FedEx Corporation (NYSE: FDX) stock investors will have been pleased by the market's reaction to the announcement of an agreement to buy European courier TNT Express. The deal appears to be a perfect fit, and FedEx's management believes it's unlikely to face the kind of regulatory hurdles that hindered United Parcel Service, Inc's (NYSE: UPS) attempt to buy TNT Express two years earlier. With that said, there are still questions to be asked about the deal in general. Specifically, what are the details behind the deal? And what about the execution risk?
TNT Express ground network is a key part of the deal. Source: TNT Express Website
Deal details, rationale
FedEx's €4.4 billion ($4.8 billion) offer for TNT Express (which had €449 million in net cash on its balance sheet at the end of the fourth-quarter) will certainly add scale -- FedEx's last four quarters of revenue add up to around 6-7 times TNT's 2014 revenue. Moreover, the deal is believed to be relatively free of the snags that aborted UPS's attempt to buy TNT, for two main reasons.
First, as FedEx management repeatedly asserted during the recent press conference, the deal is not a "redundancy play", but rather a marrying of FedEx's extensive global Express air network with TNT's European ground network. In other words, it's not likely to involve the kind of extensive redundancies that might trouble unions and public authorities in Europe.
Second, according to a Reuters article, the deal is unlikely to catapult FedEx to a level of market share that could create competition concerns. The article quotes an ING analyst who claims that FedEx's current market share in Europe is just 5%, with TNT at 12%, UPS at 16% and DHL at 19%. The FedEx/TNT combination would create a company with a size similar to that of the other leading players, whereas the UPS/TNT deal was blocked by European regulators due to competition concerns over the size of the combined entity.
The benefits of the deal for FedEx are numerous:
- Opportunity to expand its European operations with one broad brush stroke
- Synergy opportunities through an increase in density (number of nodes of operation) and productivity improvements
- Increased revenue opportunity through offering combined services to customers, particularly in the growing area of e-commerce
The advantages are obvious, but don't expect too much too soon. FedEx's management outlined its expectation for the deal to close in the first half of calender 2016. Moreover, the deal is expected have a minimal effect on the profit and loss account in its financial years -- which end at the close of May -- of 2016 and 2017.
Indeed, FedEx's management expects to be "very aggressive" in making investments in 2017 in order to aid the integration of TNT Express--something likely to hold back profit growth. However, FedEx's management also argued that the deal would be very accretive thereafter, with the full benefits seen in 2018 and 2019.
Don't forget execution risk
All of the above is fine and worthy, and it makes perfect sense for FedEx to pursue this deal, but investors need to be mindful of the execution risk for two reasons. First, the integration of TNT Express carries the usual execution risk of merging trans-contintenal companies..
Second, as we shall see in more detail below, TNT is a company in the midst of a significant transformation of its own. Moreover, it's likely that some of the assumptions FedEx's management is making about the integration are contingent upon TNT's management successfully transforming the company. And there is a lot to do there.
For example, TNT's reported revenue fell 3.2% in 2014, and its International Europe segment (41% of total 2014 sales) saw operating income halve to €30 million amid "continued pressure on sales prices". Meanwhile, Domestics segment revenue (38% of 2014 sales) fell 0.7% as management spoke of difficult trading conditions in the UK and France -- two key European markets.
In fact, in its last earnings statement, TNT's management acknowledged the company was still n the stage of "improving the quality of our revenue base and winning back customers". Moreover, a quick look at some bullet points from its outlook and agenda for 2018-2019 indicates how much there is to do:
- €800 million-€900 million of CapEx investments in 2015-2017
- €250 million-€300 million in restructuring charges in 2015-2017
- Net cost reduction of €125 million by 2018
- International segments operating income margin guidance of 8%-10% by 2018/2019, where 2014 adjusted margin was 4.6%
- Domestics segment operating income guidance of 4%-5% by 2018/2019, where 2014 adjusted margin was 2.6%
The last two points imply that TNT's management expects the cost reductions and restructuring to result in a doubling of operating income margins by 2018/2019. Indeed, a whole new management team was appointed in 2014 in order to achieve this aim..
The bottom line
All told, the deal makes perfect sense strategically, but there is a lot of work to be done before investors will know if it's a good value. TNT Express management needs to execute, and so does FedEx's. The deal promises a lot for FedEx's future direction, but it also carries a fair amount of execution risk.
As such, FedEx investors should keep a close eye out for TNT's future results and outlook statements in order to see how management is faring with its restructuring plan.
