Description

Investment Opportunity Summary

Special situation opportunity with 50%+ upside following a multi-year restructuring / IT integration effort that was executed poorly and drove multiple EPS misses, management exits, and a liquidity crisis.  Stock is at a 10-year low with multiple ways to win over the next 12 months and presents a unique risk/reward we find compelling.

Following a dreadful fiscal Q415 (ended January), investor fatigue in a “perpetual turnaround” reached its peak and created an environment of max-pessimism as both buy/sell-side have lost interest in the name.  We feel the additional capital structure complexity (converts and convert prefs) on top of “optically” high leverage post the Q4 operational miss created forced sellers and now the sub $1B MC limits the current investor base to mostly smaller, special situations investors.

We see substantial risk asymmetry with: 1) a significant FCF and balance sheet reset in fiscal 2016, 2) a new management team with (very recently) aligned incentives, 3) hidden value in a SOTP valuation, and 4) an Activist shareholder on the BOD likely to accelerate strategic alternatives in the event of further operational misses.  Base case scenario suggests 50% upside to $14+ and Bull case suggests stock could double over the next 18 months.

Business Details

UTIW is an asset-light global supply chain logistics provider that has been in operation since 1926.  UTIW offers outsourced supply chain management solutions providing everything from transportation (air and ocean freight) to warehousing and distribution services for most major industry verticals (auto, chemicals, consumer, retail, energy, pharma, etc) on a global basis.  The company has over 300 Freight Forwarding locations in ~60 countries and operates 26m sqft of warehousing / logistics centers.  UTIW’s revenues are fairly evenly split globally, with 1/3 of the business in the Americas, 25% in both Europe and Asia, and the remainder (18%) in Africa.  The company operates in 2 primary segments: Freight Forwarding (FF) and Contract Logistics and Distribution (CL&D).

UTIW’s FF segment (~ 2/3 of sales and 43% of EBITDA the last 5 years) is a US/EUR GDP+ top-line business with margins (called net revenue yields) largely determined by freight transportation capacity utilization.  FF is the most asset-light business model whereby UTIW buys capacity from carriers (airlines, trucking companies, ocean carriers) and offers this capacity to their customers as part of organizing their transportation requirements.  Due to the mainly transactional relationship, freight forwarding volumes typically develop in line with trade flows, resulting in a certain volatility of volumes and revenues.  The global FF market is highly-fragmented (top 5 players = 25% share and top 20 = 40-45% share) with limited top-line visibility, shorter-term contracts and low switching costs.

UTIW’s CL&D business (~ 1/3 sales and 57% EBITDA avg last 5 years) is more stable, driven by longer-term contracts to provide recurring logistics services to global manufacturing clients.  In this segment, the company provides professional services that extend beyond the standard receiving, storing and shipping of products; value-add services range from dedicated warehousing (managing a dedicated facility for a single customer) to multi-client warehousing (a single “shared services” facility for multiple customers in a region) to outsourced manufacturing (assemble + sequence and delivery of complex JIT orders).  UTIW’s CL&D business carries roughly 2x the contract length of FF (3-4 years versus 1-2 in FF) with much greater price-stability (pricing commitments span the length of a contract vs. renegotiated quarterly or annually) and has very high switching costs because of the increased engagement with customers.  This business has been a shining star in an otherwise weak turnaround story, putting up an average of $100m in annual EBITDA over the last 5 years.  The $200B+ global CL&D market is also highly-fragmented, with the top 10 players holding ~20% share.

A Brief History of the Turnaround

As a rule, we tend to avoid turnaround situations ascribing to the age-old adage that “most turnarounds don’t”.  I will only lay out a brief history of the effort and will direct investors to RWB’s UTIW VIC write-up in August of 2013 for a more detailed description.

Essentially the company attempted to push a 10-year IT overhaul effort into 3 years.  A roll-up that was never fully-integrated, UTIW attempted to consolidate 4 separate Freight Forwarding IT systems into 1 (the infamous “1View system”) AND upgrade to Oracle AND implement a shared-services financial management IT system (that replaced manual spreadsheets).  To recap…that was 3 huge IT / ops integration projects conducted all at once.

This is a business model that relies on fully-functioning, real-time integrated information management to manage logistics services (and payments) globally across nearly 60 countries every day.  To make a long story short, the business struggled massively during this implementation and faced multiple EPS misses, management changes and a huge working capital draw-down in early fiscal 2014 that led to a liquidity crisis and the issuance of high-cost convertible debt.    

