Apparently the European Union (EU) prefers the illusion of competition to real competition. That would be one possible conclusion from the announcement on Jan. 14, 2013, that the European Commission (EC) has rejected the many compromises offered by UPS (NYSE:UPS) in its proposed acquisition of European delivery company TNT Express and has chosen to block the deal. While this is a setback to UPS's overseas ambitions, the company can likely build over time what the EC wouldn't allow it to buy today.
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UPS Tried, but Couldn't Close the Deal
UPS went to some lengths to preserve its nearly $7 billion cash offer for TNT Express. In its attempt to get European regulators to approve the deal, UPS had offered to sell TNT's air operations (TNT Airways), open the network to competitors and sell a portion of the overlapping network to FedEx (NYSE:FDX).
These offers were in vain, however, as the EC notified the companies that it would block the proposed merger anyway. With that, UPS conceded defeat and announced that it would abandon the deal, paying a breakup fee of 200 million euros to TNT.
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Not a Surprise, but Still Arguably a Poor Decision
At the risk of veering into political commentary, this appears like a short-sighted decision on the part of the EU that is influenced more by optics and nationalism than business reality. While it's true that this deal would have made UPS the number one or number two player in several European markets, that's not to say that TNT Express is an especially strong rival on its own.
On the whole, it would seem that this rejection will leave TNT Express as the somewhat distant number four player in Europe - behind FedEx, UPS and Deutsche Post DHL. Moreover, I would question whether TNT is going to be able to marshal enough capital to build the sort of international asset base it will need to stay competitive over the long term - TNT Express can remain a significant presence within Europe, but I'm not sure the future for its revenue growth, EBITDA margins or free cash flow will be all that compelling for shareholders.
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Will UPS DIY it in Europe?
UPS shares will go up after the news that it will abandon its bid for TNT Express. I have to think that at least some of this is due to the anticipation that UPS will direct some of that capital back towards shareholders. That may well prove true, but I'm not sure it's the right move to make.
The motivation for the TNT acquisition was sound - UPS needed (and still needs) more leverage in Europe and more volume through its global infrastructure. Consequently, I think there's a good argument to be made for committing capital to building up its operations in Europe, particularly in the central and eastern European areas where TNT was relatively strong.
The Bottom Line
Deal or no deal, I'm still fairly ambivalent about UPS shares. While the company has a pretty good record of improving asset turnover over the recent years and of generating good returns on capital, I think Wall Street consistently overestimates the ability of companies such as UPS and FedEx to translate their global asset bases into dependable (and solid) free cash flow. Although I don't think these shares are particularly overvalued today, they are also no great bargain - making them a solid hold, but not a truly compelling idea for new investment.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.