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Corporate splits are in fashion.
FedEx is the last to jump on the bandwagon. The American logistics group plans be divided its higher-margin freight transportation division into a separate publicly traded company. While the move should deliver immediate gains for shareholders, it won’t address FedEx’s biggest problem: falling volumes in its core package delivery business as it battles intense competition from UPS, Amazon, Uber and others.
More and more big companies are exploring spinoffs as investors (again) sour on expanding conglomerates: Honeywell is another recent example. There are good reasons driving this trend. Spin-offs allow the parent company to run more efficient and focused operations, while the newly established group can pursue its own growth strategies. They also have the added benefit of being more tax efficient. Unlike a direct sale, they are usually tax-free.
In the case of FedEx, basic arithmetic shows why it is so important to turn freight transportation into an independent company. The unit is a “less than truckload” business, meaning it picks up small loads from customers and combines them to fill a truck. It is FedEx’s most profitable business. The $9.4 billion in revenue the unit made last year represented just 10 percent of the group’s sales, but generated a third of the group’s operating income. However, this is not fully reflected in FedEx’s valuation of just 13 times forward earnings. Exclusive carriers, such as XPO and Old Dominion Freight Line, trade at a multiple of about 33 times.
If that same multiple is applied to FedEx Freight, the business could be worth up to $43 billion as a standalone company. However, Freight is unlikely to reach that premium valuation, given that its revenue growth is slower than its competitors. In fact, both division revenues fell 7 percent and margins narrowed in the six months to the end of November. Citi analysts estimate that a more reasonable equity value for the unit would be between $30 billion and $35 billion. FedEx, whose shares have risen 9 percent this year, has a market value of $66 billion.
The devil will also be in the details. FedEx aims to complete the spinoff in 18 months. What’s not clear is how much debt the new company will have to carry and whether Freight’s current customers will defect to rivals. Additionally, it is unclear how FedEx will turn around its remaining ground and express delivery businesses without Freight revenue to subsidize its efforts. These two are low-margin businesses, which will require a large capital investment. A spin-off is no guarantee of long-term results.