At this point, 1View has been up and running for one year, the rest of the IT systems are functional and the company is in the final phase of their turnaround effort with a $60m+ structural cost-out and organizational realignment in their FF segment.  With a checkered past on execution, we don’t believe that UTIW is fully in the clear but we do think that the pig has passed through the python.

Investment Thesis

1.       Balance sheet “reset” on a massive $175m-200m working capital reduction in 2015 will dramatically improve leverage optics and UTIW’s FCF profile going forward.

Due in large part to the botched IT system integration, UTIW lost its way in managing receivables and payments.  Working capital went from a normal 4-5% of gross sales to over 8% the last 2 years – a doubling of cash tied up in the business.  UTIW became as much a lender as a logistics provider and its poor cash management ultimately drove a liquidity crisis in fiscal 2014 that was only resolved after a PE partner stepped in (P2 Partners) and forced the issuance of high-rate convertible preferred debt.  In addition, a weak fiscal 2015 (ended January) dramatically lowered the TTM EBITDA run-rate and created an optically ridiculously-levered situation, with Net Debt / EBITDA rising from 3.5x in FY 2014 to 24.3x in FY 2015.      

UTIW is committed to bringing working capital levels back to their historical average (~4% of gross sales) in FY2016, and has guided to a $175m-200m reduction overall.  The bulk of this change will come from reigning in receivables (+$100m), with the balance from better payables management (+$50m) and another $50m from recalled capital advances on behalf of 3 customers earlier in the year.  Importantly, the company is not pursuing changes in payment terms to either customers or vendors – they are merely now collecting on time.  As one industry executive clearly put it, “The bank of UTIW is now closed.”  We believe this working capital effort will materially lower the reported balance sheet net leverage to below 3.0x and helps de-risk the story.  In addition, it frees up trapped cash and will significantly lift the FCF profile of the business (which was negative the last 3 years).  

2.       A “kitchen sink” quarter in fiscal Q415 helped reset expectations (and the stock price) ahead of the new management team’s mid-April 2015 RSU grants.

By all accounts, fiscal Q415 was a huge disaster for UTIW with revenue declines and margin contraction in almost every segment.  We appreciate that the company was still working through the tail-end of its 1View implementation effort, but find such a dramatic step-down in operating performance somewhat questionable given these businesses generally track the industry’s performance.  A deep-dive analysis of prior quarterly performance (compared to peers and the industry) highlights how much the company has underperformed over the last year and also what an extreme outlier Q415 really was.  A few observations, with further detail provided in the table below:

• In fiscal Q415, UTIW put up the largest underperformance in 5 years in both Air and Ocean FF volumes versus the market / comps (-10% below on Air and -9% below on Ocean)

• Air FF yields historically carry a 120-150 bps premium over comps; in Q415 they were (60bps) below, a 200 bps negative swing

• Ocean  FF yields historically fall (150-200 bps) below comps; in Q415 they were (800bps) below, a 600 bps negative swing

So the real question is – what happened?  Management attributes much of the decline to further challenges related to 1View…volumes were lower because salespeople were distracted, too many management changes (including a new CEO), etc.  While these are all likely contributors, management also outlined several one-time items in Q415 that artificially depressed earnings – over $25m of “severance and other” costs which included reorg expenses, facility exit costs, receivables write-offs, audit and legal expenses, and other items.

We suspect the above situation points to a classic “kitchen sink” quarter, largely due to the fact that the new UTIW management team’s RSU grants were issued on 04/15/15, exactly 2 weeks after reporting fiscal Q415.

Given the personal economic interests at stake and the fact that a new team would get a “pass” for clearing house, we imagine a scene in which management was actively cheering the stock’s decline up until 04/15.  

We feel a “full reset” of expectations (and more importantly, the stock price) along with new lowered guidance ($125-150m EBITDA vs. prior $190-210m) sets up well for operational beats in 2015.

3.       Significant hidden value in the CL&D business suggests that at the current share price, investors are getting UTIW’s FF business for free.

The Contract Logistics segment is the hidden asset in this story.  While issues surrounding the FF business and the company’s botched IT implementation have dominated the discussion, UTIW’s CL&D business has steadily produced impressive results for the last 5+ years.  As mentioned previously, this business carries substantially greater barriers to entry because of the level of client engagement and exhibits a very different revenue and margin profile than the FF segment.  UTIW’s CL&D business has averaged roughly $1.5B in annual sales and $100m in EBITDA since 2010.

