It's official: e-commerce heavyweight Amazon.com (NASDAQ:AMZN) is pursuing its own air cargo network for delivery services. There were some rumors and reports to this effect a few months back, but now the deal has been confirmed. Amazon will be partnering with Air Transport Services Group (NASDAQ:ATSG), leasing 20 freighter aircraft to build a new dedicated and customized air cargo network. The duration of the 20 leases will be five to seven years.
This deal is an important step for Amazon, because it suggests that the company wants to take greater control over delivery and vertically integrate. But let's be clear about something: It's nearly impossible that Amazon would ever be able or willing to fully integrate delivery services considering the sheer scale and capital requirements that would imply. At the same time, there could be some tangible benefits of incrementally increasing the ownership and integration of delivery.
There's another wrinkle to this story, though. What actually caught my attention more than the deal itself was this statement at the bottom of the press release: "In conjunction with the commercial agreements, ATSG also has agreed to grant Amazon warrants to acquire over a five-year period up to 19.9 percent of ATSG's common shares at $9.73 per share, based on the closing price of ATSG common shares on February 9, 2016."
Why would Amazon be interested in doing that?
Who is ATSG?
First off, most people probably aren't too familiar with ATSG, especially compared to Amazon. It's a relatively small aircraft leasing company, with a market cap of under $900 million, even after today's jump. Revenue last year was $619.3 million, with net income of $41.2 million. The company has relationships with airlines in emerging markets as well as existing delivery carriers like DHL.
As of the end of September, ATSG's total operating fleet consisted of 54 aircraft with a carrying value of around $700 million. That shows you how big the deal is for ATSG since Amazon is leasing 20 aircraft.
What's Jeff Bezos up to?
Amazon now has warrants that allow it to buy a nearly-20% stake in ATSG. At the end of 2015, ATSG had about 64.1 million shares outstanding, which would put the total price tag at just under $125 million if Amazon were to exercise all of its warrants over five years. That's not the kind of money that Jeff Bezos loses sleep over, especially if it plays into his long-term world-domination strategy.
I suspect the reason why these warrants are even part of the equation is that it gives Amazon future flexibility to expand the existing partnership in a mutually beneficial way if Amazon decides to grow its air cargo network. Aircraft are expensive (ATSG plans on spending $205 million in 2016 for fleet expansion), which is partially why the aircraft leasing business is more appealing than the commercial airline business in some ways.
But if Amazon ends up wanting to expand beyond 20 aircraft in the future, these warrants will come in handy. It would be a way to help fund the acquisition of those additional aircraft, since upon exercise Amazon would help bolster ATSG's cash position through the purchase of the underlying shares, while at the same time Amazon would retain some semblance of ownership of those aircraft by owning a significant piece of ATSG.
Smooth move, Bezos.
Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.