Echo Global Logistics, Inc. (ECHO): Logistical Nightmare by Spruce Point Capital Management
Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving Echo Global Logistics, Inc. (Nasdaq: ECHO), a billion dollar company in the transportation logistics sector where we see $11.00 – $13.00 per share, or approximately 50% to 60% downside. We have a “Strong Sell” opinion detailed extensively in our presentation, which is accessible on our website. We also encourage all of our readers to follow us on Twitter @Sprucepointcap for exclusive research updates. Please review our Disclaimer at the bottom of this email.
Update on Recent Spruce Point Campaigns
We are pleased to update our readers on the tangible outcomes resulting from our recent campaigns. In April we initiated Sabre Corp with a “Strong Sell” and argued that aggressive accounting was masking fundamental pressures and cash flow overstatement. On August 2nd, Sabre issued its Q2’16 earnings, and revised its cash flow guidance downward. It also made the bizarre statement that it could not provide forward guidance on a GAAP basis without unreasonable effort! Last month, we warned our readers about AECOM, and detailed our concerns about its earnings quality and cash flow. We also argued that its AECOM Capital sales should not be considered as “core” earnings. Just this week, AECOM revised its earnings guidance lower and said annual earnings would come it the low end of its $3.00 – $3.40 range due to its inability to monetize its capital stake. The mere fact that the majority of AECOM’s annual earnings was predicated on liquidating an equity capital position should be concerning to its investors.
Echo Global Logistics Checks All of Our Boxes For the Perfect Short
Insiders with a history of value destruction, limited alignment with shareholders, a commoditized business with decaying fundamentals and diminishing transparency, inflated Non-GAAP results, problematic accounting, overvaluation, and a consensus “buy” on Wall Street…Echo Global Logistics has everything we like as the perfect short! Echo was IPO’ed in 2009 and promoted as a company with a “proprietary” technology capable of disrupting the transportation logistics market. Echo’s founders, the same people behind Groupon, have used an identical playbook to promote Echo. Echo’s founders have a repeated history of value destruction, and a knack for cashing out early before losses mount. Echo is nothing more than a transportation broker, matching demand with supply, and taking a small cut of the deal. Echo is a subscale player and has not demonstrated any operating leverage from its roll-up strategy. Free cash flow after acquisitions (including numerous contingent payments) is negative since its IPO. Echo has churned through five Chief Technology Officers and has quietly suspended all discussion of its Enhanced Transportation Management (ETM) platform, which was once the cornerstone of its IPO pitch and plastered all over its IPO prospectus. Now called “Optimizer,” its website portal is sadly not even optimized for the world’s top browser Chrome! Echo is further challenged by dozens of young start-ups backed by the founders of Amazon, Ebay, and others, and all set to disrupt fringe players like Echo with Uber-like real-time, location-based technologies. For example, as a slap in the face to Echo Global Logistics, New Enterprise Associates (NEA), Echo’s first venture backer, is now backing Transfix, a new “disruptive” online marketplace for truckload capacity offering free apps to customers. Echo’s only attempt at a mobile app in 2011 appears to have failed, and is no longer available on the Apple store or Google Play.
Masking Organic Growth Deterioration With The Acquisition of Command Transportation
Under pressure to grow revenues to $3 billion by 2018, and facing fundamental pressures in its industry such as excess transportation capacity and declining rates, Echo announced its largest deal to acquire Command Transportation. Command was founded by Paul Loeb and sold to Echo Global Logistics in June 2015. Echo paid a rich 11.2x EV/EBITDA to acquire a truckload brokerage business (a lower margin, “spot” oriented business adding a higher risk profile to shareholders). Echo leveraged itself over 3x Net Debt/EBITDA and diluted shareholders to complete the deal. Echo is an “asset-light” business, which means increased leverage on its business can be destructive for shareholders when things go bad. Echo has promoted Command’s technology platform as “industry-leading” but in reality we don’t believe it’s anything unique. To illustrate, Loeb founded American Backhaulers which was sold to industry behemoth CH Robinson (CHRW) in 1999. Loeb’s partner Jeff Silver went to study supply chain logistics at MIT, found a competitor Coyote Logistics, and just sold it to UPS, while CHRW sued Loeb/Command claiming he misappropriated the technology. In all likelihood, CHRW and UPS both have some form of Command and Echo’s secret technology sauce. But don’t take our word for it, insiders tend to know best. Based on our research, Command has had meaningful employee departures since the deal closed, and Command’s founder recently returned $750,000 in cash to Echo citing “employee retention criteria” without further specifics. Reading between the lines, we interpret this as a decidedly negative. After adjusting Echo Global Logistics’ recent reported sales figures for recent M&A deals, we find that its organic revenue growth has been declining for each of the past few quarters, and is now negative!
Outrageous Synergy Assumptions and Diverging GAAP/Non-GAAP Performance Suggest Echo Will Dramatically Miss Growth Expectations
Echo Global Logistics guided the market to expect $200-$300m of revenue synergies by 2017 from adding Command and cross selling services. The revenue synergy targets are 50-70% of the $407m enterprise value paid for Command! Moreover, we analyzed all of the recent headline making M&A deals in the sector and cannot find any transaction even close to promising this level of synergy. To make matters even more questionable, in Q2’15 (one year after closing the deal) Echo now added $3m of mysterious cost savings synergies but offered no specifics. Echo’s Non-GAAP financial performance is diverging at an alarming rate from its GAAP financials, suggesting financial strain and future problems. Not surprisingly, Echo is out touting it is already on the hunt for more acquisitions without even making good on its Command promises, but to us this just appears to be a hail mary that it can paper over its problems with more deals. To underscore our point, we observe that Echo’s audit fees have risen >40% p.a. in the past three years, and are materially higher on a revenue and per employee basis than any of its industry peers. Echo has acknowledged material weaknesses in its financial controls in the past. In 2012, it admitted it had been defrauded in its acquisition of Shipper Direct, resulting in the quiet resignation of founder Lefkofksy in Dec 2012. A coincidence or not: Echo Global Logistics had received money back from Shipper’s founders, just as it recently received money back from Command?
Echo Appears to Be Out of Compliance With Its Credit Agreement And Requires it For Short-Term Financing and Growth Initiatives!
As part of its Command deal, Echo Global Logistics entered into a $200m asset-based lending (ABL) agreement to provide itself working capital. In recent