|Shares Out. (in M):||376||P/E||17.8x||12.6x|
|Market Cap (in $M):||7,377||P/FCF||25.3x||20.4x|
|Net Debt (in $M):||1,287||EBIT||986||1,004|
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Please note the figures above are for the parent entity while the write up is for post separation. For all charts and detailed financials please refer to http://www.scribd.com/aliejaffar/documents
TNT N.V. intends to split into two separate businesses in Q1 2011. Mail business which is traditional postal services business in the Netherlands and Express business which is a global Courier-Express-Parcel ("CEP") business that competes with the likes of FedEx, UPS and DHL. I believe the Mail business, post-separation, offers a very compelling short opportunity at the current implied and estimated enterprise value.
Netherlands passed a legislation in April 2009 that opened up the domestic mail business to competition for the <50g mail category or ~75% of market by revenue (the other ~25% of market had been de-regulated over a decade ago). Since the passage of the law several competitors have announced entry into the sub 50g category and have set aggressive growth plans.
Pricing competition: here it comes...
Many analysts and investors alike have assumed that pricing competition in Netherlands will be benign post-liberalization. Analysts often point to the fact that Netherlands has one of the lowest priced mail in Europe and conclude that as a result of this the market is unlikely to face significant amount of price erosion and. Yet this simplistic analysis ignores the very attractive geographic structure of Netherlands which provides for a very low cost of mail distribution. The average population density of Netherlands is over 1,000/sq mi as compared to less than 600/sq mi for most of Europe and the median below 300/sq mi. This translates into very attractive margins for TNT Mail which earns ~30% EBITDA margins on its domestic mail business as compared to ~10% for the next most profitable peer and less than 5% for most of the other peers
I believe pricing for the overall sub-50g market is likely to fall by over 15% over the next 2-3 years. I derive this estimate by triangulating through a number of different methods all of which point to similar or bigger drops in estimate. Please refer to Exhibit 1 with detailed market-segmentation for below discussion:
Long-term competitive disadvantage: high cost structure:
Perhaps even more concerning than the coming price declines is the structural cost disadvantage that TNT Mail has as compared to competitors. While I do not currently model out company losing share beyond management stated guidance of maintaining above 70% market share (from current ~81% market share and ~85% last year) The company faces a real threat of losing significant amount of market share over long-term which has the vicious cycle affect of causing decreased competitiveness due to increasing cost-structure as a result of de-economies of scale. In particular:
Hence, while one would at first assume that TNT mail would have the low-cost structure in Mail due to the high-fixed cost nature of the business and the large economies of scale benefits the above two factors currently lead to competitors having average total cost/item that is in-line to slightly better than TNT. As competitors continue to gain market share they will see their ATC slide down the cost scale which will allow them to continue to reduce prices. I estimate that at 25% market share, Sandd would be able to reduce its ATC to €0.14/item down from €0.19/item at the moment. While TNT Mail has a very aggressive cost-cutting program this program will only allow it to reduce number of employees and hence move to 3-day delivery schedule for mail that is not covered under USO. This program does not reduce the actual labor cost/hr for TNT which is likely to remain a key competitive disadvantage for the company.
Secular decline in mail
I will not go into much details about the secular decline story for the mail business. I believe this story is fairly well understood by the market and both management and analysts have discussed this in great details. Suffice is to say that management expects continued volume declines in the 4-6%/yr for mail business as result of substitution from online billing and other e-commerce based trends. The company has shown some good data during its last two analyst days showing that while interent penetration and online banking are highly penetrated in Netherlands, the move toward e-billing is still in early stages with penetration for e-billing below 20% for most bill-types (eg utilities, phone bills etc).
In Exhibit 2 I show the sum-of-parts valuation analysis on the street for the Mail business. As can be seen from this exhibit both the market-implied price as well as the street consensus estimates indicate the mail business is likely to have an enterprise value in the range of €3.8-4.5b or about 5.5-6x 2011 EV/EBITDA multiple. In-line with closest publicly traded peer Austria Post. I believe this valuation method is misleading as Austria Post currently pays a 6.5-7% dividend yield and trades at 11% free cash flow yield. TNT mail on the other hand would be trading at 3% free-cash-flow yield at the indicated valuation (this is because TNT mail has large pension and restructuring cash outlflows that are perpetual and lead to a structural ongoing free-cash-flow that is significantly below EBITDA). These valuation levels are in of themselves expensive for TNT mail. I believe the free-cash-flow would further fall by circa 40% over the next 2-3 years driven by the 15% estimated decline in pricing and loss of volume due to secular declines and market share losses. The sensitivity table in Exhibit 1 show how EBITDA and adjusted free-cash-flow (ex-restructuring cash outflows and normalized for steady-state pension outflows) change based on varying assumptions around price and market share losses. Using 11% free-cash-flow yield from Austria Post and applying to adjusted free-cash-flow I get to valuation range of ~€2b for the mail business or about 50% below the current implied valuation.
The short-thesis is based on following key points:
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