out.
XPO logistics is consistently hitting their restructuring milestones, first through their 2021 spin-off of GXO logistics, then through their sale of the Intermodal business, and now with the renaming of their soon to be spun-out brokerage business. For more detail on XPOs progress so far please see our previous XPO logistics episodes.
Given last weeks announced name of RXO logistics it seemed appropriate to tackle this section of the spin-off in greater detail. For starters, RXO’s brokerage business is the one business resulting from this restructuring that I’d hold for the long term. The macro-economic drivers that advantage the brokerage business are covered in previous episodes of the podcast but are worth covering again here.
For starters the economy seems headed towards steadily rising prices that won’t soon be abated by central bank policy. Businesses with high operational costs tend to suffer margin contraction in inflationary markets and this pressure would negatively impact XPOs core, Less than Truckload (LTL), business much more than RXOs brokerage business. A few examples might serve to illustrate this point.
Consider the fact that XPO Logistics remain-co will employ 21,000 employees as compared to only 5,500 employees at RXO. These figures are even more telling when you consider that XPO only produced 3x the operating income of RXO with XPOs pro-forma accounting statements showing 600mm in operating income compared to RXOs 200mm. Put simply XPO must employ significantly more workers than does RXO to produce each dollar of operating income.
Payroll represents a meaningful portion of any businesses expenses and those expenses are starting off at a higher base at XPO when compare to RXO. Of course going forward we can expect to see upward pressure on wages as employees demand compensation that keeps pace with rising prices which will in turn do more to squeeze profit margins at XPO than RXO.
Next consider the higher property, plant, and equipment costs at XPO versus RXO. XPO logistics owns and maintains 292 terminals, 8,100 trucks and 26,000 trailors whereas a brokerage business relies on much lower cost computer equipment and the leveraging of tech enabled networks. In fact the Drive XPO mobile app could double its earnings simply by increases the apps user base by 2x. If anything the network value would rise with more users participating and the added users would cost the company little to no additional capex to service and retain.
Compare this to the task of doubling less than truckload revenue at XPO. It’s always possible to increase the utilization and efficiency of a trucking network but there are physical limits to that process. At some point you can’t add any more cargo to a truck or reduce fleet downtime without expanding the size of the fleet and quite predictably expanding the fleet size is going to drive up your costs. Costs may rise faster in an inflationary environment than would normally be the case as each truck and trailor you purchase to grow your network costs incrementally more than the equipment you already own making growth an exercise in diminishing returns. Again RXO won’t experience the same issues within their business model because a technology platform can support nearly endless additional users without incurring added costs or margin pressure.
What if all these inflationary pressures don’t manifest? Under normal economic conditions free of supply chain disruptions, cost pressures, and labor shortages your best bet might be to simply hold XPO logistics and follow the current CEO. As we covered in previous episodes XPOs CEO Mr Jacobs has an excellent track record and skin in the game. He owns a significant chunk of the company and therefore is invested in the result of this cooperate break up. Acknowledging those facts, however, I believe that a low-cost operator business model offers a more robust margin of safety than does a rockstar CEO particularly when a business is up against macro-economic headwinds.
As Buffett himself pointed out “When a management team with a reputation for brilliance meets a business with a reputation of mediocrity it’s the reputation of the business that remains intact”. In other words the strength of a business model can determine a great deal more about an investments prospects than can the management team, all else being equal.
Well with that brief discussion out of the way we hope you learned something about XPOs unfolding spin-off and we’ll continue to update you as the company provides more clarity going forward.