Value Investing

Spruce Point Re-Establishes Short Position In Echo Global Logistics, Inc. (ECHO)

Spruce Point Capital Management is pleased to announce it has released a critical update on Echo Global Logistics, Inc. (Nasdaq: ECHO), a poorly constructed roll-up of 3rd party logistics brokers.

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Spruce Point first reported on ECHO in September 2016, warning of 50%-60% downside risk; share subsequently collapsed 50% to $13 this year after ECHO suspended its long-term guidance and acquisition strategy. Due to temporary improvements in spot trucking prices post two hurricanes, shares have rallied back nearly 120% - making ECHO an attractive short again. We will explain how new developments in blockchain technologies being applied to the transportation and supply chain are highly likely to compress ECHO's margins and competitive position even further.

As a result, we have re-issued a "Strong Sell" opinion and a long-term price target of approximately $9.00 - $15.00 per share, or approximately 50% to 65% downside risk.


Spruce Point Has Re-Established A Short Position in Echo Global Logistics (“Echo”) For The Following Reasons:

Our Initial Concerns About ECHO From September 2016 Proved Prescient: In our initial report entitled “Logistical Nightmare”, we warned about ECHO’s terrible management, failed roll-up strategy in the transportation logistics sector, aggressive use of Non-GAAP results, and its inability to maintain its competitive position in an increasingly technology-centric environment, would all lead to severe disappointment. ECHO’s analysts were calling for a $29 price target at the time, but with shares at $27, we argued the risk/reward was skewed towards 50% - 60% downside. With successive earnings disappointments, and mounting evidence that ECHO’s acquisition of Command Transportation in 2015 was a bust, ECHO suspended long-term guidance and its acquisition strategy in July 2017. ECHO’s share price reached a low of $13.00, hitting our long-term price target range

Just A Little Luck Bails Out ECHO (Temporarily): Since hitting a low in July, ECHO’s share price has rallied an astounding 117% back to $28/share with a little help from tightening of spot rates in areas affected by natural disasters such as Hurricane Harvey and Irma. This temporary phenomenon led to “surprise” upside to numbers: in Q3’17 sales increased YoY by 10.7%. However, even in such a tight rate environment, ECHO’s YoY GAAP earnings increased just 1 cent from $0.08 to $0.09 or 6.6% - this underwhelming earnings increase demonstrates the lack of leverage in its business. ECHO’s management confidently proclaimed: “Given the strength of our recent results and the trends in our business, we are increasing our revenue expectations for the fourth quarter of 2017 to between $460 million and $500 million, which also raises our full year 2017 revenue guidance to a range of $1.855 billion to $1.895 billion.” Recall just a few months earlier ECHO’s management suspended long-term guidance, which illustrates how little credibility they actually have in understanding their own markets and operating environment

Command Deal Increasingly Looks Like A Bust: Our initial report warned that ECHO significantly overpaid for Command Transportation, and encumbered its assets with $230m of debt for a people-intensive asset light business. ECHO hyped $200 - $300m of revenue synergies, and an integrated technology platform that would provide significant earnings leverage. After millions spent on integration costs, capital expenditures and even a fancy new headquarters, ECHO has failed to come even close to its revenue synergy target. In Q3’17, the CEO indicated just $85m of “qualifiable” revenue synergies, and that he could not even quantify benefits from its “improved” technology platform. We note that ECHO’s Chief Technology officer quietly resigned in June 2017, which marks the 5th CTO ECHO churned through in 10 years. Based on our research, many former Command employees have fled to Arrive Logistics

Our Early Warnings of Technology Disruption, Margin Compression Coming To Fruition: We initially warned that a wave of new technology start-ups were poised to steal share and compress ECHO’s margins. In particular, we highlighted the coming threats from Uber and the application of its ride-sharing app to match supply and demand for trucking freight. We also pointed out that Amazon was likely to offer its vast logistics services as a business. Now with both of these companies (and others) competing for capacity, ECHO’s margins appear in structural decline. ECHO’s net revenue margins have compressed from nearly 35%+ in 2016 to 17%, and even declined by 50bps in Q3’17, supposedly a “strong” quarter. While management and some bulls might want you to think its margins are cyclically lower, we believe the issue is more structural and company-specific in nature

Blockchain Now A New Worry For ECHO: Blockchain has received attention for its applications in crypto currency trading and finance. However, the supply chain and logistics industry, headed by the Blockchain In Transportation Alliance (BITA) are already working on ways to apply it in a manner that improves visibility, accountability and control along the logistics value chain. While still early days, in all likelihood any intermediary or middlemen in the transportation delivery process that adds cost (e.g. brokers like ECHO), are most at risk as contract terms and processes become standardized and transparent. Industry heavyweights such as UPS are already adopting blockchain and working on a decentralized brokerage system - essentially an open marketplace for shippers and carriers. Leveraging the transparency of information on the blockchain, the marketplace will let shippers optimize cost and time for every shipment. We interpret this UPS development as a substantial negative for ECHO

Terrible Risk / Reward Owning ECHO, Still See 50% - 65% Downside: Our conviction that technology is displacing ECHO has increased. Besides a temporary improvement in rates, we still believe ECHO is poorly positioned to succeed and has a much weaker balance sheet having burned through half its cash (near an all-time low). Its $230m busted convertible bond comes due in 2020 and is an overhang from its failed Command deal. Some analysts, remaining forever optimistic, see in excess of $30/share as a price target, but on average are at $25.75/share, representing 8% of immediate downside risk. Wall St. extrapolates recent earnings, and assumes ECHO will produce 11% sales growth and nearly 30% earnings growth, but we believe this is wildly optimistic and could set investors about for further disappointment from this perennial laggard. Trading at the richest 2018 multiple in the sector at 28x and 15x P/E and EBITDA, we believe ECHO should trade at discount to reflect its terrible management and poor positioning

Another Great Opportunity To Short A Low Quality Company On A Bounce

Worse company and unchanged share price? ECHO’s share behavior is irrational and reflects a misunderstanding of its business. There is ample evidence to suggest that the Command acquisition was a bust, leaving ECHO saddled with debt and a near record low cash on its balance sheet. Its margins have contracted significantly, which we believe is due to structural changes in its industry

Echo Global Logistics, Inc. (ECHO)

Article by Spruce Point Capital Management

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