Austrian Post POST AV W
October 17, 2006 - 5:23pm EST by
murphy503
2006 2007
Price: 29.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 2,065 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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  • Monopoly
  • Recent IPO
  • Large Net Cash Position
  • Non-Recurring Expense
  • Stable Management
  • Sell-side Research Errors

Description

Austrian Post offers investors an opportunity to own a cash-rich, growing monopoly, and prolific cash flow generator for less than 5x free cash flow. 

 

The Austrian national postal service, Austrian Post (Oesterreichische Post in German), is currently priced at a huge discount to its intrinsic value.  The opportunity is all the more remarkable given that it is a € 2.0B (US $2.6B) market cap company with solid liquidity.  We believe the shares could return multiples of our investment.

 

The key points to our thesis are as follows:

1.       Dominant position with stable and largely acyclical cash flows

2.       Ridiculously strong balance sheet for a stable monopoly, with €6 per share of cash

3.       Recent IPO process led to significant undervaluation

4.       Non-cash, non-recurring accounting provision is obscuring true earnings power

5.       Over depreciation depresses earnings, understates real economics

6.       The Company is not well understood by the sell-side analysts, which will lead to a significant outperformance vs. consensus estimates

 

The Company trades on the Vienna exchange under the ticker POST, its symbol on Bloomberg is POST AV, and on Yahoo is POST.VI.  Austrian Post was privatized via an IPO this summer, with the Austrian government selling 35m of 70m total shares.  POST trades for around € 29.50 per share at the time of this write-up.  The Company will carry about € 8 of net cash on the balance sheet by the end of this year and has an additional € 2 of real estate held for sale.  POST will generate around €278m of maintenance free cash flow this year, or about € 4 per share.  So you are paying about € 19.50 for € 4 of free cash flow. 

 

The Company has suffered from several recent sell-side analyst downgrades on account of the shares reaching a stated target price.  We think the analysts don’t really understand the economics of the business.  We are looking for POST to significantly beat consensus numbers as they did in the first half.  The year end consensus is tightly clustered around stale management guidance from before the IPO, and is actually much lower than LTM performance.  POST should deliver modest growth YOY in the 2nd half and recognize cost savings due to already completed headcount reductions of 800 people in the first 6 months.  Analysts are partly misunderstanding the financials due to some confusing accounting accruals and asset write-offs from last year – more on this later.  This management team is ultra conservative, and has prudently set a low bar, as they admitted to us recently.  This earnings and cash flow “surprise” will force the sell-side analysts to reconfigure their earnings and DCF models (which are a mess but don’t get me started). 

 

Austrian Post primarily makes money from postage for delivery of letter mail, direct mail and periodicals, which generates 76% of revenue and 90% of the profitability. Shipping consumer parcels and packages (similar to FedEx and UPS) represents 12% of revenue.  POST also uses the branch network to retail financial products for a banking partner (Bawag of Refco fame), sell mobile phones, stationery, DVD’s and other products, which represents 12% of revenue.  POST has a little over 24,000 employees, 6 sorting facilities and about 1,900 branches.  You can check out investor presentations at the IR website here: (http://post.at/ir/en/).

 

Financials and Valuation

Please note that the figures below are our estimates and are adjusted to exclude non-recurring, non-cash accounting provisions and severance costs, and gains on asset sales. For conservatism we have not excluded cash severance and related costs incurred in 2005 that are not likely to recur in 2006.  We also do not back out the €2 per share real estate value in the multiples below.  We assume all cash flow is retained on the balance sheet, rather than paid out in dividends or used to buy back shares.  Interest income is excluded from free cash flow.

 

Financials and Valuation

 

 

2004

2005

LTM

2006E

2007E

2008E

Revenue

 

 

1654

1702

1728

1,752

1,790

1,836

Reported EBITDA

 

 

202

225

241

NA

NA

NA

Adjusted EBITDA

 

 

263

321

340

358

376

400

Maintenance Capex

 

 

40

40

40

40

40

40

Interest Expense (ex. Income)

 

 

7

5

4

3

0

0

Taxes @ 25% of reported PTI

 

 

26

25

28

37

57

70

Cash Flow

 

 

190

251

268

278

280

290

Shares (mm)

 

 

70

70

70

70

70

70

Cash Flow / share

 

 

2.71

3.59

3.84

3.97

3.99

4.14

 

 

 

 

 

 

 

 

 

Net Cash Balance / share

 

 

1.40

4.46

5.95

8.09

12.08

16.22

Share Price – Net Cash

 

 

28.10

25.04

23.55

21.41

17.42

13.28

 

 

 

 

 

 

 

 

 

FCF multiple / share

 

 

10.4x

7.0x

6.1x

5.4x

4.4x

3.2x

TEV / EBITDA

 

 

NA

NA

4.8x

4.2x

3.2x

2.3x

TEV / EBITDA – Mnt. Capex

 

 

NA

NA

5.5x

4.7x

3.6x

2.6x

 

Segments

The Company operates under 3 segments: Mail, Parcels & Logistics, and Branches.  The Mail segment represented over 90% of 2005 pre-overhead EBIT, and is sub-divided into Letters, Direct Mail, and Media Post (newspaper and magazine delivery).

 

Revenue Breakdown

 

 

2004

2005

LTM

2006E

2007E

2008E

Letters

 

 

769

782

779

790

790

790

Direct Mail and Media

 

 

487

508

524

529

544

566

Parcels and Logistics

 

 

199

212

221

231

250

269

Branches

 

 

196

194

198

198

202

206

Other

 

 

4

5

6

5

5

5

Total

 

 

1654

1702

1728

1752

1790

1836

 

Financial Commentary

We expect the current level of cash flow to grow modestly over time.  Overall POST should see stable, low single-digit volume growth.  Letter mail volume will be flat to up 1 or 2%, while direct mail volumes will increase by 4-5%.  Email substitution fears from several years ago have proven to be less of a threat than earlier anticipated.  Only 8% of letters are C2C, which are more prone to substitution, while B2C (bills, govt. communications, etc) remain the lion’s share of volumes.  We have not assumed they are able to raise postage pricing in our model, but that would provide significant upside.  POST raised prices by 16% in 1998 and by 8% in 2003.  Pricing in direct mail will be down 1%-2% in unaddressed and flat in addressed.  Pockets of strong growth exist in the parcels segment, especially the recent entry into B2B, and in Eastern European operations (parcels and direct mail). 

