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.
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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 years, Echo has become much more dependent on short-term financing, a worrisome sign given its poor cash management policies. For example, we observe that Echo earns no interest income on its cash balances! In our opinion, Echo is not currently in compliance with its ABL covenants. In March 2016, Echo announced an agreement to expand its headquarter lease to 225k sqft. By our analysis, this makes little economic sense as each of its 1,300 employees will have 170 sqft. (almost an entire office per person). The terms of Echo Global Logistics’ ABL agreement limit additional indebtedness to $12.5m, but by reviewing the footnotes of Echo’s operating leases, it is clear they’ve assumed ~$42m of leases. Not surprisingly, Echo dropped the language in its recent 10-Q that appeared in previous financial filings stating that it was in compliance with ABL agreement! A covenant breach would limit Echo’s ability to implement its acquisition growth strategy.
Normalizing Echo’s Financial Performance For Various Accounting Distortions Gets Us 50% – 60% Downside:
In our opinion, Echo’s financial statements cannot be taken at face value due to a plethora of questionable accounting assumptions, and changes of financial presentation, and disclosure that distort the true condition of its business. For example, we observe that Echo stopped disclosing enterprise customers, which was a critical selling point of its IPO to demonstrate revenue and cash flow stability. Echo Global Logistics even stopped disclosing shipping volumes, a critical metric to evaluate its business! From an accounting perspective, investors should recall that Groupon was forced to restate its revenues from gross to net revenues pre-IPO after questioning by the SEC. Around this time, Echo quietly changed its presentation of “gross profit” to “net revenue.” Upon reviewing Echo’s Terms of Service and recent accounting guidance, it also appears that Echo’s gross revenue accounting is problematic given it appears to act as an agent (broker), and shifts financial responsibilities to carriers to perform the client service. Another clear area of concern is Echo’s intangible amortization policies. We observe that Echo Global Logistics has stretched its assumption for amortizing customer relationships every single year and now has the most aggressive assumption in the industry! Wall Street sell-side analysts have a nearly unanimous “buy” recommendation on Echo, and see an average upside to $29.65 (+11%). In our view, this is a terrible risk/reward proposition for owning Echo’s shares. By normalizing Echo’s accounting methods, and giving them no credit for their preposterous synergies, we believe Echo’s true EPS and EBITDA are approx. 35% and 20% lower than 2017 street estimates. Echo trades at a rich 11.5x inflated 2017E EBITDA multiple. By applying a discounted industry multiple of 8x – 9x to our normalized EBITDA, we derive a price target of $11.00 – $13.00 per share (approx. 50 – 60% downside).
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About Spruce Point Capital Management
Spruce Point Capital Management, LLC is a New York based investment manager founded in 2009. The firm focuses on short-selling and special situations opportunities. The firm conducts in depth forensic fundamental research and takes an activist approach to investing. Our research challenges conventional thinking with deep fundamental analysis, analytical rigor, and conclusions rooted with our unique viewpoints. For more information visit our website, and follow us on Twitter @Sprucepointcap
This research expresses our investment opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in our complete research presentation report on our website. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained herein may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. Any historical performance achieved from any idea or opinion from Spruce Point Capital Management should not be considered an indicator of future performance. You should do your own research and due diligence before making any investment decision with respect to any of the securities covered herein.
You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and/or are long puts/short call options of the stock) covered herein, including without limitation Echo Global Logistics, Inc. (“Echo”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation.
This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.
To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of Echo Global Logistics, Inc. or other insiders of Echo Global Logistics, Inc. that has not been publicly disclosed by Echo Global Logistics. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All rights reserved. This document may not be reproduced or disseminated in whole or in part without the prior written consent of Spruce Point Capital Management LLC.