Monday, May 23, 2005

What CAN’T brown do for you?

On Monday, May 16th, UPS, the world’s largest package delivery company, agreed to buy Overnite Corporation, a leading provider of less-than-truckload transportation services, for $1.25 billion. Less-than-truckload (LTL) carriers, which typically carry freight of less than 10,000 pounds, consolidate the loads of numerous customers into single trailers through a network of terminals. The acquisition of Overnite, the fifth largest player in this LTL space, offering a full spectrum of regional, inter-regional, and long-haul services nationwide, marks UPS’ continued attempts to diversify beyond its original package delivery business. In 2004, UPS acquired Menlo Worldwide Forwarding, a move that strengthened its heavy airfreight and supply-chain management businesses. Highlighting the need for UPS to expand its product base, UPS Chairman and CEO Mike Eskew deemed Overnite a “perfect strategic fit”, as the company attempts to “offer…customers the broadest portfolio of transportation and logistics services available from a single source”.

The popular press has touted the purchase of Overnite as the largest acquisition in UPS’ nearly 100 year history. While certainly factual, it is still relatively small given the company’s considerable size. With a market capitalization of nearly $84 billion, and cash on hand of just over $4.5 billion, UPS has ample liquidity to absorb Overnite. However, while not a “blockbuster” acquisition, the venture into the LTL space represents a marked change in UPS’ strategy. Wall Street and the financial press are fairly unanimous in their belief that Overnite is a good strategic fit for UPS. The acquisition will help UPS expand its available transportation and logistics services and reduce its reliance on the domestic ground package business, a segment of the market that UPS continues to lose market share to rival FedEx. Analysts have observed that recent consolidation in the once-fragmented trucking division may be motivating UPS to move forward into the LTL segment sooner than expected. FedEx, currently the second largest LTL provider, acquired two former carriers and has experienced high revenue and operating income growth in their LTL division (Fedex Freight) over the past 3 years. The industry leader, Yellow Roadway Corp, solidified their competitive positioning through the acquisition of USF Corp in February. Citigroup analyst Scott Flower believes that, while it is encouraging to see UPS “fill an evident gap in its service portfolio”, the existing competition should not be ignored. Flower asserts that FedEx Freight is a “well-regarded LTL operation…that has resulted in cross-selling opportunities.” However, he believes that expanding their product base should enable UPS to better compete with those shippers that have a more expansive suite of freight hauling capabilities.

The acquisition of Overnite is certainly not without risk. All too often, management is quick to ascribe synergistic benefits from a proposed transaction. It appears as if UPS management, however, is somewhat realistic as they enter the LTL space. UPS should be able to capture some of the cross-selling opportunities that have made FedEx Freight such a success. However, management is correct in observing that the synergies will largely be confined to revenues, as the operational differences between LTL and UPS’ parcel terminal operations will mitigate any further cost reductions.

The potentially combative role of labor unions (i.e. Teamsters) poses the largest risk to the Overnite acquisition. If recent history is any gauge, the powerful role of the labor unions can be disruptive to UPS’ daily operations. The UPS labor strike of 1997 not only effected UPS operations ($700 million in lost revenue) but had a spillover effect on the U.S. economy as a whole. Eight years later, UPS’ labor force continues to be largely unionized. Overnite, however, is largely non-unionized, with only 1% of their employee base under union control. Labor strategy thus plays a crucial role with this acquisition. Will the Teamsters win out in their attempt to unionize the Overnite employee base? What the media and analysts have been focusing on is the effects of potential integration risks between the two companies However, one of Overnite’s competitive advantages within the LTL space is its lower cost business model. If this independent labor force becomes unionized, Overnite’s lower cost labor pool arguably will become more expensive for UPS. Very quickly Overnite’s competitive advantage could begin to erode.

What isn’t clear necessarily is how the purchase of Overnite is consistent with UPS’ recent strategy of increased growth via their international operations. Additionally, is UPS abandoning their strategy of maintaining higher margins versus their peers? Historically the company has remained focussed on maintaining price, while competitors such as FedEx and DHL have stolen market share by way of price cuts and/or increased service and marketing campaigns. James Valentine, analyst at Morgan Stanley, warned that the acquisitions of Menlo and Overnite have taken UPS into parts of the transportation industry with “lower returns on investment than in package delivery.” While his observation is certainly noteworthy, at nearly double the operating margins of their nearest competitors, it appears as if UPS does have some flexibility. And with this flexibility, UPS may very well be able to “gain some ground” in the U.S.

Michael Miranda and Brad Pitzele


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