On Dec. 13, 2018, short-selling firm Spruce Point Capital Management LLC took XPO Logistics, Inc. (NYSE:XPO) to the woodshed in one of the harshest attacks ever directed at a publicly traded transportation and logistics company. XPO, Spruce Point wrote in a 69-page report, relies on asset sales, external financing and factoring receivables just to survive. XPO’s $6.1 billion in capital deployment since 2011, funds that went to 17 acquisitions in four years, had generated just $73 million in cumulative adjusted free cash flow, results that reflected a “failed business strategy,” according to Spruce Point. What’s more, XPO Chairman and CEO Brad Jacobs had surrounded himself with a “web” of longtime associates who had been convicted of illegal acts in the past, the report charged.
Should credit conditions tighten and the cost of capital escalate, Spruce Point warned, XPO could collapse in “Enron-style” fashion, a reference to the high-flying energy trader that dissolved in 2001 amid massive accounting fraud that led to prison time for three top executives.
XPO shares — which had already fallen about 50% from nosebleed levels of $116 a share in September 2018 — promptly cratered on the report’s release. Shares plumbed an intra-day low of $41.05, down $17 a share from the prior-day’s close, before closing at $44.50. It was the worst one-day performance in the company’s then nearly eight-year history.
The counterattack was swift, aimed mostly at Ben Axler, New York-based Spruce Point’s founder and chief investment officer. Analysts slammed the report as misleading and based on erroneous data. Deutsche Bank’s Amit Mehrotra, arguably the most bullish analyst on XPO, went so far as to publish a special research note extracting numerous passages from the report and then disputing them one by one. Mehrotra said the sharp sell-off in XPO shares would create one of the most compelling buying opportunities in recent memory.
His comments have proved prescient, at least up until now. XPO shares closed Friday at $83.31 a share, more than doubling the intra-day low of last Dec. 13. Since that fateful day, shares would never close below $46 a share. Investors who initiated long positions a year ago or added to existing positions at the time have made substantial profits. XPO also reaped the rewards after authorizing a $1 billion share buyback the day after the report was published and a second $1.5 billion buyback two months later. Through June 30, XPO, which declined to comment for this story, has bought back 34.5 million shares for $1.9 billion, at an average price of $53.42 a share. It did not make any share repurchases in the third quarter.
It is unclear if or when Axler, who did not respond to requests for comment, covered Spruce Point’s short position, or if the company still holds all or part of it. Yet if comments on Twitter earlier this year are any indication, he is unrepentant. In August, noting that XPO had reported a string of disappointing quarterly results, he tweeted that it was “time for real change in management and at the Board level.” Axler followed that up in September, tweeting: “Tip to public companies that think a hasty buyback is an adequate way to combat an activist short seller instead of directly addressing the issues: it generally doesn’t work.”
Axler also apparently takes a dim view of the analysts covering XPO, saying in the December report that their brokers had been “recruited” by the company, and that none of them conducted a “forensic look into XPO’s earnings quality, or revealed its board and management’s connections to convicted felons.”
It can be argued that Axler’s comments played a role in changing the course of XPO’s strategy. Earlier this year, Jacobs revealed that XPO was close to pulling the trigger on an acquisition that would have doubled the size of the $17 billion company. However, the sharp drop in XPO shares made a buyback a more cost-effective use of the company’s capital, he said. XPO, which had not made an acquisition since it acquired Con-way in September 2015, was widely expected to make one or two acquisitions by the end of 2018. It did not make any last year or this year.
Like all short sellers, Spruce Point wins some and loses some. However, short selling in general has been a challenge in a 10-plus-year bull market. In late September, Lou Whiteman, a journalist who writes for the financial website The Motley Fool, posted a list of 12 active short positions held by Spruce Point. Of those, nine had shown gains ostensibly since Spruce Point established short positions in each, based on Whiteman’s data. According to Whiteman’s Twitter feed, Spruce Point blocked him from emailing the company through its website.
One notable Spruce Point short position in transport has been freight broker Echo Global Logistics (NASDAQ:ECHO). Spruce Point has actually shorted Echo shares twice: The first time was on Sept. 9, 2016, at $24.79 a share. Echo shares declined to $13.85 a share by July 2017, just above Spruce Point’s $13-a-share target and making the firm a tidy profit. Spruce Point re-established a short position in Echo on Dec. 21, 2017, with shares trading at about $28.55 share. Echo shares climbed as high as $35.60 a share in September 2018 before starting a 15-month descent which has left it at $19.43 a share as of Dec. 13. It is unclear what position, if any, Spruce Point still holds in Echo.
In the letter that disclosed the second short position, Axler reiterated the points that prompted the first action, namely that Echo was plagued by poor management, a failed roll-up strategy and poor positioning in an increasingly techno-centric freight environment. The “astounding” 117% rally in its share price from five months prior was due mostly to the tightening of spot market pricing in the wake of Hurricanes Harvey and Irma, Axler wrote. Echo’s lousy fundamentals would eventually re-assert themselves, he predicted.
J. Bruce Chan, who covers Echo and other brokers for investment firm Stifel, said Echo’s recent problems are due to weak macro conditions and a difficult environment for brokers, not to structural issues with the company. “I think the pressure on the brokerage stocks is overdone here,” Chan said Dec. 13. “While we see limited demand growth next year, it should be a tighter supply market, and that tightening should happen more gradually than what we saw in 2017,” when supply contracted in the wake of the implementation of the electronic logging device (ELD) mandate.
Chan also took issue with the notion that Echo is being marginalized by the move to digitization. “Our thesis is and has been that a few winners emerge from the (digital freight matching) set, and that they begin to look much more like incumbent leaders,” he said. “This is not a ‘winner-take-all’ situation in our view. The sandbox is getting bigger, and everyone has an opportunity to benefit from more efficient operations.”