 

Most of the cost structure is fixed, which primarily includes labor at sorting facilities and the delivery network.  Wages are the biggest cost component and will increase by 3.5% per year.  This will be more than offset by productivity improvements, which represent a huge opportunity for the Company.  Over the last few years the current management team has begun rationalizing the employee base and infrastructure.  Employee headcount has been reduced from over 30k to 24k (CAGR of 4.6%); the branch network has gone from 3,000 to 1,900 and sorting facilities from 39 to 6.  This management team knows how to reduce costs in a politically sensitive fashion.  When questioned on this they will soft pedal future headcount reductions, as there are obvious political sensitivities and employee morale issues to contend with.  However, we know from speaking to people inside the Company, competitors and industry sources that POST still has massive levels of redundancy and waste, and management knows this.  We expect the Company to shed 4-5% of its work force in each of the next 3 years.  Keep in mind this was a jobs program run by the Austrian government for 150 years.

 

There are several reasons why POST trades at a steep discount to intrinsic value:

 
1. IPO dynamics

The shares have only been traded for 4 months and were priced in a difficult market for US and European IPO’s.  In determining the valuation it was decided to price the shares off of a 5% dividend yield, while giving shareholders the cash and real estate for free.  The current dividend of €1.00 per share used as the basis for this dividend yield is highly arbitrary and represents 25% of free cash flow.

 

It was not in management’s interests to push for a higher valuation. Management was granted “appreciation rights” (free options with a 1.5x multiplier) that were struck at the average price of the first 60 trading days.  As long as they can generate a 40% total return to shareholders over the next 3 years, they will receive a cash payment equal to 150% of the future trading value of the share price times their options.  In order to receive the options, they were required to purchase 30% of the current value in shares at the IPO valuation with their own money.  The 60 day pricing period recently ended and the Company has begun meeting with investors.

 

Moreover, the government of Austria aggressively marketed the shares to retail investors, and the Company encouraged and financially motivated (through a matching program) employee share ownership.  Over 50% of employees now own shares. 

 

Finally the Austrian government wanted to prove that they could execute a successful result, which was defined by how much the shares appreciated after the offering.  The Austrian government still owns 51% of the shares.

 

It remains in everyone’s interest to see the share price continue to appreciate.

 

2. Non-cash non-recurring provisions obscure true economics

The Company recognized approximately €107m of non-cash provisions in 2005 and expects to take another €95m of provisions in 2006.  These provisions are mostly related to “underutilization” of certain employees.  Under Austrian law, certain employees left over from pre-1995 days were designated as “civil servants”.  These employees can not be laid off.  Six hundred of these individuals are currently in a jobs bank, a la General Motors.  They only work part-time.  If they choose to sit in the “development center” until they reach retirement age, they are entitled to do so, at full compensation.  Under IFRS accounting guidelines, the Company is required to take a provision equivalent to the net present value of all future payroll obligations for these individuals until retirement, multiplied by the degree of underutilization (~50%), and put this total on the balance sheet.  So basically they are taking about 20 years (on average) of future payroll expenses all in the current year.  As these employees are paid, leave or are reassigned, the provision will be reduced.  Without this non-cash provision 2005 earnings would have doubled, as would the dividends (based on 70% stated payout ratio).  To get to the true earnings power of the Company you need to add back the non-cash portion of the provision found in the cash flow statement.

 

Although many of the sell-side analysts mention that this is a non-cash provision, all of them include it in on an unadjusted basis in their EBITDA, EPS and dividend payout ratios.  When the Company was marketing the IPO, the provisions were run through the P&L and deflated earnings when doing relative valuations with Deutsche Post and others.  It also impacted the dividend level, given the stated 70% payout ratio of net income.

 

If no additional employees are made redundant the Company would recognize no provision in 2007.  However next year the Company expects that it will recognize approximately €60m of underutilization expense related to additional employees becoming underutilized, or a greater degree of underutilization of existing employees in the jobs bank.  According to management the provision will continue to diminish over time.

 

3. Depreciation overstates capital intensity and depresses earnings

Finally depreciation expense is approximately 2.5x maintenance capex.  The first reason is that in 2005 the Company recognized €29m in asset writedowns, which increased depreciation expense.  They also recognized a €17m non-cash provision for underutilization of real estate assets.  Of course this €46m decreased net income, which suppressed the dividend used as the basis for valuation. 

 

Another reason depreciation expense overstates the ongoing capital intensity of the business is due to the fact that the Company is almost finished with a €600m investment program modernizing and automating its infrastructure.  POST converted its 39 mail sorting facilities into 6 state-of-the-art automated facilities. 

 

The Company will recognize about €100m of depreciation expense this year, and will spend about €40m on replacement and maintenance capex.  In the first half of this year total capex was only €14.6m.  This year’s growth capex of €20-30m is related to completion of the final of the 6 sorting facilities and construction of an Eastern European parcel facility.

 

4. Sell-side overestimating the impact of liberalization

Today only 2 segments of POST’s revenue are protected from competition – any letter mail and addressed mail under 50 grams is delivered exclusively by POST.  Letter mail and addressed direct mail over 50 grams have been liberalized in stages over the last several years.  Parcels, most direct mail and newspapers have always been open for competition.  We have spoken with a number of competitors and industry sources to gain a better understanding of the full opening (“liberalization”) of the postal market and general competitive dynamics.  In summary, only about 30% of POST revenue (direct mail and newspapers) should be subject to increased competition over time.  The earliest possible date will be January of 2009.  This date could easily slip several years after that, depending on the level of wrangling among competing interests in the EU.  Importantly, recent discussions at the EU indicate that the national regulator of the individual countries will have the final say in opening the market to competition.

