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Case #4: THE BATTLE FOR VALUE, 2004: FEDEX CORP. VS. UNITED PARCEL SERVICE, INC.

Synopsis and Objectives Set in June 2004

To assess the financial performance of FedEx Corp. and United Parcel Service, Inc (UPS). The two firms have competed intensely for dominance of the overnight express package industry. This case is intended for use in an introductory discussion of corporate value creation and its sources. It requires no numerical computations; rather, the tasks are to interpret the results and to reflect upon their implications. The contrasting record of the two firms affords a platform to: Assess economic profit analysis (also known as Economic Value Added) and, more generally, the measurement of financial performance and health. The case provides a complete historical economic profit analysis for both firms, and permits comparison with other classic approaches to historical performance analysis. This comparison affords the opportunity to discuss the attributes of healthy and successful companies, and to explore the strengths and weaknesses of economic profit. Key learning points about economic profit include its dependence on the conventions of generally accepted accounting principles (GAAP) and its ignorance of strategic option value. Evaluate the financial implications of rigorous competition and corporate transformation.

Questions 1. What are the enabling and inhibiting factors facing the two firms as they pursue their goals? Do you think that either firm can attain a sustainable competitive advantage in this business? 2. Why did FedExs stock price outstrip UPSs during the initiation of talks over liberalized air cargo routes between the U.S. and China? Assuming a perfectly efficient stock market, how might one interpret a 14% increase in FedExs market value of equity? 3. How have FedEx and UPS performed since the early 1990s? Which firm is doing better?

4. If you had to identify one of those companies as excellent, which company would you choose? On what basis did you make your decision? More generally, what is excellence in business?

The turbulent change within this industry must be a major influence on investors expectations and assessments of contingent value. One of the important lessons in this case is that the dominating influence of turbulent change may be the rule rather than the exception. The economist Joseph Schumpeter described capitalism as a regime of unruly change (rather than restful equilibrium) and as a gale of competition that unleashes a process of creative destruction. Schumpeter wrote: In capitalist reality, as distinguished from its textbook picture, it is not [static] competition which counts, but the competition from the new commodity, the new technology, the new source of supply, the new type of organizationcompetition, which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms, but at their very lives.... This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist has got to live in.1

1 Joseph A. Schumpeter, Capitalism, Socialism and Democracy, 6th ed. (London: Unwin Paperbacks, 1987)

The strengths and weaknesses of various financial measures Strengths 1. Direct inspection of the financial statements Reveals trends Comparison of absolute sizes 2. Financial ratios Adjusts for size differences (a relative, not absolute, measure) Provides comparative measures of efficiency and growth Widely-used measures of performance Linked to market price of stock Weaknesses Does not permit a ready assessment of efficiency Biased by size differences Book, not market, values Influenced by GAAP choices Backward, not forward, looking Based on book, not market, values Influenced by GAAP choices

3. Earnings per share (EPS) and price/earnings ratios

EPS influenced by GAAP choices EPS is not a cash flow P/E difficult to interpret Sensitive to choice of observation period Sensitive to choice of observation period Needs to be risk adjusted Influenced by GAAP choices Ignores latent option values

4. Total returns to investors

Cash flow based Market value based Permits benchmarking vs. other investments Risk adjusted Permits benchmarking Theoretically linked to market values Logically appealing Increasingly widely used

5. Economic profit (EVA)

Summary of Comparative Results Source (case exhibit number)

FedEx Financial ratio analysis Activity Liquidity Leverage Profitability Growth Improving Improving Declining Worse than UPS High

UPS Weakening Better than FedEx Consistently low Better than FedEx Lower than FedEx

2, 3

EPS EPS compound annual growth rate (CAGR) 19932003 EPS compound annual growth rate (CAGR) 19992003 Total market returns Cum. total return (19922003) Cum. return net of S&P (1992 2003) Economic profit EVA 2003 Cumulative for 19922003 EVA Market value added Difference

27.54% 6.98%

13.89% 34.30%

528.02% 372.83%

705.95% 550.75%

(in millions) $170 ($2,252) $11,191 $13,443

(in millions) $1,195 9, 10 $4,328 $62,028 $57,700

Graph of Economic Profit: FedEx Corp.


1992 2.2 1993 2.7 1994 4.3 1995 3.4 1996 4.4 1997 6.0 1998 9.5 1999 16.3 2000 10.1 2001 11.9 2002 16.1 2003 19.1

Market value of equity (US$ billions) EVATM Annual EVA (US$ millions) Cumulative EVA (US$ millions)

(261) (261)

(246) (507)

(154) (661)

(115) (777)

(219) (995)

(215) (1,210)

(102) (1,312)

(190) (1,502)

(151) (1,653)

(396) (2,049)

(373) (2,422)

170 (2,252)

FedEx Corp. Economic Profit


500 25

0 20 -500 EVA (US$ millions) 15 Market Value (US$ billions)

-1000 Annual EVA, left axis Cumulative EVA, left axis Market Value of Equity, right axis

-1500

10

-2000

5 -2500

-3000 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Graph of Economic Profit: United Parcel Service, Inc.


Market value of equity (US$ billions) EVATM Annual EVA (US$ millions) Cumulative EVA (US$ millions) 1992 11.0 1993 12.0 1994 13.6 1995 15.0 1996 16.7 1997 17.3 1998 21.9 1999 83.5 2000 66.7 2001 61.1 2002 70.8 2003 84.2

(70) (70)

(17) (87)

(158) (246)

217 (28)

74 45

(138) (92)

405 313

949 1,262

881 2,143

599 2,741

392 3,133

1,195 4,328

United Parcel Service, Inc. Economic Profit


5000 90 80 4000 Annual EVA, left axis Cumulative EVA, left axis Market Value, right axis 2000 40 1000 30 20 0 10 -1000 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 0 70 60 50 Market Value (US$ billions)

EVA (US$ millions)

3000

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