Short-seller blasts XPO’s accounting, management practices in 69-page report

An investment firm that acknowledges it is short on XPO Logistics stock issued a scathing report on the company’s management practices today, saying that it has conducted a “deep forensic financial investigation” and come to the conclusion that “XPO has perpetuated a massive financial scheme on the public designed to inflate the value of its share price, while offering no tangible evidence that it has created any financial value.”

Spruce Point Capital Management, like all short -sellers, profits when the price of a stock declines. Short-sellers borrow and then sell a stock when its price is high, then buy it back once the price has fallen and pocket the difference.

Spruce Point’s explosive report, which XPO (NYSE: XPO) strongly contests, sent its stock price into a tailspin. And while some commentators and analysts questioned several of the report’s conclusions, it will nonetheless create a more difficult environment for XPO on Wall Street.

Spruce Point also sent a letter to eight U.S. Senators blasting XPO.

“We believe XPO has used sophisticated, aggressive, and potentially misleading accounting and financial reporting to inflate its financial performance, thereby allowing its management to earn rich bonuses at the expense of public pensions, and institutional investors entrusted with the public’s hard-earned money,” the letter states.

The senators have asked XPO for an explanation following a New York Times article on workplace conditions. Spruce Point is urging the senators to broaden the “scope of your investigation into XPO” and is offering to assist.

XPO Logistics stock finished the day down $15.78, off 26.18% to close at $44.49. The stock is down 33% in the past five days and off significantly from its 52-week high of $116.27. The stock fell $6.42 yesterday following an investor meeting where XPO officials said they expect adjusted 2019 earnings before interest, taxes, depreciation, and amortization, or EBITDA, to grow by 12 to 15%, although that is under what some analysts expect.

As the stock plummeted, some analysts weren’t convinced that XPO is as bad as Spruce says.

Though the company does have a large debt burden, some analysts peg it as $4.1 billion, not $4.7 billion as stated in the report, plus the company has $400 million in cash, according to Motley Fool.

And while Spruce Point questioned the company’s free cash flow, XPO has generated free cash flow for the past two years and its trailing free cash flow stands at $288 million, according to Motley Fool writer Rich Smith.

Lastly, while Spruce Point claims that XPO depends on asset sales to keep itself afloat, the last time the company recorded cash from such a divestiture was in 2016, according to Smith’s reporting.

XPO itself also pushed back on the report, pointing out that Spruce Point stands to benefit if investors flee.

“Today’s report from a short selling firm is intentionally misleading, with significant inaccuracies, and fails to reflect that XPO has delivered strong performance for its long-term shareholders. The facts demonstrate that the short seller’s claims, most of which have been previously floated and refuted, are baseless and an attempt to string together unrelated pieces of incorrect information to paint an inaccurate impression of the company. We will communicate directly with our investors regarding this short seller’s report,” an XPO spokesperson wrote in a statement to FreightWaves.

In an equity note issued in response to Wednesday’s sell-off before the markets opened Thursday, Cowen analyst Jason Seidl said the firm remained positive on XPO.

Seidl said the “current sell-off—XPO shares are down about 45% so far this quarter, bringing their YTD performance to about-27%—which had been occurring throughout 4Q and was amplified following [Wednesday’s] 8-K, is unwarranted.”

“In particular, we continue to believe that we’re still only in the early innings of XPO’s XPO Direct product, which has a flexible distribution model that targets omnichannel retail and e-commerce customer,” wrote Seidl.

“As management noted on their 3Q18 conference call, the product is scaling rapidly. The weekly total value that moved through XPO Direct in October was 20x the weekly value from summer weeks. Management expects XPO Direct to be a $1 bn business over the next 3 years. In our view, this remains one of XPO’s most compelling segments moving forwards,” he wrote.

He concluded that XPO management remains confident in a strong peak season that will benefit Q4 earnings.

“We haven’t heard any commentary or seen any data to definitively say that peak was weaker than expected. Lastly, XPO’s intermodal business continues to be a source of confidence for us, and we believe that it’ll continue taking share from the highway.”

That position is at odds with Spruce Point Capital Management, which made its 69-page report available for download from the firm’s website. The report opens with a cover of a red truck that Spruce Point has re-labeled P.O.S. Logistics.

The report includes a series of news headlines that the firm says were used to “prime the pump for more non-economic deal-making to excite investors.” These included reports that the company was ready to spend up to $8 billion on acquisitions and that Home Depot was looking to “buy a $9 billion logistics company so Amazon doesn’t.”

In the letter to the senators, signed by Ben Axler, managing partner of Spruce Point Capital Management, the firm alleges that XPO has provided no “tangible financial return” to investors following 17 acquisitions since CEO Brad Jacobs took control of the company in 2011. Despite deploying $6.1 billion in capital, XPO “has generated a paltry $73m of cumulative adjusted free cash flow. In our view, this is indicative of a failed business strategy, supported by our country’s banking system and public institutional investors, yielding a 1.2% return on invested capital in 7 years.”

The letter sent to the senators states that the firm’s investigation found that XPO relies on “external capital, asset sales, and factoring receivables to survive and is covering up financial strain and a working capital crunch by over-drafting bank accounts, and using sophisticated and aggressive accounting and financial techniques to portray itself in a more favorable fashion.”

Axler’s letter also states that two of Jacob’s associates, Mike Nolan and John Milne, “were convicted of accounting fraud and sent to jail for fraud at United Rentals. XPO’s director G.C. Andersen recently employed John Milne at his financial advisory firm during a time the company worked on private placements (potentially XPO’s own deals). John Milne is back in jail again for a second time after failing to pay restitution, despite having the capacity to do so.”

Axler also claimed that Adrian Kingshott, XPO’s audit committee director, owned a firm that “acted as a distribution agent” for Marc Drier, who admitted running a $400 million Ponzi scheme in 2009, according to CNBC.

FreightWaves was not able to independently verify Nolan’s and Milne’s status.

Barron’s also reported today that “In June, brokerage industry regulator Finra fined and sanctioned the boutique banking firm G.C. Andersen Partners Capital, which is run by Chris Andersen, an XPO director from 2011 to 2016 who helped Jacobs finance each of his public companies. According to a settlement in which Andersen Partners didn’t admit or deny the regulator’s charges, the banking firm violated Finra rules by employing the felon John Milne, a colleague of Jacobs at his first big roll-up, United Waste, and then at United Rentals. In 2009, Milne pled guilty to faking profits at United Rentals by arranging phony deals with the equipment maker Terex —another firm on whose board Chris Andersen served.”

Barrons notes that no allegation of wrongdoing was ever leveled at Anderson or Jacobs.

Axler went on to rehash allegations of mistreatment of pregnant workers in XPO warehouses, which began with a New York Times October report on workplace conditions and treatment of workers at a warehouse in Memphis. The Times report noted that some of the allegations occurred before XPO took over the facility.

“In our opinion, XPO has used a nearly identical playbook used at United Rentals leading up to its SEC investigation, executive felony convictions, and share price collapse. We find concrete evidence to suggest dubious tax accounting, under reporting of bad debts, phantom income through irreconcilable M&A earn-out liabilities, and aggressive amortization assumptions: all designed to portray glowing ‘Non-GAAP’ results. Additionally, we provide evidence that its ‘organic revenue growth’ cannot be relied upon, and its free cash flow does not reflect its fragile financial condition,” the Axler letter reads.

Jacobs founded United Rentals in 1997 along with Milne, stepping down as CEO at the conclusion of 2003 and severing all connections to the company in 2007.