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The Battle for Value: Federal Express Corporation vs. United Parcel Service of America, Inc.

The Battle for Value: Federal Express Corporation vs. United Parcel Service of America, Inc. MBAD 6157H November 2007. Synopsis. Time: July 1995 Want to assess the financial performance of Federal Express and UPS Two strong competitors in the overnight express package industry

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The Battle for Value: Federal Express Corporation vs. United Parcel Service of America, Inc.

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  1. The Battle for Value:Federal Express Corporation vs.United Parcel Service of America, Inc. MBAD 6157H November 2007

  2. Synopsis • Time: July 1995 • Want to assess the financial performance of Federal Express and UPS • Two strong competitors in the overnight express package industry • Not a number-crunching case, rather, we need to interpret results and reflect on the implications

  3. Main Issues/Objectives • The definition of “excellence” from a corporate finance point of view • The use of economic profit analysis and the measurement of financial performance and health • Economic profit analysis vs. other classic approaches such as financial reports and ratios, and stock price performance. • The opportunity to discuss the attributes of healthy and successful companies and to explore the strengths and weaknesses of economic profit.

  4. Main Issues/Objectives • Key learning points about economic profit: (1) its dependence on GAAP conventions, and (2) its ignorance of strategic option value. • Business segment analysis to identify strong and weak sectors. • The financial implications of rigorous competition and corporate transformation • Corporate transformation: customer focus, total quality management, product innovation, re-engineering, alliances,…and so on.

  5. EVA • EVA: Economic Value Added • EVA = NOPAT - C% (TC) • where NOPAT = net operating profits after taxes • C% = percentage cost of capital • TC = total capital • GAAP : Generally Accepted Accounting Principles

  6. Mission Statement • Objectives • stock price • market share • profits • EPS, P/E ratio • size of the firm (assets) • quality products/services • best in technology • …….etc.

  7. Ways to Measure Financial Excellence • Direct inspection of the financial statements • Financial ratios • EPS and P/E ratios • Total returns to investors • Economic Profit (Economic Value Added)

  8. An Important Event • July 10, 1995 • J.C. Penney announced the award to UPS of a $1 billion, five-year contract for delivery services. • At the announcement, the stock price of FedEx fell 2.33 percent => total market value of equity declined by $85 million.

  9. Surprised by the Event? • FedEx was perceived as innovative, entrepreneurial, and an operational leader • quality is what they are selling (time definite transportation) • UPS had the reputation as a big, bureaucratic industry follower. UPS was trying to shed this image and to make a transition to be an innovator and competitive in the new world of air-express package industry.

  10. Future Trends • Focus on product innovation, customers’ needs, quality, and reengineering • Capital-intensive investments • Shifting market shares

  11. Analysis: Part 1 • Describe the competition in the overnight package delivery industry and the strategies by which these two firms are meeting the competition. What are the enabling and inhibiting factors facing the two firms as they pursue their goals? Do you think either firm can attain sustainable competitive advantage in this business? • Objective: Explore the historical origins of the two firms

  12. Analysis: Part 2 • Why did FedEx’s stock price decline at J.C. Penney’s announcement? Assuming a perfectly efficient stock market, how might on interpret this loss of $85 million in FedEx’s market value of equity? • Objective: Explore a basic idea about stock price

  13. Analysis: Part 3 • How have Federal Express and United Parcel Service performed since the mid-1980s? Which firm is doing better? Discuss the insights you derived from the two firms’ financial statements, financial ratios, stock price performance, and economic profit (or EVA). Also describe how EVA is estimated, and its strengths and weaknesses as a measure of performance. • Objective: Evaluate firm performances based on various measures

  14. Analysis: Part 4 • If you had to identify one of these companies as “excellent” which would you choose? On what basis? More generally, what is “excellence” in business? • Objective: A reflection on the normative implications of financial and operational performance.