We believe UTIW’s CL&D business represents strategic value for a potential acquirer.  Given recent transactions in the space have been at 14-15x LTM EBITDA (Toll Holdings and APL in Feb 2015) suggest UTIW’s CL&D business could carry at least a 12-14x multiple as a stand-alone business, implying a value of $1.2-$1.4B on a current UTIW EV of $1.48B.   If the above comp valuation analysis is indeed fair, the implied stub value of $200m for UTIW’s FF business with $3B of revenue and $80m normal EBITDA highlights the valuation disconnect and extreme pessimism around the stock.

Further evidence of a bid for CL&D businesses is evident in the market right now with XPO’s recent acquisition of Norbert Dentressangle (purchased largely for its $2.8B CL&D business, of which XPO had none).  We feel UTIW’s recent 30%+ decline in price will re-invigorate potential suitors and may lead to a deal.  The most likely candidate remains Danish 3PL and road transport company DSV, who was rumored to have been in advanced talks to acquire UTIW in late 2014 (with the stock at $14).

A closer look at DSV suggests that acquiring UTIW could be a strategic home-run by more than doubling their CL&D business and providing greater geographic balance (DSV is 97% Europe/Mid East/Nordics currently), turning them into a truly global player.  On the FF side, there would likely be less revenue and more cost synergies, as the companies show considerable regional overlap.

Finally, it should be noted that the FF and CL&D segments are run as entirely distinct businesses within UTIW.  They are fully-functioning stand-alone divisions with their own sales force, back-office operations, overhead structure, etc.  Some sell-side analysts have downplayed the strategic value and the SOTP argument by arguing that FF and CL&D are intimately inter-twined.  UTIW’s CFO told us explicitly they could easily separate CL&D from FF.  While we are not hanging our hat on a take-out thesis, we feel the strategic value of CL&D is very compelling and may account for the entire value of the stock currently.

Variant View

• Investor fatigue on history of underperformance and management turnover; max-pessimism as both buy/sell-side have lost interest with valuation at 10-yr lows.

• Substantial risk asymmetry with low implied SOTP valuation, significant FCF & B/S lift in fiscal 2016, and a new management team with aligned incentives.

• Complex capital structure ($175m 7% convert prefs & $400m 4.5% convert senior notes) on top of “optically” high leverage post fiscal Q415 operational miss coupled w/ a messy earnings history limits investor base to mostly smaller, special situations investors.

• High-quality activist investor (P2 Partners) largest shareholder and on the BoD.  P2 will oversee responsible capital allocation and quickly explore strategic alts if necessary, especially in the event of further operational misses. There is one highly logical buyer in DSV but other suitors may follow.

• Stock setup is strong with favorable underlying industry trends recently cited by EXPD suggesting material positive inflection in calendar Q115 (Jan-March) in both Air and Ocean Freight; Air volumes +13% and Ocean volumes +12%, following MSD growth throughout 2014.  UTIW will report fiscal Q116 (ending April) in June and their full-year guidance could prove conservative if volume trends remain strong.

Valuation and Price Target

We value UTIW on an EV/EBITDA basis using calendar year 2017 (UTIW’s fiscal 2018) EBITDA estimates and a pro-forma balance sheet.

In our BASE CASE scenario, we arrive at a ~$14-15 PT (50-55% upside) assuming 2017 EBITDA of $215m at 7.5x, less ($11m) net debt = $1.63B in equity value over 107m shares.

Under our BULL CASE scenario, we arrive at a $20 PT (112% upside) assuming 2017 EBITDA of $275m at 8.0x and $101m net cash over 112m shares.

Note: In both scenarios, we use the treasury method to adjust for the converts.  In our base case, we assume the Convertible Pref notes are converted in calendar 2016 (conversion px of $13.87), which dilutes the current share count of 105.5m by ~1.1m if the stock reaches our PT of $15.  In our bull case, we assume the same conversion for the Convert Prefs and also assume the 4.5% Convert Senior Notes are converted (conversion price of $14.50), which dilutes the share count by about 7m shares assuming the stock reaches our bull case of $20 PT.

Catalyst

- Continued strength in Freight Forwarding industry fundamentals
- Operational / EPS beats in fiscal 2016 on lowered expectations
- Public declaration of pursuit of strategic alternatives 
- Buy-out offer from strategic acquirer