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Drivers of value for national postal operations

June 16, 2011

In approaching the valuation of a national postal company, we need to consider carefully how a unique set of market and regulatory factors work together. The value of a company is typically calculated by comparing the results of three analyses:
• Consideration of the net assets of the business;
• Review of the comparative performance of similar businesses;
• Modelling of expected cash flows over a 10-year period.
In respect of a national postal operation, these can be approached as follows.

A review of asset values
Experience of other utility privatisations suggests that net assets written down in the accounts (on a historic costs basis) may underestimate their potential sale proceeds.

Given the extensive process of modernisation now being undertaken, and the significant opportunities for network re-optimisation due to changing volume mix, there may well be scope for highly profitable sales of real estate. However the timing of any asset sales may well also be important, for example if a fire sale of assets were undertaken during a moment of weakness in the real estate market.

Clearly the terms of any separation between different business segments, for example where retail postal operations may be kept in state control, will also be extremely important.

A review of comparable performance
There is considerable variance in the commercial performance of national postal companies, which makes it difficult to find an exact comparator. Some national posts have been able to achieve reasonable returns (EBITDA margin of around 10 to 15 percent) even during the current economic downturn and have a history of higher returns. Others remain in financial difficulty.

An explanation can be found in the different national strategies for both the post and its ownership, with fully or part-private postal operations generally achieving higher margins. In part this is due to the way in which regulatory policy has developed and cost control has been handled by the company.

Future business performance
Estimations of the value of postal companies rely primarily on judgements about their potential for future cash flows. Drivers of profitability at national postal companies reflect their history as public service providers. Legacy issues connected to decades of public service and civil service employment conditions remain, with industrial relations problems and uneconomic network structures still unresolved in some posts. Key elements of their financial success still lie outside their control:
• National posts continue to have important social obligations that can impose costs in serving remote areas at low prices and five or six day weekly delivery.
• Their finances are influenced by the actions of national regulators, both in respect of capping prices that they can charge and in limiting their flexibility to flex service and pricing profiles in response to changing demands or competitive pressures.
• It is difficult for national postal companies to address the erosion in demand for traditional transactional mail products. Over time, revenues from such products are likely to substantially decline as mailers seek cheaper or electronic solutions.
However it can also be argued that the returns generated by national postal companies are also dependent on their own commercial behaviour, with key commercial decisions to be made in relation to:
• Managing costs down as the volumes profile changes;
• Retaining or growing market share in the most dynamic market segments.

Managing down costs involves three key elements. First, taking benefit from the latest sorting and delivery sequencing automation to increase technical efficiency; second, moving to more efficient and cheaper working practices; and third, generating greater cost flexibility. This can be done through:
• Increased technical efficiency that can change the shape of the efficient postal network, reducing transport costs, enabling greater economies of scale in sorting and delivery sequencing, and reducing the headcount needed.
• More efficient and cheaper working practices that can involve changing shift patterns towards part time working, reducing overtime arrangements and putting greater reliance on self-employed staff or on recruiting of staff employed on different (inferior) terms and conditions. In some national posts this has also involved a firm restraint of pay rises to below the rate of inflation.
• Greater cost flexibility may involve increasing the reaction time between volume changes and changing employment levels and network parameters, and greater reliance on temporary or self-employed staff.

Of course it is also important to stress that the handling of pensions rights held by the work force remains a key issue in relation to the relative competitiveness of national posts, compared with entrants into the market.

Looking forwards, the extent to which national postal companies can seize future commercial opportunities will also affect their value.

Digitisation of services and increasing use of hybrid mail solutions may provide additional new revenues. Whilst revenues for traditional products may decline there is likely to be a continued growth in Internet retail distribution. Over time this will create a very different market profile with packets and parcels replacing traditional mail, and in doing so increasing the intensity of competition in the market as a whole. Far from declining, the postal market as whole may be growing by the end of this decade. However, such a change exposes national postal companies to greater intensity of competition and may also impact upon the potential margins available.

Increased competition should also imply reduced regulation. Over time, therefore, we may see reduced universal service obligations, with changes towards five-day or even three-day delivery, lower next-day service requirements and further removal of bulk mail services from universal service conditions. We could also see greater pricing flexibility and lower quality of service restrictions on the national postal providers.

We have seen that the future profitability of national postal companies is the best indicator of their value and that this will depend on a complex interaction of market and regulatory developments and – more significantly – on how they themselves respond to them. This can therefore lead to a range of possible values depending on the severity or otherwise of market and regulatory conditions and the actions taken by the national postal company.

This can be shown in simplified terms in the chart below.

Drivers of value for postal companies (Source: Trova Consulting)

June 16, 2011 


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