Mr. Smith Goes to Holland

COULD IT BE?
The previous post in this series was Air Carrier Wars: Managing Market Share for Optimal Earnings. In it I compared actual market shares with optimal ones for each of the five leading air express carriers: Kuhne+Nagel (SWX: KNIN); TNT (AEX: TNT); FedEx (NYSE: FDX); United Parcel Service (NYSE: UPS); and DHL (XET: DPW).

DPW turned in the worst performance of the group. Its maximum earnings market share (31.8%) was a full 13 points less than its actual share (44.8%) of revenues.

UPS turned in a much better relative performance with a maximum earnings share of 18.6% compared with actual share of 22.9%.

FDX, TNT and KNIN all posted actual shares of revenue that were significantly less than their maximum earnings shares.

These findings begged two questions:

Would you dare tell Dr. Frank Appel, Chairman of DHL that he should harvest sales for earnings?
Could you convince Frederick W. Smith, CEO of FDX to increase sales by as much as 27% through organic growth or acquisition?

My answers were “No” and “Maybe,” in that order. The purpose of this post is to explore alternative answers to these two questions.

LATE BREAKING NEWS
Almost a week later a New York Times article published on May 29, 2008 reported that DHL planned to partner with UPS to restructure its loss-making US business.

The American unit would record an underlying operating loss of $1.3 billion this year, reducing to $300 million in 2011, Deutsche Post told a news conference at its headquarters on Wednesday.

DHL Express also planned to cut its network capacity by 30 percent and lower overhead and administration costs. Up to 10 percent of Express employees would be affected, Post said.

“We have promised to relentlessly focus on improving financial performance,” the chief executive Frank Appel said. “I am confident we have found a sustainable way forward for U.S. Express.”

I guess Dr. Appel didn’t need my analysis to know his company was throwing money down the drain.

SHOULD FDX ACQUIRE TNT?
Digging through TNT Facts I discovered that FDX and the Dutch express company have had a long standing partnership:

In the early 1990's GD Express Worldwide further expanded with key milestones being the introduction of a daily transatlantic freighter service, the development of an Asian Air Network and the delivery contract for all Federal Express shipments in Europe (bold added).

I also discovered talk of a FDX merger with TNT has been around for some time. The following comments surfaced in an article on the possibility:

As shares of the world's fourth-largest package carrier fizzled Thursday, Wall Street matchmakers couldn't resist thinking FedEx Corp. would be the perfect suitor.

Dutch transportation company TNT NV, a composite of three entities - the Dutch postal service, express delivery and logistics - lost more than 5 percent of its stockholder value Thursday, a day after a private German investor said he was putting together a group, including an unnamed strategic investor in the logistics field, to buy it.

"It would give FedEx a strong presence within Europe and the ability to offer comprehensive logistics and supply chain solutions," said Jon Langenfeld, analyst at Robert W. Baird & Co.

These discoveries turned on a light bulb in my mind: What would be the optimal vs. actual earnings of this combination?

FDX+TNT OPTIMAL EARNINGS
In a nutshell, more market share is a good thing only up to a point. After a company reaches that point, earnings begin to decline -- because the cost of the next share point suddenly exceeds its value. Where “that point” occurs depends on a host of things. And it may occur at a very low or a very high market share. But sooner or later that point will be reached. You can get a quick overview of this principle in my audio slide show: The Role of Maximum Earnings.

The following chart compares actual with optimal earnings of a merged FDX-TNT based on 2007 financial statements. It’s a surprising story.

The combined share of actual revenues would be 23.77% [FDX=16.25%; TNT= 7.52%]. The combined company’s optimal share of revenues would be 23.59% -- just 18 basis points lower than actual shares. Combined actual compared with optimal revenues would be $51.55 vs. $51.14 billion USD. Actual vs. optimal earnings [EBITD] of a merged FDX-TNT are virtually the same: $12.06 billion.

MR. SMITH GOES TO HOLLAND
If Fred Smith needs additional motivation to visit TNT in Holland to pursue a merger this earnings forecast should be it. The next question he might like to have answered is this: What would be the market value of the combined companies? The following posts in this series will explore this question using the principles of competitive stock valuation from my book Competing for Customers and Capital.

Thanks for visiting. As always your comments are welcome.