News / TNT takeover could be a 'match made in heaven', says FedEx – but there are risks

© Khunaspix Dreamstime.

FedEx’s €4.4bn offer for TNT Express has been hailed as a great deal, at least on paper, by many pundits, while Tex Gunning, chief executive of the Dutch parcel-delivery company, must be a relieved man.

It is no secret that TNT has underinvested in its core Europe operations since the proposed takeover by UPS was blocked by European regulators a couple of years ago. At that point it is fair to say that TNT hit something of a brick wall, and has not fully recovered since.

Now, FedEx is coming to the rescue.

Fred Smith: TNT “revenue accretive”

Strength in the dollar-euro exchange rate and a more appealing outlook for Europe, spurred by monetary easing, have made the acquisition compelling, according to FedEx, which said the deal was “a match made in heaven.”

Chief executive Fred Smith talked of “planets being perfectly aligned”, expressing optimism about global macroeconomic trends as well as anticipated regulatory approval.

It is not without risks, however.

In fact, at €4.4bn, the price tag for TNT’s equity is generous, even though it stands well below UPS’s €5.2bn offer in 2012. While there may be reasons to be optimistic about the deal’s strategic and financial rationale, I am concerned about the economic merits of the tie-up – which, in fairness, aren’t easy to digest.

The offer

The unaffected stock price of TNT was about €6 on 6 April, for an implied total equity value of €3.3bn.

So, FedEx is paying a €1.1bn premium to secure all the assets of the Dutch company – which is not much lower than the €1.8bn premium offered by UPS in 2012. UPS’s offer similarly came at a time when TNT stock traded just above €6, although in dollar terms the value of TNT stock is now 20% lower than in 2012. This simply means that UPS would have been paying over the odds – and banking on cost synergies – to snap up TNT.

“UPS estimates that the transaction will deliver an annual run rate of approximately €400m-€550m (US$525m-$725m) of pre-tax cost synergies achieved by the end of year four after closing,” UPS said on 19 March 2012, several months before the EU antitrust decision that UPS had not offered adequate concessions.

Synergies

FedEx may struggle to deliver a tiny fraction of those synergies, because it has minimal exposure to Europe and little overlap by business units in countries where it boasts meaningful presence.

On the face of it, the deal may seem a bargain, as it values TNT at 10x forward adjusted operating cash flow – a 30% discount on UPS’s offer in 2012. FedEx is well managed and has a track record in execution, but a low level of projected cost synergies and the significant future investment TNT requires could weigh on the deal’s success.

Assuming the combined FedEx/TNT entity hits synergies of €134m a year (2% of TNT’s revenue), the net present value of projected synergies – making certain assumption for the tax rate and the cost of capital – would equate to between €857m and €938m, which remains less than FedEx’s €1bn premium.

In M&A, that points to value destruction for shareholders whose hopes hinge on the possibility that the combined entity will be able to find revenue synergies, cross-selling products into each other’s distribution channels.

Frankly, I’d expect little revenue synergy in this deal, although Mr Smith said it was meant to be “very revenue accretive” in the long term. So far, what I know is that earnings dilution appears inevitable, and returns may drop on the back of new heavy investment to the tune of €500m.

Investment

Along with synergies, success hinges on how much heavy investment FedEx will pour into TNT – which, at present, is a money pit.

TNT’s economic losses have widened to €195m in 2014 from €83m in 2012, and its cash-burn rate has similarly deteriorated over the period.

Investment becomes a hot topic, because shortly after the TNT deal was announced reports suggested that UPS planned to invest €1bn of additional capital to expand its European package delivery network.

FedEx has a clear strategy in mind, given that last week its chief financial officer, Alan Graf, said: “We plan to be very aggressive on spending on integration in the first year.” Hence, the short-term risk profile of FedEx heightens for shareholders.

According to TNT’s projection, capital expenditure is expected to rise significantly into 2018. TNT expects “€800m to €900m of capital expenditure investments during the period 2015 to 2017,” it pointed out in its annual results – and that compares with €462m between 2012 and 2014.

Of course, TNT’s €4.4bn take-out price represents only 9.5% of FedEx’s market cap, so TNT is effectively just a bolt-on. But the real risk for FedEx executives is they may take their eyes off the ball in more lucrative markets while acquiring a company in need of a comprehensive restructuring in a part of the world – Europe – that is running the risk of falling into a deflationary spiral until 2025 or later, particularly if wages do not rise at a faster pace.

The good news is that TNT has cash on the balance sheet, while some of its debts could be refinanced by FedEx at cheaper rates.

“At the end of 2014, net cash decreased by 4.3% to €449m (2013: €469m). With available cash and cash equivalents of €652m and an undrawn committed facility of €600m, TNT’s financial position is sound, as reflected in its credit ratings of BBB+ (stable) by S&P and Baa2 (negative) by Moody’s,” TNT said in its annual results.

FedEx shareholders have seen their holdings rise 3% – some three percentage points above the S&P 500 Index – in the last few days of trading, but short-term gains and long-term value are two very different things.

If the deal successfully closes, the gap with European market leader Deutsche Post-DHL (19% market share) will narrow, as FedEx/TNT will likely overtake UPS (16%) into second place with a 17% combined share – yet the price for such an outcome could be much higher than the headline number suggests.