 

After consulting with industry sources, we learned that both major Austrian political parties are resisting open competition against POST.  The outgoing administration has often butted heads with the EU competition authority.  The government has limited competitor access to apartment mailboxes, required competitors (not POST) to charge a value-added tax of approximately 20%, and offered opaque regulatory guidelines. 

 

Geography is an important factor.  Austria has only 8m people.  Vienna has a population of 1.5m, and is the only large city – the next closest is Graz with a population of 285,000.  It is a very mountainous country with low population density, hardly ideal for a new entrant.

 

Despite having competition in most segments for years, POST has a 95% market share in B2C and C2C parcels, an 85% share in direct mail, and a 56% share in newspaper delivery.  POST is now among the most effective postal services in Europe with 97% delivery on the following day, from 62% a few years ago.  High customer satisfaction is a strong impediment to development of competition.

 

It makes the most sense to go through each of the sub-segments.  As is the case in most other European markets, the letter mail business will not see any material competition.  Letter mail is a natural monopoly.  This is because a new entrant in the letter mail business would need to make a prohibitively large investment in infrastructure (branches, sorting centers) and personnel (for daily delivery) that would not likely be profitable, much less deliver a sufficient return on capital.  For example, if Deutsche Post (Germany) were to some day enter and achieve a 10% share of the total Austrian letter market and generate a 10% EBIT margin (better than their current operations in other large countries), it would represent about €5m of incremental earnings, or .004 of incremental EPS.  This would pale in comparison to the capital investment.  Vienna’s sorting facility was completed in almost 2 years at a cost of €150m. 

 

Direct mail makes up 20% of POST revenue. Revenue is evenly split between addressed direct mail (credit card solicitations, catalogs) and unaddressed direct mail (coupons, fliers, restaurant menus, etc).   This is the segment where most competition exists in European markets.   Fortunately for Austrian Post, a couple years ago they were given clearance to acquire their largest competitor, Feibra.   At this point the only competitor of any scale is a JV between a struggling Austrian publishing group and the Dutch postal provider. 

 

A good case study is the liberalization of the Swedish market, which occurred in 1993.  Thirteen years later Sweden Post has 93% market share.  One competitor, CityMail, emerged in 4 urban markets and delivers direct mail and newspapers only. Like Sweden, Austria is an extremely mountainous country with a small degree of urbanization.

 
Finally, management believes that by 2012 they may lose 5-7% of the market, which would amount to an average of 1% off of revenue growth in each of the next several years. Competitors have suggested a similar level of share participation to us.

 

For more information on the development of competition in European postal markets, you can look at several market studies on the EU Commission’s website:

http://ec.europa.eu/internal_market/post/studies_en.htm

 

Management

Management comes from industry (Siemens, banking, several consulting firms, retail and logistics companies), and the CEO and CFO have been with the Company since 1999.  They have done an impressive job converting a sleepy government run bureaucracy into a modern and competitive enterprise.  Besides modernizing the Company, they have dramatically improved customer service and delivery times. 

 

Eastern European expansion in parcels and direct mail

Austria’s proximity to Eastern Europe has provided Austrian companies with a strategic advantage for expansion in high growth countries like the Czech Republic, Slovakia, Slovenia and Croatia.  Austrian Post has a strong position in several of these nascent markets which have been served by state-run, highly inefficient incumbents. POST should benefit from rapid growth in direct mail and parcels per capita (currently a small fraction of central and western European countries).  POST is the #2 provider of parcels and unaddressed direct mail in Slovakia, #1 in parcels in Hungary, and #2 in parcels in Croatia.  Revenue from these markets is around €40m, but this will expand rapidly going forward as penetration converges with Western European levels. Moreover, because of their familiarity with these markets, Austrian Post is well positioned to acquire or invest in national postal operators upon privatization.

 

Real Estate

POST has sold off some of its excess real estate, but continues to own a lot of its branch network and all of its sorting facilities.  All of POST’s property is unmortgaged.  POST also owns real estate no longer in use that is classified as investment property, which is booked at €60m but appraised at €135m (€2/share).  We believe this valuation discrepancy probably exists for a great deal of its buildings and land on the balance sheet, which is carried at €527m.  The investment property will be sold in the next year or two.  We think the portfolio is valuable.  Austrian Post receives €20m in annual rents in a long-dated arrangement with Telecom Austria for storage of equipment in its branch network.  We think this revenue deserves a market cap rate (6 or 7%).  After talking with management, we think a sale-leaseback transaction is unlikely, but does provide some margin of safety. 

 

Use of cash

Management would like to use some of its cash hoard on acquisitions of Eastern European mail and parcel businesses.  Unless there is a privatization in the next few years, it is unlikely that this will be a large use of proceeds.  Management is also interested in opportunities where they can leverage their existing infrastructure, such as logistics providers in Austria.  They have publicly stated that if they do not find assets that will generate a sufficient return on capital in the next 2 years, they will return cash to shareholders in the form of regular and extraordinary dividends.

 

Comparable Valuation

 

 

 

P/E

2006E

LTM TEV / EBITDA

TNT (TNT NA)

 

15.7x

9.4x

Deutsche Post (DPW GR)

 

12.5x

6.0x

 

Deutsche Post and TNT are in more competitive, large, urban markets.  Deutsche Post is being penalized for its heavy loss-making DHL operation in the U.S. 

 

Trading

The share volume statistics on Bloomberg are inaccurate, as we know for certain that volume has been greater than what has been recorded recently.  The shares trade until 11:30 am on the East Coast.