  15. Discussion: Part 1Company Origins and Strategic Forces of the Industry • Any assessment of financial performance and health of the two firms must be based on the key drivers of expectations and contingencies. • UPS was the dominant firm in the oligopolistic industry. • FedEx rose as an innovator in the industry

  16. Before 1990 stable setting economies of scale and higher profits consistent thinking committed to a dominant product or design resist adopting innovations 1990s competition on all functional areas including service innovation, quality, and geography customer focus totally quality mgt info technology globalization strategic alliances Key Features of the Industry

  17. Discussion: Part 1Company Origins and Strategic Forces of the Industry • The turbulent change within the industry must be a major influence on investor expectations and assessments of contingent value

  18. Discussion: Part 2FedEx’s Stock Price Reaction • Stock price: the sum of the PV of predictable future CFs (dividends and terminal value) to shareholders plus a contingent component • Why terminal value and/or contingent component might decline at the Penney announcement? • Loss of expected profits from Penney and restriction of FedEx’s ability to finance internally

  19. Discussion: Part 2FedEx’s Stock Price Reaction • Denying to FedEx some future business with Penney; UPS’s gain is FedEx’s loss; Zero-sum competition in air express • Signal of competitive disadvantage of FedEx relative to UPS. Whether or not the relationship with Penney was actually profitable for FedEx, the failure to win business may suggest that FedEx is slipping competitively.

  20. Discussion: Part 3The Financial Performance of FedEx and UPS • The relative strengths and weaknesses of the various criteria used to compare these two firms • Interpretation of the results and assessment of the implications

  21. Discussion: Part 3The Financial Performance of FedEx and UPS • Financial criteria: strengths and weaknesses (Table 1) • Interpreting the comparative results: Table 2; Insights from this table: • FedEx is growing faster than UPS on most criteria except in book assets and income (could be attributed to difference in culture, scale, or life-cycle

  22. Discussion: Part 3The Financial Performance of FedEx and UPS • A ‘red flag”: UPS has a higher EPS growth than FedEx => FedEx has been unable to translate net income growth into high EPS growth • Sustainability: FedEx had an average of 6.1% return on equity over 1985-94 with 11.98% growth in book assets => need significant amounts of equity and debt for financing; UPS earned 22.2% on equity while growing at a 16.12% in book assets in the same period => the growth is self-sustainable even with a 27% dividend payout ratio

  23. Discussion: Part 3The Financial Performance of FedEx and UPS • Return to investors: $1 invested in 1982 in FedEx UPS Be worth ?? In 1995 $1.94 $40.92 Be worth ? In 1995 $5.34 $34.63 after adjusted for less thanmore than opportunity costs S&P 500 S&P 500

  24. Discussion: Part 3The Financial Performance of FedEx and UPS • EVA analysis: Table 4 and 5 • 1990-1991 decline?? • EVA results may reveal a war of attrition => the winners of such wars tend to be the contestants with the greater resources

  25. Discussion: Part 3EVA vs MVA • One hint from Table 2 that the demise is not FedEx’s fate yet….. => While EVA was $1.387 billion, MVA declined only $0.641billion. The capital markets is “more optimistic” than the EVA numbers. Why?? • Estimation error in NOPAT and capital investment resulting from reliance on GAAP figures

  26. Discussion: Part 3 EVA vs MVA • Ignorance of terminal value and option value • EVA is a one-year measure and backward-looking • Ignores potential future NOPAT • Ignores uncertain outcomes or options • Stewart Myers (1977): firms have two kinds of assets => assets in place and growth opportunities. EVA only help us understand the value of assets in place

  27. Discussion: Part 3 EVA vs MVA • Ways in which FedEx can create option value • The mastery of special skills and technologies; huge investments in process improvement and new technologies=> financially sensible investments of human capital • International expansion: Table 3 shows a summary comparison of domestic and international segments for both firms; International segment can be viewed as a option that could create value in the future

  28. Discussion: Part 3EVA vs MVA • Capital Market Inefficiency: The difference between FedEx’s EVA and MVA could be due to overoptimism of the investors.

  29. Discussion: Part 4Which Firm is “Excellent”?

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