Delivering value

By Nick Kirrage.

A takeover deal can be more attractive if the bidding company bides its time

When it comes to the control of international deliveries, global logistics has for some years now been dominated in the US by UPS and Fedex and in Europe by UPS, DHL and TNT plus a host of regional postal players. For a similar period, investors have seen the sector as ripe for consolidation and TNT as an obvious takeover candidate – and UPS has finally made a move.

As the smallest giant, so to speak, TNT was seen as having some obvious attractions for the US players – not least its European base and recent programme of overseas investment. All these businesses are cyclical in nature and, five years ago, TNT was making a 10% profit margin and growing strongly. Fedex, UPS or whoever was going to have to pay a high price to win it – or so the market thought.

What the market did not understand, however, was there was no pressing need to bid for TNT. With the sector essentially an oligopoly, it is not as if there were dozens of potential suitors so any of the leviathans prepared to take a long-term perspective could afford to bide their time.

Sure enough, there was a nasty cyclical downturn and TNT, which had been funding its emerging-markets expansion through its European business, saw the latter’s profitability come down very strongly. Having been spun off from its parent company a year ago at a price of around €9 (£7.60), TNT’s share price fell closer to €5 and UPS has now, very cleverly, bid €9 a share.

The behavioural finance aspect of bidding is that, as soon as you crystallise any kind of price in your mind, you reference off that price. Thus, if you bid €9 for something, it is very unlikely you will subsequently be happy to pay €18 and more likely you will be looking to pay, say, €11.

As such, by starting the process when TNT’s shares are so depressed because the market is focused on short-term profitability, UPS is in a very strong position. It is effectively paying a large premium on today’s share price so short-term shareholders, of which sadly there are many, see a return of approaching 100% while longer-term holders,  knowing the short-termists will likely accept the deal, must weigh up how much more they can realistically expect from their shares relative to €9.

At €9, meanwhile, UPS is effectively obtaining a price of 8x 2006 profits and, while TNT’s profits have fallen since 2006, has the long-term value of the business? Probably not. It has invested heavily, has a good emerging markets presence and the areas it serves are very depressed. Looking to the future, increasing global interconnectivity makes logistics look a reasonably attractive business – particularly in China and the rest of Asia.

As such, 8x 2006 profits is probably not the right price – indeed, back in 2006, the market was talking about paying 15x profits. However, the psychology of when and how you bid is extremely powerful and UPS has done incredibly well to avoid becoming involved in bidding for the business at cyclical highs and instead waiting until a combination of profits and sentiment are low.

We often highlight examples of companies that overpay for businesses – who become involved in bidding wars at the wrong time because they just want to do a deal. We will never comment on whether or not an acquisition will be successful but this is one where it would appear a greater degree of discipline may potentially lead to a more attractive investment.

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