Catalyst

o Mgmt. markets to investors in NY and Europe (already set up)
o Company significantly beats 2H consensus
o Recognition of huge cash flow vs. earnings discrepancy
o Increased dividends and cash balance
    sort by    

    Description

    Austrian Post offers investors an opportunity to own a cash-rich, growing monopoly, and prolific cash flow generator for less than 5x free cash flow. 

     

    The Austrian national postal service, Austrian Post (Oesterreichische Post in German), is currently priced at a huge discount to its intrinsic value.  The opportunity is all the more remarkable given that it is a € 2.0B (US $2.6B) market cap company with solid liquidity.  We believe the shares could return multiples of our investment.

     

    The key points to our thesis are as follows:

    1.       Dominant position with stable and largely acyclical cash flows

    2.       Ridiculously strong balance sheet for a stable monopoly, with €6 per share of cash

    3.       Recent IPO process led to significant undervaluation

    4.       Non-cash, non-recurring accounting provision is obscuring true earnings power

    5.       Over depreciation depresses earnings, understates real economics

    6.       The Company is not well understood by the sell-side analysts, which will lead to a significant outperformance vs. consensus estimates

     

    The Company trades on the Vienna exchange under the ticker POST, its symbol on Bloomberg is POST AV, and on Yahoo is POST.VI.  Austrian Post was privatized via an IPO this summer, with the Austrian government selling 35m of 70m total shares.  POST trades for around € 29.50 per share at the time of this write-up.  The Company will carry about € 8 of net cash on the balance sheet by the end of this year and has an additional € 2 of real estate held for sale.  POST will generate around €278m of maintenance free cash flow this year, or about € 4 per share.  So you are paying about € 19.50 for € 4 of free cash flow. 

     

    The Company has suffered from several recent sell-side analyst downgrades on account of the shares reaching a stated target price.  We think the analysts don’t really understand the economics of the business.  We are looking for POST to significantly beat consensus numbers as they did in the first half.  The year end consensus is tightly clustered around stale management guidance from before the IPO, and is actually much lower than LTM performance.  POST should deliver modest growth YOY in the 2nd half and recognize cost savings due to already completed headcount reductions of 800 people in the first 6 months.  Analysts are partly misunderstanding the financials due to some confusing accounting accruals and asset write-offs from last year – more on this later.  This management team is ultra conservative, and has prudently set a low bar, as they admitted to us recently.  This earnings and cash flow “surprise” will force the sell-side analysts to reconfigure their earnings and DCF models (which are a mess but don’t get me started). 

     

    Austrian Post primarily makes money from postage for delivery of letter mail, direct mail and periodicals, which generates 76% of revenue and 90% of the profitability. Shipping consumer parcels and packages (similar to FedEx and UPS) represents 12% of revenue.  POST also uses the branch network to retail financial products for a banking partner (Bawag of Refco fame), sell mobile phones, stationery, DVD’s and other products, which represents 12% of revenue.  POST has a little over 24,000 employees, 6 sorting facilities and about 1,900 branches.  You can check out investor presentations at the IR website here: (http://post.at/ir/en/).

     

    Financials and Valuation

    Please note that the figures below are our estimates and are adjusted to exclude non-recurring, non-cash accounting provisions and severance costs, and gains on asset sales. For conservatism we have not excluded cash severance and related costs incurred in 2005 that are not likely to recur in 2006.  We also do not back out the €2 per share real estate value in the multiples below.  We assume all cash flow is retained on the balance sheet, rather than paid out in dividends or used to buy back shares.  Interest income is excluded from free cash flow.

     

    Financials and Valuation

     

     

    2004

    2005

    LTM

    2006E

    2007E

    2008E

    Revenue

     

     

    1654

    1702

    1728

    1,752

    1,790

    1,836

    Reported EBITDA

     

     

    202

    225

    241

    NA

    NA

    NA

    Adjusted EBITDA

     

     

    263

    321

    340

    358

    376

    400

    Maintenance Capex

     

     

    40

    40

    40

    40

    40

    40

    Interest Expense (ex. Income)

     

     

    7

    5

    4

    3

    0

    0

    Taxes @ 25% of reported PTI

     

     

    26

    25

    28

    37

    57

    70

    Cash Flow

     

     

    190

    251

    268

    278

    280

    290

    Shares (mm)

     

     

    70

    70

    70

    70

    70

    70

    Cash Flow / share

     

     

    2.71

    3.59

    3.84

    3.97

    3.99

    4.14

     

     

     

     

     

     

     

     

     

    Net Cash Balance / share

     

     

    1.40

    4.46

    5.95

    8.09

    12.08

    16.22

    Share Price – Net Cash

     

     

    28.10

    25.04

    23.55

    21.41

    17.42

    13.28

     

     

     

     

     

     

     

     

     

    FCF multiple / share

     

     

    10.4x

    7.0x

    6.1x

    5.4x

    4.4x

    3.2x

    TEV / EBITDA

     

     

    NA

    NA

    4.8x

    4.2x

    3.2x

    2.3x

    TEV / EBITDA – Mnt. Capex

     

     

    NA

    NA

    5.5x

    4.7x

    3.6x

    2.6x

     

    Segments

    The Company operates under 3 segments: Mail, Parcels & Logistics, and Branches.  The Mail segment represented over 90% of 2005 pre-overhead EBIT, and is sub-divided into Letters, Direct Mail, and Media Post (newspaper and magazine delivery).

     

    Revenue Breakdown

     

     

    2004

    2005

    LTM

    2006E

    2007E

    2008E

    Letters

     

     

    769

    782

    779

    790

    790

    790

    Direct Mail and Media

     

     

    487

    508

    524

    529

    544

    566

    Parcels and Logistics

     

     

    199

    212

    221

    231

    250

    269

    Branches

     

     

    196

    194

    198

    198

    202

    206

    Other

     

     

    4

    5

    6

    5

    5

    5

    Total

     

     

    1654

    1702

    1728

    1752

    1790

    1836

     

    Financial Commentary

    We expect the current level of cash flow to grow modestly over time.  Overall POST should see stable, low single-digit volume growth.  Letter mail volume will be flat to up 1 or 2%, while direct mail volumes will increase by 4-5%.  Email substitution fears from several years ago have proven to be less of a threat than earlier anticipated.  Only 8% of letters are C2C, which are more prone to substitution, while B2C (bills, govt. communications, etc) remain the lion’s share of volumes.  We have not assumed they are able to raise postage pricing in our model, but that would provide significant upside.  POST raised prices by 16% in 1998 and by 8% in 2003.  Pricing in direct mail will be down 1%-2% in unaddressed and flat in addressed.  Pockets of strong growth exist in the parcels segment, especially the recent entry into B2B, and in Eastern European operations (parcels and direct mail). 

