XPO buys Pacer International to establish foothold in intermodal space

XPO Logistics Inc. said yesterday it acquired intermodal marketing company Pacer International Inc. in a cash-stock deal valued at about $335 million, or about $9 a share in cash and XPO stock.

The transaction vaults Greenwich, Conn.-based XPO into the intermodal arena and insulates the company from the vagaries of the freight brokerage business, the largest segment of its revenue mix but one that has been increasingly vulnerable to profit-compressing commoditization. XPO is also in the freight forwarding and expedited transportation segments.

Dublin, Ohio-based Pacer generated about $1 billion in revenue in the 12-month period ending Nov. 30. The acquisition effectively doubles XPO's current revenue to about $2 billion. Bradley S. Jacobs, XPO's founder, chairman, and CEO, has said he expects the company to have $5 billion in revenue by 2017 through a combination of acquisitions and organic expansion.

Pacer is the nation's third largest intermodal marketing company behind J.B. Hunt Transportation Services Inc. and the Hub Group Inc. According to XPO, Pacer is the largest intermodal provider in the cross-border U.S.-Mexico market. The trade lane is believed to hold much potential but has yet to be fully exploited as far as intermodal services are concerned. About 60 percent of Pacer's revenue is generated within the contiguous 48 states, with the remainder coming from U.S.-Mexico transborder services, Jacobs said.

All of Pacer's top executives will remain with XPO following the acquisition, XPO said.

As of late afternoon, Pacer stock was trading at $8.98 a share, a shade below the $9 transaction price. The transaction represents an 8-percent premium over Pacer's closing stock price on Friday. XPO stock was bid up to as high as $30.77 a share, a new record for the company.

BUILDING A BROADER BASE
The last three XPO acquisitions—Pacer, last-mile delivery company 3PD, and NLM, a provider of transportation management services for the expedited shipping market—have been outside of XPO's core brokerage segment. Jacobs told DC Velocity last October that acquisitions in the intermodal and the freight management sectors would be priorities in the months to come.

In a research note, John G. Larkin, lead transportation analyst for investment firm Stifel, Nicolaus & Co., said the company has "wisely...de-emphasized growth in the less defensible truck brokerage market, which in recent years has become more commoditized." This "crafty change in strategic course," as Larkin put it, should make it easier for XPO to achieve its long-term objectives.

In an interview yesterday, Jacobs said XPO is not concerned about profit regression in brokerage and that the company is not moving away from aggressively pursuing brokerage opportunities. "Of the 100 or so acquisition candidates that are on our list, most of them are in freight brokerage," he said.

The brokerage industry is a $50 billion-a-year, deeply fragmented business that can be highly profitable for an acquirer that can achieve both freight density and economies of scale, Jacobs asserted. "In terms of where the money is, it is in brokerage," he said.

PACER'S EVOLUTION
As for XPO's most recent acquisition, Pacer has a complicated history. The evolution of Pacer mirrors that of modern-day intermodalism. In the early 1980s, Don Orris, who would become Pacer's CEO, championed the development of double-stack intermodal service while heading the intermodal division of Singapore-based steamship giant APL. In 1984, railroads began moving intermodal trains with specially designed cars capable of handling two tiers of containers instead of one. Double-stack service revolutionized domestic and international transportation by allowing railroads to handle more freight with the same locomotive power and track capacity, and to do so more safely than anyone could have imagined.

For years, Pacer handled virtually all of the Union Pacific Railroad Co.'s (UP's) domestic intermodal moves of international freight from U.S. ports to inland points. Through its "Stacktrain" service, Pacer wholesaled its capacity to intermodal marketing companies and retailers. However, the UP arrangement, which was considered a stellar deal for Pacer, was eventually unwound. Pacer morphed into an intermodal marketing company that, like others, "retailed" freight to beneficial cargo owners.

The loss of the legacy contract, and the problems that ensued in adjusting from being a wholesaler to a retailer of intermodal capacity, took its toll on Pacer's value. Its stock, which traded near $35 a share around 2006, had fallen to under $3 by late 2009 before beginning its climb to current levels.

One intermodal industry executive sharply critical of Pacer management expressed astonishment that it would be acquired at a "stratospheric" level of 11 times earnings before interest, taxes, depreciation, and amortization (EBITDA). Well-run nonasset based companies shouldn't be valued at anything more than eight or nine times EBITDA, the executive said.

"People are picking their jaws off the floor on this one," the executive said.

The executive, who asked not to be identified, said Pacer has been unable to compete for intermodal business with either Hunt or Hub Group. The executive added that XPO, in its quest for revenue to drive the growth demands of analysts and investors, may have overreached with the Pacer acquisition. "They are paying too much for too little," the executive said.