FedEx Wins $10.5 Bln. Postal Deal to Provide Expedited Mail Service

This story appears in the April 29 print edition of Transport Topics.

FedEx Corp. last week won a $10.5 billion contract to continue providing domestic airmail transportation for the U.S. Postal Service, defeating a bid by UPS Inc. to grab at least a share of that business.

Under the seven-year agreement, FedEx’s Express segment will continue to use its aircraft to transport Express and Priority Mail between airports within the United States.

The new contract, announced April 23, begins in October and will replace an existing agreement between FedEx and the Postal Service that expires in September. FedEx has provided airport-to-airport transportation for the Postal Service since 2001.

“FedEx Express will continue the outstanding service that we have provided to the USPS for the past 12 years under this new agreement,” David Bronczek, CEO of FedEx Express, said in the company’s announcement of the deal. “This contract provides enhanced value and additional flexibility allowing the USPS to respond to possible changes. We look forward to continuing our successful business relationship with the USPS.”

In a separate statement, the Postal Service said it had conducted a competitive bidding process for the air contract.

“Following a rigorous evaluation of technical aspects, pricing and other factors in the proposals, the Postal Service determined that the FedEx proposal represented the best value,” the Postal Service said.

It also said the new contract includes “service improvements, capacity flexibility and other planned operational improvements.”

UPS expressed disappointment about the Postal Service’s decision to award the contract solely to FedEx.

“The USPS and UPS have a great working relationship as both partners and competitors and today’s announcement of an exclusive award is a disappointment,” UPS spokeswoman Kara Ross said in a statement. “UPS has other contracts with the USPS and will continue to provide excellent service and the company looks forward to future opportunities to expand its business with the USPS.”

UPS said in July that it would challenge FedEx for the Postal Service contract.

Analysts hailed the deal as a big victory for FedEx, despite questions about pricing under the new contract.

In a report, Deutsche Bank analyst Justin Yagerman described the contract as “a sorely needed shot in the arm” for FedEx stock, which he said has “flailed with investor doubt” following a “lackluster” fiscal third quarter.

Investors feared that “for either competitive or political reasons,” UPS might capture a large portion of this business, Yagerman said.

Kevin Sterling, an analyst for BB&T Capital Markets, wrote that, “given the well-documented financial troubles of the Post Office and the competitive nature of the bidding process,” it is likely that FedEx “had to make some concessions on price and minimum guarantees to give the Post Office financial flexibility.”

“Despite the potential reduction in profitability, we think it made sense for FedEx to aggressively bid on the USPS contract because of the infrastructure investments the company has made to service the Post Office’s lift requirements,” Sterling said in a research note.

At $10.5 billion over seven years, the contract represents an average of $1.5 billion in revenue per year.

Yagerman said it is “uncertain how big a haircut” that represents, compared with the current run rate, but assuming it was roughly $1.6 billion last year, “we believe the contract implies about $100 million less revenue per year.”

In another report, Arthur Hatfield of Raymond James said, “We view this deal as the best FedEx could have hoped for in the current environment and due to the fact that it was likely a highly competitive process.”

He estimated that lower expected pricing under the new contract would trim earnings by 15 cents in fiscal 2014 and 20 cents in fiscal 2015.

“The alternatives were much worse, be it an entire loss of the contract to a rival or a loss of a meaningful piece of the contract,” Hatfield said.

Writing to clients of William Blair & Co., analyst Nate Brochmann said his firm assumes FedEx made some pricing compromises, “but we do not expect a significant effect on the company’s overall results.”

“In our view, it is advantageous to both parties that the contract remained largely unchanged,” he said.

David Ross, an analyst at Stifel, Nicolaus & Co., wrote that his firm believes the cost and risk of switching providers was “a significant consideration for the USPS in choosing its partner.”

UPS and FedEx Corp. rank No. 1 and No. 2, respectively, on the Transport Topics Top 100 list of the largest U.S. and Canadian for-hire carriers.