     

    Most of the cost structure is fixed, which primarily includes labor at sorting facilities and the delivery network.  Wages are the biggest cost component and will increase by 3.5% per year.  This will be more than offset by productivity improvements, which represent a huge opportunity for the Company.  Over the last few years the current management team has begun rationalizing the employee base and infrastructure.  Employee headcount has been reduced from over 30k to 24k (CAGR of 4.6%); the branch network has gone from 3,000 to 1,900 and sorting facilities from 39 to 6.  This management team knows how to reduce costs in a politically sensitive fashion.  When questioned on this they will soft pedal future headcount reductions, as there are obvious political sensitivities and employee morale issues to contend with.  However, we know from speaking to people inside the Company, competitors and industry sources that POST still has massive levels of redundancy and waste, and management knows this.  We expect the Company to shed 4-5% of its work force in each of the next 3 years.  Keep in mind this was a jobs program run by the Austrian government for 150 years.

     

    There are several reasons why POST trades at a steep discount to intrinsic value:

     
    1. IPO dynamics

    The shares have only been traded for 4 months and were priced in a difficult market for US and European IPO’s.  In determining the valuation it was decided to price the shares off of a 5% dividend yield, while giving shareholders the cash and real estate for free.  The current dividend of €1.00 per share used as the basis for this dividend yield is highly arbitrary and represents 25% of free cash flow.

     

    It was not in management’s interests to push for a higher valuation. Management was granted “appreciation rights” (free options with a 1.5x multiplier) that were struck at the average price of the first 60 trading days.  As long as they can generate a 40% total return to shareholders over the next 3 years, they will receive a cash payment equal to 150% of the future trading value of the share price times their options.  In order to receive the options, they were required to purchase 30% of the current value in shares at the IPO valuation with their own money.  The 60 day pricing period recently ended and the Company has begun meeting with investors.

     

    Moreover, the government of Austria aggressively marketed the shares to retail investors, and the Company encouraged and financially motivated (through a matching program) employee share ownership.  Over 50% of employees now own shares. 

     

    Finally the Austrian government wanted to prove that they could execute a successful result, which was defined by how much the shares appreciated after the offering.  The Austrian government still owns 51% of the shares.

     

    It remains in everyone’s interest to see the share price continue to appreciate.

     

    2. Non-cash non-recurring provisions obscure true economics

    The Company recognized approximately €107m of non-cash provisions in 2005 and expects to take another €95m of provisions in 2006.  These provisions are mostly related to “underutilization” of certain employees.  Under Austrian law, certain employees left over from pre-1995 days were designated as “civil servants”.  These employees can not be laid off.  Six hundred of these individuals are currently in a jobs bank, a la General Motors.  They only work part-time.  If they choose to sit in the “development center” until they reach retirement age, they are entitled to do so, at full compensation.  Under IFRS accounting guidelines, the Company is required to take a provision equivalent to the net present value of all future payroll obligations for these individuals until retirement, multiplied by the degree of underutilization (~50%), and put this total on the balance sheet.  So basically they are taking about 20 years (on average) of future payroll expenses all in the current year.  As these employees are paid, leave or are reassigned, the provision will be reduced.  Without this non-cash provision 2005 earnings would have doubled, as would the dividends (based on 70% stated payout ratio).  To get to the true earnings power of the Company you need to add back the non-cash portion of the provision found in the cash flow statement.

     

    Although many of the sell-side analysts mention that this is a non-cash provision, all of them include it in on an unadjusted basis in their EBITDA, EPS and dividend payout ratios.  When the Company was marketing the IPO, the provisions were run through the P&L and deflated earnings when doing relative valuations with Deutsche Post and others.  It also impacted the dividend level, given the stated 70% payout ratio of net income.

     

    If no additional employees are made redundant the Company would recognize no provision in 2007.  However next year the Company expects that it will recognize approximately €60m of underutilization expense related to additional employees becoming underutilized, or a greater degree of underutilization of existing employees in the jobs bank.  According to management the provision will continue to diminish over time.

     

    3. Depreciation overstates capital intensity and depresses earnings

    Finally depreciation expense is approximately 2.5x maintenance capex.  The first reason is that in 2005 the Company recognized €29m in asset writedowns, which increased depreciation expense.  They also recognized a €17m non-cash provision for underutilization of real estate assets.  Of course this €46m decreased net income, which suppressed the dividend used as the basis for valuation. 

     

    Another reason depreciation expense overstates the ongoing capital intensity of the business is due to the fact that the Company is almost finished with a €600m investment program modernizing and automating its infrastructure.  POST converted its 39 mail sorting facilities into 6 state-of-the-art automated facilities. 

     

    The Company will recognize about €100m of depreciation expense this year, and will spend about €40m on replacement and maintenance capex.  In the first half of this year total capex was only €14.6m.  This year’s growth capex of €20-30m is related to completion of the final of the 6 sorting facilities and construction of an Eastern European parcel facility.

