The Battle for Value, 2004: FedEx Corp. vs. United Parcel Service, Inc.

Patrick Cunningham M03619570

Professor John Phelps, Ph.D.

January 17, 2014

Executive Summary:

This case study analyzed both financially and operationally the two leading package-delivery firms in the industry. By analyzing the financial statements of each company I was able to determine the alternatives to each companys problems, which were financing the expansion into China and working with an unskilled labor force. The alternatives for these problems were having a secondary offering, creating in house training programs, contracting services out to third parties, and hiring experienced Chinese executives to run Chinese services.

The recommendation provided for both UPS and Fed-Ex, given that the air transportation market in China is now open to both companies, is that they should have a secondary offering to help finance the expansion into China. By offering an issuance of 100 million shares each company will be able to make 6.398 billion (Fed-Ex) and 7.455 billion (UPS) towards acquisitions for expansion in the Chinese Market.

Table of Contents: Executive Summary Page 1 Situational Analysis Page 4 Alternatives Page 5 Recommendation Page 7 Appendices Page 9

Situational Analysis:

The 2004 air-transportation agreement between China and the United States was a significant opportunity in the package-delivery industry for two U.S. companies. Fed-Ex and UPS, the two leading firms in the package-delivery market, had completely saturated the U.S. package-delivery segment. This agreement was the perfect opportunity to increase growth in the international package-delivery business. But, with new opportunities comes new problems for both Fed-Ex and UPS. The first problem is working with an unskilled labor force in China. In an industry that relies heavily on efficiency and accuracy it is imperative that you have a strong, skilled labor force. A challenge with working in China is finding that skilled and educated labor force. Most of Chinas workforce is for production of cheap products at a cheap wage. Both UPS and Fed-Ex would need to find a skilled labor force for this delivery and logistics service industry. The second problem is being able to successfully finance the new expansion into China. The new agreement allows for five times as many commercial cargo flights, to and from any airport in either China or U.S. With the overall air cargo in China increasing at 30% a year and expecting to do this for the next fiver years it means there are plenty of opportunities for Fed-Ex and UPS to benefit. But, with one hundred flights a week up for grabs, it may come down to which company is more financially able to fund the new additions of fleet of cargo planes that will be needed to fulfill the new demands.

Alternatives:

The alternative for successfully financing the expansion into China is a secondary offering. A secondary offering would be when a public company creates additional shares of stock in order to raise more money for the business. The positives of this would be that there would be more capital for each company to help finance the expansion into China. In addition, this could help them pay of some debt and not have to rely on just revenue from sales. The negatives of this alternative are a dilution of ownership, which is the reduction of ownership percentage of a shareholders stock. This could affect other shareholders stock value, which could have a negative affect on the companys stock.

The first alternative for unskilled labor forces in China is creating in house training programs. The positives of doing in house training is that the company has control over who trains the workforce. They can have them trained exactly how they want so they will do exactly what is expected. Also, they can lower costs by not having to pay for some other company to come in and train the labor force. UPS or Fed-Ex can just have one of their employees they already pay train them therefore they wont have extra expenditure. The negatives of doing in house training are that it can be very time consuming to train an entire workforce. Each company would have to put a program together and then implement the program to the entire unskilled workforce. This entire process could be very time consuming which can cost not just time but hurt the bottom line as well. Another negative could be the possibility of cultural differences between the workforce and the people training them. If the training staff is from the U.S. they may not

understand the culture of China and have confusion among each other. This could also be very time consuming and money wasting.

The second alternative for unskilled labor forces in China is contracting services out to third party carriers. The positives of this alternative are that the third party carrier would already be acclimated with China and know how the industry works in it. This could be very beneficial because you wouldnt have to waste time and resources building your own assets. Neither company would have to buy more cargo planes, delivery trucks, buildings, etc. The negatives would be that you wouldnt be able to make as much as you are truly capable. Each company would have to pay the third party carrier to deliver for them therefore they couldnt completely maximize their profits. In addition, by going through a third party carrier, each company wouldnt be able to fully control the quality of their deliveries. This could be very risky because if the third party carrier messes up then you may lose the customers business now and in the future.

The third alternative for unskilled labor forces in China is to hire experienced Chinese executives to run the services in China. The positives of this alternative would be that they know the workforces background and would be able to communicate easily with them. In addition, the labor force may trust Chinese executives more because they can they have been surrounded by the culture and know more how China works. The negatives of this alternative are that perhaps the Chinese executives have different philosophies or more difficult to control than in house executives. They may not believe in the same values that each company have and it may be more difficult to enforce.

Recommendation:

Based on the alternatives analyzed I believe the best alternative is funding the expansion into China through a secondary offering. Just like in 1999 when UPS offered a stock split and IPO, this is an effective way to raise capital to fund an expansion into China. Now, my case of recommended funding through a secondary offering can be made from each firms ratios in Figure 1. These two ratios show how attractive these two companies look to possible investors. The first ratio for each company shows that they both had a controllable debt compared to equity, which means they are a lower risk. The second ratio shows both companies can more than easily cover the minimum interest payments and wouldnt be defaulting on debt. Since both companies are both financially stable, theoretically, they could both create 100 million shares for issuance. The stock prices for Fed-Ex and UPS at the end of year 2003 were respectively, $63.98 and $74.55. Therefore, Fed-Ex could raise 6.398 billion and UPS could raise 7.455 billion to aggressively expand in China. Although those appear to be large numbers, both companies had a good growth rate over the past 10 years and should continue. In Figure 2 it shows how both Fed-Ex and UPS had a solid compound annual growth rate in sales, net income, and operating income from 1993 to 2003. In addition, the number of shares created can be realistic since it is no higher than what Fed-Ex offered in 1999, which was 109.4 million shares. Therefore, either Fed-Ex or UPS could raise capital for expansion into China by issuing a secondary offering of stock.

Appendices

Appendices

Figure 1: Name of Ratio Debt/Equity Ratio Times Interest Earned Capital Expenditure Ratio 2003 Fed-Ex Ratio .28 10.51 .22 2003 UPS Ratio .26 36.41 .33

Figure 2:
Fed-Ex CAGR of Sales CAGR of Net Income CAGR of Operating Income 11.53% 35.51% 13.64% UPS 7.32% 18.83% 12.35%