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The Truth About the Postal Service's 'Fiscal Cliff'

By

And why the private sector needs the USPS to survive.

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MINYANVILLE ORIGINAL It was reported this week that the US Postal Service has hit its $15 billion borrowing limit from the Treasury for the first time ever -- which means the USPS will be relying solely on revenue from stamps and shipping charges to cover its operating costs through the end of the year.

"Being at the limit is a serious situation because our limited liquidity does not give us operating flexibility," Postal Service spokesman David Partenheimer told the Wall Street Journal on Wednesday. "Without passage of comprehensive legislation as part of the Postal Service's business plan to return to financial stability, we continue to project low levels of cash."

While many see this situation as a simple case of black-and-white, the reality is actually quite complex.

"We encourage the media to pause and fully consider the situation before jumping to the conclusion that the US Post Service, having reached its $15 billion borrowing limit for the first time, is facing a fiscal cliff," said National Association of Letter Carriers president Fredric Rolando in a statement released yesterday. "It's not."

Rolando explained that although the USPS has, in fact, reached its borrowing limit, it also has a $25 billion surplus in its pension funds.

"Unfortunately, at the direction of Congress, the Postal Service has been forced to set aside more than $45 billion to pre-fund the health care costs of its future retirees and is required to unnecessarily set aside billions more -- although no other business or government agency in this country is required to pre-fund these benefits, and although the amount already accumulated will provide for retirees for decades to come," he argued. "By mandating these payments and refusing to allow the Postal Service to access its own pension fund surplus, Congress has turned a manageable business challenge into a nightmare of artificial deadlines and unnecessary financial burdens."

Indeed, the old handwritten letter has been largely replaced by email. But the Internet and e-commerce have also led to increased growth in the Postal Service's shipping business -- and believe it or not, this is an operating segment that both FedEx (NYSE:FDX) and UPS (NYSE:UPS) rely on heavily themselves.

As we reported over the summer, FedEx earned $1.495 billion from the Postal Service last year as the agency's number one supplier. UPS, the Postal Service's 11th largest supplier, earned $102 million from the Postal Service, a $7 million increase from the year before.

"FedEx, UPS, and the US Postal Service are more business partners today than they are competitors," David Hendel, an attorney in the Postal Service Contracting practice at the law firm of Husch Blackwell, who compiles an annual list of the Postal Service's top contractors, told me. (FedEx and UPS are far from the only companies that enjoy lucrative partnerships with the Postal Service. A quick scan of the Husch Blackwell list shows Northrop Grumman (NYSE:NOC) taking in $410 million from Postal Service contracts last year. IBM (NYSE:IBM) made $108 million from Postal Service contracts. And United Airlines (NYSE:UAL) brought in $102 million.)

FedEx has flown Express Mail, Priority Mail, and First Class Mail for the Postal Service since 2000. According to Alan Robinson, Executive Director of the Center for the Study of the Postal Market and the publisher of the Courier Express and Postal Observer, the income generated by this "represents around 60% of FedEx Express's US domestic air freight revenue."

Per Robinson, "Most of this revenue comes from flying mail and parcels during the day when FedEx airplanes would be otherwise parked." Thus, if FedEx were to lose this contract, it "would reduce the utilization of its aircraft possibly putting pressure on FedEx's margins on its other air freight and Express business."

Indeed, FedEx's latest 10-K stated, "[T]he USPS has informed us that it intends to solicit proposals for the provision of air transportation services currently provided by FedEx Express upon the expiration of the current agreement in September 2013."

It continues:

Accordingly, upon the expiration of the current agreement, the transportation services we provide to the USPS could be transitioned, in whole or in part, to another provider. This would have a negative impact on our asset utilization and profitability. Moreover, to the extent that any such services are retained by us, the terms and conditions of the new arrangement may be less favorable than those currently in place.

Dr. Gene Del Polito, President of the Association for Postal Commerce in Washington, DC, told me that UPS will be bidding on the contract, as the revenue is obviously substantial. However, while the Postal Service relies on FedEx and UPS to achieve efficiencies in its operations, FedEx and UPS also rely on the Postal Service for similar benefits of their own.

"For FedEx and UPS, the costs are lower to deliver in urban areas, and higher in rural ones," Del Polito said. "For the Postal Service, that cost structure is the exact opposite. So FedEx and UPS use the Postal Service for 'last-mile' delivery in many areas where it would cost them too much to deliver that mail -- they prepare it for re-entry via the Postal Service which then walks it out for final delivery." (To put a number on this, Alan Robinson determined in 2011 that "30.4% of FedEx Ground shipments are delivered by the United States Postal Service.")

Del Polito explained that "there was a time when you would hear concerns from FedEx and UPS that the Postal Service was unfairly competing against them, but now you will hear they are 'partners' because they have figured out how to get good value out of a set-up that makes sense for them."

The arrangement does make sense for FedEx and UPS, from an operational and economic standpoint. Interestingly, a purely competitive structure wouldn't work, as FedEx and UPS don't want the responsibilities that they would be saddled with if the playing field were perfectly level.

Here's Lauren T. Andrews, writing in the William & Mary Business Law Review:

For example, the USPS is charged by governmental decree with providing universal service to all parts of the country, even in areas that may not be profitable. Private companies, on the other hand, can essentially ignore and avoid areas that may not be profitable, areas where they may otherwise be forced to serve if the postal monopolies were lifted and regulations put in place. Furthermore, companies such as UPS and FedEx would likely have no interest in the delivery of "letters," primarily because it is not as profitable as larger parcel and package delivery. In fact, a UPS Spokesman, Norman Black, stated, "We believe that the government plays a role in terms of ensuring that every mailbox is reached every day …. That is not a responsibility that UPS would want."

And, not only would they not want it, David Hendel maintains they couldn't do it.

"Neither FedEx or UPS are even in the same league as the Postal Service, which goes to 100 million addresses every day," he told me. "What they do, they do well. But they don't do what the Postal Service does."

Honest.

Follow Justin Rohrlich on Twitter: @chickenalaking
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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