M&A Just One Avenue Of Growth For GXO

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The need for warehouse space and the people and tech to run it is at an all-time high. Getting goods to consumers faster has become the equation every supply chain manager is trying to solve. However, industrial real estate vacancies are at record lows and skilled labor remains a pinch point across many parts of the world. The combination has created an abundance of opportunities for well-positioned logistics facility operators.

GXO GXO is one such provider thriving in the space, growing both organically and through M&A. The company became the world's largest pure-play contract logistics outfit when it spun off from XPO Logistics XPO last summer.

Potentially another big deal to go along with record results

GXO is currently executing on multiple fronts: posting record quarterly results (revenue, EBITDA and adjusted EPS) recently and announcing a tentative agreement to acquire U.K.-based Clipper Logistics for roughly $1.3 billion on Sunday.

The Clipper (CLG.L.EB) deal would complement the burgeoning GXO Direct unit, which is a shared distribution fulfillment network operating primarily in the U.S. GXO Direct allows customers to facilitate fulfillment functions using a flexible, variable-cost model without leasing an entire facility.

Clipper runs approximately 50 sites (15 million square feet of space) across the U.K., Germany and Poland. The facilities handle e-commerce, e-fulfillment and returns management functions for multiple customers out of the same location.

A successful e-commerce operation requires additional space and the forward deployment of inventories in order to reduce delivery times. GXO Direct and Clipper provide the technology and facility network to position inventory closer to the customer. GXO Direct has one- and two-day ground coverage to 99% of the U.S. population.

"We're seeing very, very strong demand for that business," Mark Manduca, chief investment officer at GXO, told FreightWaves in an interview. "People want to get closer and closer to their own customer."

The potential transaction is another play for share by GXO in the European logistics market. Combined with North America, GXO believes the two regions represent a $430 billion total addressable opportunity, of which only 30% is currently outsourced.

Two-thirds of Clipper's revenue is tied to e-commerce and returns, 85% of which comes from the U.K. The company reported revenue of $946 million in its recent fiscal year ended April 30. But it will easily eclipse that mark in its current fiscal year as revenue for the first half was up 33% year-over-year. 

By comparison, GXO Direct has an annual revenue run rate north of $200 million. The bulk of GXO's nearly $8 billion in consolidated revenue is tied to large customers operating out of fully dedicated sites.

Acquisition price	~$1.3B
Combined value	~$13B enterprise value
Clipper's revenue run rate	$946M in FY21
GXO's revenue run rate	$7.9B in 2021
Earnings potential	12% EBITDA margin
Financing	75% cash, 25% equity
Other acquisitions	Menlo Logistics, Norbert Dentressangle & New Breed Logistics

Table: Company reports

GXO has grown through numerous acquisitions over the years as part of XPO.

The group acquired the bulk of Kuehne + Nagel's KHNGY contract logistics unit in the U.K. and Ireland in 2020. It announced the $3.5 billion acquisition of contract logistics provider and freight forwarder Norbert Dentressangle in 2015. It also picked up Menlo Logistics the same year when it acquired less-than-truckload carrier Con-way in a $3 billion deal.

GXO now operates more than 900 facilities in nearly 30 countries with 200 million square feet of space and 120,000 employees.

"It's not growth at any price. We're very targeted about the way we go about our growth," Manduca said.

He said it's about finding the right partner serving the right industry. Often deals get done because of the cross-sell opportunities into new verticals they present or for the expertise in a particular area that the target possesses.

"The global market for logistics is very fragmented," Manduca said. "Every global logistics market that focuses on warehousing and supply chains has an element of fragmentation to it. And it's relatively higher across Europe and the U.S. So, lots of opportunities to see consolidation in the space."

But organic growth is the No. 1 priority currently

An increased need to outsource e-commerce fulfillment has pushed GXO's pipeline to a record of $2.5 billion. Contract wins from 2021 are expected to increase revenue by approximately $830 million in 2022 and by more than $5 billion over the life of the deals.

On its fourth-quarter call, management said organic growth opportunities were top priority along with technology investments. Future uses of cash also included acquisitions, third in order, followed by share repurchases and dividends, a distant fourth.

Last year, the company generated $455 million in cash flow from operations ($216 million in free cash flow) and closed the period with net debt-to-adjusted EBITDA of 1x. If the Clipper deal closes, that number likely climbs above 1.8x as GXO takes on debt to fund the cash portion (75%) of the cash and equity transaction (net debt more than doubles but pro forma EBITDA provides some offset).

GXO plans to maintain its investment-grade credit rating through the process, which may slow deal flow as it deleverages. However, with net capital expenditures running at only 3% of revenue (only 1% required for maintenance capex) the company appears likely to see similar FCF generation in 2022 (guidance calls for FCF to be 30% of adjusted EBITDA of $725 million at the midpoint of the range, 15% higher year-over-year).

Similar results in the out years will allow it to deleverage from the deal fairly quickly.

GXO's contracts are generating returns on invested capital above 30% now, "so the bar is very high for wanting to do anything with our cash pile," Manduca said. "The priorities for us are very much organic first. That's this massive TAM that we're playing for."

Most of GXO's contracts extend for several years with deals inked with its top-20 clients lasting 15 years on average. It typically takes GXO three years to recoup its startup investment but the contract is profitable from day one. The company also benefits from revenue growth within its existing contracts as services – space, labor or layering in additional technologies – continue to be added throughout the duration of the deal.

"We're focused on writing great contracts first and foremost," Manduca said. "Write great contracts, at improved returns, at higher margins, and that is the flywheel of this business. It produces a wonderful cash flow stream."

Thirty percent of new activity in 2021 came from the expansion of services with existing customers. It expanded operations with 16 of its top 20 customers during the year.

"Technology is at the bedrock of what we're doing," Manduca said. "More than 50% of our capex is spent on technology and that can be everything from software, hardware, automation, robotics, it is proper investment. It's one of the reasons why we have won so many blue-chip customers."

Contracts across the logistics industry include automated warehouses only 5% of the time, whereas 30% of GXO's 2021 revenue was generated from automated sites. Total tech and automated systems revenue grew by 94% last year.

"We're still in the first innings of [automation as an opportunity]," Manduca said. "To a certain degree we believe that's one of the main reasons customers stay with us."

Contracts on spaces with advanced tech, robots and automation typically carry 300 basis points of incremental margin. GXO's revenue retention is in the mid- to high-90% range since the August spinoff.

"It's very much land and expand," Manduca said. "When we win a customer, we tend to keep a customer."

GXO grew revenue 28% year-over-year in 2021 to $7.9 billion. The company's guidance calls for 8-12% growth in 2022, one-third of which is expected to come from existing customers with two-thirds tied to new contracts.

"We're at the foothills of a significant growth story here across e-comm, automation and outsourcing," Manduca concluded. "Some of these trends will go on for the next 30 to 40 years. So it's very much right place, right time."

A group of insiders holding 23% of Clipper's stock, including its executive chairman, CEO and CFO, have agreed irrevocably to the terms of the potential acquisition. A "firm intention to make an offer" is required by March 20.

Shares of GXO are up 44% since the spin compared to shares of XPO (-14%) and the S&P 500 (-2%).

Click for more FreightWaves articles by Todd Maiden.

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