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As It Eyes the Skies,, Inc Just Deepened Its Relationship with Air Transport Services Group

By Andrew Tonner – Mar 25, 2016 at 3:40PM

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With Amazon's own fulfillment business taking shape, investors in UPS and FedEx should pay close attention.

Source: Amazon

Up in the sky, look: It's a bird. It's a plane. No, it's (AMZN 3.04%)

Generating ample attention in recent weeks, e-commerce powerhouse Amazon plans to create its own air freight service, a move that spells bad news for current delivery partners like FedEx (FDX 0.22%) and UPS (UPS 1.33%).

Then this week Amazon moved to deepen its relationship with newfound partner Air Transport Services Group (ATSG 0.14%) when it exercised the equity options it acquired from their recent deal.

Amazon's latest deal
According to a recent SEC filing, Amazon exercised its option to purchase just under 7.1 million shares of Air Transport Services Group stock, which translates into a 9.99% ownership stake in its newfound air freight partner. With a strike price of $9.73 per share, the investment cost Amazon $68.9 million. Not a bad deal for Amazon, given Air Transport Services Group's stock price of $14.31 as of Wednesday's close nets Amazon a nice $32.5 million dollar paper gain on its investment. Per the terms of their original agreement, Amazon retains options to purchase as much as 19.9% of Air Transport Services Group's stock, though it isn't clear whether Amazon will ultimately choose to do so.

For those not immediately familiar, the core of Amazon and Air Transport Services Group's deal will allow the Seattle-based e-commerce leviathan to lease 20 Boeing 767 freight airplanes to Amazon's Fulfillment Services division over a period lasting from 5 to 7 years. Amazon will use its new toys to begin handling its own logistics for as much as 15% of the firm's annual shipment volume by one analyst's reckoning.

However, it's the bigger picture implications of the deal that should truly have FedEx and UPS investors concerned.

Start of something bigger
As we should hopefully have learned by now, Amazon typically prefers to operate on as large a scale as possible, and many, myself included, see Amazon's deal with Air Transport Services Group as the start of its push into the global freight and logistics business. As wild as Amazon owning a large percentage of the global supply chain might seem, the idea is actually very much in keeping with Amazon's longtime business strategy.

Over the years, Amazon has developed an impressive knack for creating new businesses that actually help finance its own low-margin e-commerce operations. The two best-known examples of this are Amazon's third-party retail listings on its website and Amazon Web Services. Both initiatives fit squarely within the broader growth strategy Amazon employs, which is known as the Flywheel Strategy.

As the thinking goes, Amazon enjoys a number of levers it can pull to help accelerate its growth, one of which is lowering its costs, which in turn enables Amazon to charge lower prices on its own e-commerce operations. And as wildly ambitious as it might seem, many feel that's what Amazon ultimately hopes to accomplish with its shipping services. Fulfillment costs grew faster than total revenue for the company last year, and now represent the biggest single line item of the firm's operational costs.

Switching fulfillment costs from an activity that drains cash from Amazon's business to one that helps fund its operations could have major competitive implications for the company itself and the likes of FedEx and UPS. So while Amazon is just getting started in what will almost assuredly be a multi-year development period, investors in FedEx and UPS will want to pay close attention to Amazon's growing fulfillment ambitions.

Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends and FedEx. The Motley Fool recommends United Parcel Service. 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.

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