     

    4. Sell-side overestimating the impact of liberalization

    Today only 2 segments of POST’s revenue are protected from competition – any letter mail and addressed mail under 50 grams is delivered exclusively by POST.  Letter mail and addressed direct mail over 50 grams have been liberalized in stages over the last several years.  Parcels, most direct mail and newspapers have always been open for competition.  We have spoken with a number of competitors and industry sources to gain a better understanding of the full opening (“liberalization”) of the postal market and general competitive dynamics.  In summary, only about 30% of POST revenue (direct mail and newspapers) should be subject to increased competition over time.  The earliest possible date will be January of 2009.  This date could easily slip several years after that, depending on the level of wrangling among competing interests in the EU.  Importantly, recent discussions at the EU indicate that the national regulator of the individual countries will have the final say in opening the market to competition.

     

    After consulting with industry sources, we learned that both major Austrian political parties are resisting open competition against POST.  The outgoing administration has often butted heads with the EU competition authority.  The government has limited competitor access to apartment mailboxes, required competitors (not POST) to charge a value-added tax of approximately 20%, and offered opaque regulatory guidelines. 

     

    Geography is an important factor.  Austria has only 8m people.  Vienna has a population of 1.5m, and is the only large city – the next closest is Graz with a population of 285,000.  It is a very mountainous country with low population density, hardly ideal for a new entrant.

     

    Despite having competition in most segments for years, POST has a 95% market share in B2C and C2C parcels, an 85% share in direct mail, and a 56% share in newspaper delivery.  POST is now among the most effective postal services in Europe with 97% delivery on the following day, from 62% a few years ago.  High customer satisfaction is a strong impediment to development of competition.

     

    It makes the most sense to go through each of the sub-segments.  As is the case in most other European markets, the letter mail business will not see any material competition.  Letter mail is a natural monopoly.  This is because a new entrant in the letter mail business would need to make a prohibitively large investment in infrastructure (branches, sorting centers) and personnel (for daily delivery) that would not likely be profitable, much less deliver a sufficient return on capital.  For example, if Deutsche Post (Germany) were to some day enter and achieve a 10% share of the total Austrian letter market and generate a 10% EBIT margin (better than their current operations in other large countries), it would represent about €5m of incremental earnings, or .004 of incremental EPS.  This would pale in comparison to the capital investment.  Vienna’s sorting facility was completed in almost 2 years at a cost of €150m. 

     

    Direct mail makes up 20% of POST revenue. Revenue is evenly split between addressed direct mail (credit card solicitations, catalogs) and unaddressed direct mail (coupons, fliers, restaurant menus, etc).   This is the segment where most competition exists in European markets.   Fortunately for Austrian Post, a couple years ago they were given clearance to acquire their largest competitor, Feibra.   At this point the only competitor of any scale is a JV between a struggling Austrian publishing group and the Dutch postal provider. 

     

    A good case study is the liberalization of the Swedish market, which occurred in 1993.  Thirteen years later Sweden Post has 93% market share.  One competitor, CityMail, emerged in 4 urban markets and delivers direct mail and newspapers only. Like Sweden, Austria is an extremely mountainous country with a small degree of urbanization.

     
    Finally, management believes that by 2012 they may lose 5-7% of the market, which would amount to an average of 1% off of revenue growth in each of the next several years. Competitors have suggested a similar level of share participation to us.

     

    For more information on the development of competition in European postal markets, you can look at several market studies on the EU Commission’s website:

    http://ec.europa.eu/internal_market/post/studies_en.htm

     

    Management

    Management comes from industry (Siemens, banking, several consulting firms, retail and logistics companies), and the CEO and CFO have been with the Company since 1999.  They have done an impressive job converting a sleepy government run bureaucracy into a modern and competitive enterprise.  Besides modernizing the Company, they have dramatically improved customer service and delivery times. 

     

    Eastern European expansion in parcels and direct mail

    Austria’s proximity to Eastern Europe has provided Austrian companies with a strategic advantage for expansion in high growth countries like the Czech Republic, Slovakia, Slovenia and Croatia.  Austrian Post has a strong position in several of these nascent markets which have been served by state-run, highly inefficient incumbents. POST should benefit from rapid growth in direct mail and parcels per capita (currently a small fraction of central and western European countries).  POST is the #2 provider of parcels and unaddressed direct mail in Slovakia, #1 in parcels in Hungary, and #2 in parcels in Croatia.  Revenue from these markets is around €40m, but this will expand rapidly going forward as penetration converges with Western European levels. Moreover, because of their familiarity with these markets, Austrian Post is well positioned to acquire or invest in national postal operators upon privatization.

     

    Real Estate

    POST has sold off some of its excess real estate, but continues to own a lot of its branch network and all of its sorting facilities.  All of POST’s property is unmortgaged.  POST also owns real estate no longer in use that is classified as investment property, which is booked at €60m but appraised at €135m (€2/share).  We believe this valuation discrepancy probably exists for a great deal of its buildings and land on the balance sheet, which is carried at €527m.  The investment property will be sold in the next year or two.  We think the portfolio is valuable.  Austrian Post receives €20m in annual rents in a long-dated arrangement with Telecom Austria for storage of equipment in its branch network.  We think this revenue deserves a market cap rate (6 or 7%).  After talking with management, we think a sale-leaseback transaction is unlikely, but does provide some margin of safety. 

     

    Use of cash

    Management would like to use some of its cash hoard on acquisitions of Eastern European mail and parcel businesses.  Unless there is a privatization in the next few years, it is unlikely that this will be a large use of proceeds.  Management is also interested in opportunities where they can leverage their existing infrastructure, such as logistics providers in Austria.  They have publicly stated that if they do not find assets that will generate a sufficient return on capital in the next 2 years, they will return cash to shareholders in the form of regular and extraordinary dividends.

     

    Comparable Valuation

     

     

     

    P/E

    2006E

    LTM TEV / EBITDA

    TNT (TNT NA)

     

    15.7x

    9.4x

    Deutsche Post (DPW GR)

     

    12.5x

    6.0x

     

    Deutsche Post and TNT are in more competitive, large, urban markets.  Deutsche Post is being penalized for its heavy loss-making DHL operation in the U.S. 

