Any company with publicly traded debt views its rating from agencies such as Standard & Poor’s as of paramount importance. And last week, 3PL RXO received a thumbs-up from Standard & Poor’s Global Ratings (NYSE: SPGI) on the steps it has taken to fund its acquisition of Coyote Logistics.
But it didn’t come with a higher debt rating.
S&P issued its report on the back of RXO’s (NYSE: RXO) closing of the deal to acquire Coyote from UPS (NYSE: UPS). The announcement of the closing Sept. 16 came a few days after RXO announced a $500 million offering of its common stock, in addition to the $550 million combined common stock and warrant issuance announced in August.
That came several weeks after RXO’s late June disclosure of its plans to purchase Coyote.
No longer assuming any use of debt
Reviewing the two-step plan to use equity to fund the $1.025 billion acquisition of Coyote, S&P said, “we believe these proceeds are sufficient to fund the Coyote acquisitions, and we no longer assume it will require any debt financing.” It described the equity-funded acquisition as “credit positive.”
S&P’s first comment about the transaction in June said the agency believed there would be “some” debt financing necessary to get the deal done.
The focus of S&P and its chief rivals, Moody’s (NYSE: MCO) and Fitch Investors Service, is on a company’s ability to repay its publicly traded debt. S&P and Moody’s are split on RXO’s rating, with Moody’s giving the 3PL a Baa3 rating, which is investment-grade, and S&P a BB+ rating. The S&P rating is lower on an equivalency basis than Moody’s. More importantly, it is not investment-grade.
But Moody’s earlier this year lowered its outlook on RXO’s debt to negative, loosely defined as the agency believing conditions may exist for a downgrade.
S&P was positive about the outlook for the company’s debt metrics following the Coyote deal and its debt-free status.
Credit metrics to improve
The ratings agency said it estimates that the 3PL’s debt-to-EBITDA ratio – a key metric – will be about 3X in 2024 and will improve to mid-2X next year.
Those numbers are an improvement over what S&P Global said in June at the time of the Coyote acquisition. At that time, S&P said it expected the debt-to-EBITDA ratio to be in the mid-3X area this year and improve to a high-2X number in 2025.
Another key metric for ratings agencies is funds from operations. In its latest report, S&P said it expects that number at RXO will be about 27% this year and improve to the low-30% range next year.
That number above 30% might normally be enough to trigger an upgrade in a company’s debt rating, the ratings agency said. But S&P said it isn’t doing that, and the freight market is the reason.
“In our view, persistently weak freight market conditions pose a key risk to our forecast, given that freight rates remain subdued and we expect this weakness will likely persist over the near term,” S&P said. “We believe the market will eventually recover, though the excess capacity in the industry has persisted much longer than we had previously envisioned and the timing of the eventual recovery is uncertain.”
The funding for the Coyote acquisition is in two parts. One was disclosed in August. The second came last week just before the closing was announced.
The first tranche of equity financing came in a $550 million deal with MFN Partners and Orbis Investments in a private financing. That deal involved the sale of about 20.9 million shares at $20.21 per share, and the sale of warrants for an additional 6.25 million shares at $20.20. Those prices reflect where RXO stock was the day before it announced the purchase of Coyote.
The second tranche, announced Sept. 12, involves the sale of about 19.2 million shares at $26 per share to a group of underwriters.
The stock price’s move up from $20.21 to $26 in the $500 million share offering reflects the fact that even though the roughly $1 billion in new shares is dilutive to existing shareholders, the market is bullish on the potential for Coyote inside RXO.
“We had targeted a $350 million fundraise as its last equity piece (and at $28/sh), so the upsized deal and slightly lower price adds a bit more dilution (17.9 million shares issued vs. our prior 13.4 mil target, a 4% increase on current base),” the transportation team led by Ken Hoexter at Bank of America Merrill Lynch said in a report. The dilution did lead BOA Merrill to reduce its price target for RXO stock to $30 from $31.
The dilution may have had some impact on the price, however. After closing near $20.20 right before the deal was announced, RXO’s stock climbed as high as $31.90 at the end of July. Two dilutive deals later, it was trading Wednesday near $28 per share.
By contrast, the largest 3PL, C.H. Robinson (NASDAQ: CHRW) closed Aug. 1 at about $102.20. It hit a 52-week high earlier this week at $109.22 and matched it Wednesday. The S&P 500 is up about 5% since Aug. 1.
TD Cowen opines after meeting with management
The transportation team led by Jason Seidl at TD Cowen met this week with RXO management. And while its report on the meetings is mostly positive, TD Cowen is holding its price target for RXO at $28 per share “while acknowledging potential upside if synergies materialize.”
RXO management has said that reducing the amount of purchased transportation is a key target for reducing costs. “Management reiterated what we consider a conservative $25 million operating expense synergy target,” the TD Cowen report said.
RXO and Coyote together will have $5 billion in “capacity procurement, allowing small margin improvement to generate significant gross profits dollar accretion,” the report said. “We expect the magnitude of the opportunity to become more apparent as the Coyote integration proceeds and RXO gains visibility into which parts of the business command the best buy rates by lane.”
Digesting Coyote won’t take RXO out of the acquisition game, the TD Cowen report said. RXO will “remain acquisitive,” and the company’s management “emphasized the merits of acquiring at the bottom of the freight cycle,” TD Cowen said.
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