     

    Trading

    The share volume statistics on Bloomberg are inaccurate, as we know for certain that volume has been greater than what has been recorded recently.  The shares trade until 11:30 am on the East Coast.

    Catalyst

    o Mgmt. markets to investors in NY and Europe (already set up)
    o Company significantly beats 2H consensus
    o Recognition of huge cash flow vs. earnings discrepancy
    o Increased dividends and cash balance

    Messages


    SubjectThanks for the very interestin
    Entry10/18/2006 10:35 AM
    Membercanuck272
    Thanks for the very interesting idea.
    Is the 25% tax rate the standard corporate tax rate in Austria?
    How large are top management's equity incentives, in terms of number of shares/options?
    You mention types of potential acquisitions at the end of the write-ups. Any idea on the size of potential targets, and whether those companies are large enough to be meaningful to Austrian Post?

    Subjectprovision question
    Entry10/18/2006 11:42 AM
    Memberad188
    The June 30 balance sheet shows almost 500mn of ST and LT provisions, I assume some post-retirement and also the redundancy provisions which you mentioned. Isn't this effectively debt that should offset your cash figure? Also, what is a "normalized" annual provision charge.

    Interesting idea though it doesn't seem like a multi-bagger. Thanks.

    Subjectsell-side analysts
    Entry10/18/2006 12:42 PM
    Memberoogum858
    i'd be curious to hear what sort of concerns the sell-side analysts have and what their bear case is.
    good write up.

    Subjectelectronic substitution/online
    Entry10/18/2006 01:23 PM
    Memberscrooge833
    How much,do u think, are the negative effects of electronic substitution/online bill payment to the revenues?

    SubjectFollow Up Question
    Entry10/18/2006 09:33 PM
    Membercanuck272
    Murphy -
    Hearing your explanation of the long term liabilities, what comes to mind is that there are probably two equally correct ways to look at this obligation:
    1. Add the liability to enterprise value, but then adjust EBITDA for the costs relating to these employees that will not be flowing through the p&l anymore, or
    2. Ignore the this as a liability, but make sure the EBITDA is after the on-going costs of these employees.
    Do you agree, and if so, what are the correct apples to apples numbers for EV and EBITDA?
    Thanks again.

    SubjectCanuck/Ad
    Entry10/21/2006 02:12 PM
    Memberattila882
    I also have an issue with how the provisions were treated in the valuation.

    Let's look at a hypothetical situation a few years out -- in, say, 2009, there will be no more extra charges on the income statement for provisions. So your reported net income will be bumped up by 100mm+ compared to today. However, you'll be looking at a 600mm+ provision liability on the balance sheet. This provision will be gradually paid off over 20 years, from 2009 onward, and these payments will NOT run through the income statement post-2009 because they have already been provisioned.

    So essentially then, post-2009, your net income will be overstated each year by however much of the provision is paid out. Say it is 600mm/20 years, or 30mm a year.

    It would seem to me that the only way to look at Austrian Post on an apples-to-apples basis is to either compare the market cap of 2bn EUR to your estimate of FCF LESS this 30mm a year...

    OR

    To net out the provisions against the excess cash, resulting in an EV of 2bn.

    Either way, I get a multiple of around 10x earnings, which is cheap, but not as cheap as in your writeup, particularly for the growth profile.

    SubjectMurphy
    Entry10/24/2006 12:17 PM
    Memberattila882
    Thanks for your thorough response and clarification. It was my mistake to say 600mm. I was eyeballing it and included all of the other provisions that the company was taking as well (termination provisions, jubilee, etc.). The real number should be roughly 350mm when all is said and done.

    Two follow-up questions:

    1. I understand how you get to the 167mm provision (600 employees x 40K x 50%, projected out 20-odd years using a 4% discount rate and some level of assumed attrition). Ignoring potential reversals for a moment, how does management eventually get to 350mm? Is it just that more people will be moved into the job bank between '06-'09, and hence classified as underutilized?

    The way I figure it, 350mm implies roughly 26mm of under-utilization payments per year (from 2009 forward). This compares with 12mm per year today. As you mentioned, of the 12mm today, 6.7mm is accreted onto the income statement as an expense (167 x 4%), while the remaining 5.3mm is effectively an off-income-statement expense.

    Post-2008, with 350mm accrued, roughly 14mm will be accreted onto the income statement as an expense (350 x 4%), while the remaining 12mm (26mm of annual payments minus 14mm accreted) is effectively an off-income-statement expense.

    So net-net, in 2009, your real employee expense is understated by nearly 20mm (12mm off-income-statement expense + difference between 2009's 14mm accreted expense and today's 5.3mm number). Effectively, it isn't too different than doing 350mm/20 years. Again, assuming no reversals.

    Does this logic make sense to you? Don't get me wrong -- Austrian Post is cheap regardless and I think it has enough rocket-fuel behind it now to go much higher. But I want to be sure that I am correct in believing that post-2008 earnings will be effectively understated by 20mm a year because of these accounting machinations.

    2. Any idea why 2Q06 Mail division EBIT fell 18%? I see that D&A for Mail went up pretty dramatically in 1H06 -- is that the reason? I understand that the move from 100g to 50g should not affect Austrian Post too much...

    SubjectRegulation of Rates
    Entry10/27/2006 10:53 AM
    Memberconway968
    I apologize if this has been stated, but I have missed it if it has been.

    Are there any regulations on the rates POST can charge? Can they only increase postage with inflation, etc.?

    And are there any regulations on the structure of rates? For example, can they charge city mail lower rates than rural mail? Or does their USO obligations not allow that?

    Do the answers to any of the above change in 2009 if legislation goes thru?

    Thanks.

    SubjectReply to Jazz
    Entry11/24/2006 11:42 AM
    Membermurphy503
    Goldman Sachs and Auerbach Grayson will be taking them around at the beginning of next week.

    SubjectReported earnings, no reaction
    Entry03/15/2007 04:51 AM
    Membervanbr707
    Austrian Post just reported earnings for 2nd half 2006 yesterday... thoughts?

    The stock didn't move on the results...I assume that is dissapointing since one of the catalysts you mentioned was "significantly beating estimates for 2H06"?

    Comments appreciated

    I also saw Goldman upgraded POST right before the results to a BUY

    SubjectI read in a research update fr
    Entry03/19/2007 10:46 AM
    Membercanuck272
    I read in a research update from an Austrian firm, Raiffeisen Research, that the reason for the sell-off was the entry of a company called Hermes into the Austrian parcel market. Anyone have any insights into this?

    SubjectQuestion for Murphy
    Entry03/19/2007 12:36 PM
    Membercanuck272
    Murphy -
    Looking throught the annual report, it appears that the increase in the Employee Under-utilization account came from an allocation of 132mm, Use was 19mm, and there were 27mm of reversals, all higher than expected. Do you know why all these items were higher than expected? Were more people put into this category, or did the percentage of under-utilization increase. Also, do the higher reversals suggest more people leaving the program? Any other insights on this issue?
    I read through the research report mentioned in my last message, and it appears that Hermes is owned by Otto Versand, a large parcel customer of POST, and that the loss of the Otto Versand business to Hermes will result in an EBITDA loss of 20-25mm according to POST management. Any other light you could shed on this issue would be much appreciated.
    Thank you in advance for your responses.
    By the way, the firm that wrote the report, Raiffeisen, is analyzing POST on an-adjusted EBIT and P/E basis, taking into account the addback of the under-utilization provision.

    SubjectMurphy
    Entry03/23/2007 10:42 AM
    Membermav44

    Murphy - have you met with Post on their recent New York trip? Sounds like they are saying that without price increases in the core mail division, free cash flow will be declining the next few years, compounded by the new competitive threat in parcels. You think they are being overly conservative or have your views changed on this?

    Subject"interest-bearing provisions"
    Entry03/26/2007 06:55 PM
    Memberzeke375
    As I was reading through the '06 annual report, I was surprised on p. 69, under the Liquidity section, that management refers to "interest-bearing provisions" amounting to EUR451.6m. Can anyone here explain why these provisions could in any way be considered interest-bearing? That same page of the annual report nets out those liabilities against the cash and investments, reporting that the company ended in a position of EUR173.9m net debt(as highlighted in the sidebar on p. 69). Is this just another case of management's excessive conservatism / political posturing that the company isn't awash in net cash?

    Subject1H2007 Results
    Entry08/09/2007 12:02 PM
    Membersvflc022
    Wow, the price movement has left us wondering whether POST has got some sub-prime exposure in their balance sheet...

    Seems that the market is fixating on the fact that Hermers entered the Austrian market. As much as this indicates increased competition, apparently this will hardly amount to much more than 1% of total revenues (17% of last year's volume of a sub-division that generated EUR15.9 Mil of revenues in 1H2007).

    Murphy, how have recent developments - postponement of liberalization, more acquisitions, entrance of new competition/loss of customer on parcels - affected your view on the thesis?

    Thanks in advance for your thoughts.

    SubjectCustomer Loss to Hermes
    Entry08/29/2007 10:31 AM
    Membersvflc022
    VIENNA (Thomson Financial) - Oesterreichische Post AG (Austrian Post) is to lose one of its biggest clients, the German mail-order company Quelle, to Hermes, a German parcel service, from January 1 next year, according to a report in the Austrian daily Der Standard citing unnamed sources.

    While a spokesman for Quelle confirmed to the newspaper that it is in talks with Hermes, he refused to say whether or not Hermes will receive the delivery order for its 15 mln packages annually.

    fiona.flanagan@thomson.com


    SubjectCustomer loss
    Entry08/29/2007 11:10 AM
    Membergrant387
    Sounds bad - but trying to figure out the impact.

    Most important I believe the loss is in the Parcel and Logistics division not in the Mail Division.

    Also,

    The Company expected unit losses which was factored in guidance. It looks like they factored in an 8 million unit decline. The acquisition of meiller direct may offset some of this loss is my guess.

    My concerns lie in the fact that employee count is growing solidly so I'm not sure we see any future margin benefits from the "so called" under-utilization that was discussed a year or so ago. Also - capex still seems high.

    Post seems a mixed bag. Net debt is minimal. Its still has monopolistic characteristics but that is being challenged. At 7x ebitda it doesn't appear cheap or expensive.

    Interested in picking up the thread for Murphy??


    SubjectRe: Customer Loss
    Entry08/29/2007 03:53 PM
    Membersvflc022
    The Hermes customer loss is old news indeed. However, the Quelle customer loss to Hermes is not. This would add another 15 million lost packages per year to the 8 million lost with the exit of Hermes. What I'm trying to assess here is the real magnitude of the competitive threat and the impact of that on POST's profitability.

    This is from Otto Group's latest financial results (http://www.ottogroup.com/press_20070621.html):

    "Hermes is launching its own distribution system for the delivery of mail order and private parcels in Austria on 1st July. By the end of 2007, its infrastructure will comprise 5 distribution centres, 35 branches and approximately 1,000 parcel shops. The stated aim of the Hermes Logistics Group is to be delivering at least 20 percent of Austria’s B2C and C2C packages by 2008."

    SubjectPOST IR on Customer Loss
    Entry08/30/2007 11:30 AM
    Membersvflc022
    This is a reply from Harald Hagenauer, head of IR, regarding the Quelle issue:

    "From: Hagenauer Harald [mailto:Harald.Hagenauer@post.at]
    Sent: Wednesday, August 29, 2007 10:19
    Subject: AW: POST losing client

    no new facts - no press release

    Quelle is still our client, we are in talks and are confident to keep Quelle as client

    best regards

    Harald"


    SubjectRe:POSTScript
    Entry09/20/2007 10:51 AM
    Membersvflc022
    I have to agree with sea946. Numc911 is a front-runner for top board posting of the year. Thank you for sharing all the valuable information.
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