Gas merger

Is Linde Selling Itself Short?

Inspira, zone industrialo – portuaire de Salaise – Sablons
Is Linde making an expensive mistake? Source: HAMILTON/REA/laif

D-Day is looming for the $73 billion 50-50 merger of industrial gas suppliers Linde and Praxair, and the mix could yet prove explosive.

Shareholders have until Oct. 24 to exchange their Linde shares for shares in the new company on a 1-to-1 basis, but so far uptake has been slow. As of Tuesday, just 21.8 percent of Linde’s capital had been tendered, the German firm said, and that included the shares of Norway’s Norges, the world’s biggest sovereign wealth fund, which with 5 percent is Linde’s second-biggest shareholder.

An acceptance rate of 75 percent has been set for the merger to go through. Linde Chief Executive Aldo Belloni has been wooing investors with promises that the merger with the smaller US firm will deliver $1.2 billion in annual synergies. Both firms make products such as refrigerants and medical gases, as well as build gas plants.

Many Linde shareholders have doubts about whether the deal makes sense. They fear that the job cuts and site closures needed to realize synergies from the tie-up have stalled as a result of guarantees made by the management to appease workers unhappy about the deal. They are also miffed that an extraordinary general meeting has not been called to approve the deal, unlike at Praxair.

And now they may have another reason to be skeptical. A closer look at the companies’ assets suggests that contrary to management claims this won’t be a merger of equals and that the deal undervalues Linde in key areas.

Concerns about undervaluation were first raised at Linde’s annual shareholders’ meeting in May, and the latest figures seem to support the view.

There are strong arguments in favor of the 1-1 exchange. The companies’ stock market valuations were similar until the end of 2015, after which Praxair’s even exceeded Linde’s by 15 percent.

But by most other criteria, Linde is the weightier of the two. Its revenue is 80 percent higher than Praxair’s, and it has more than twice as many employees. Its free cash profit last year exceeded Praxair’s by 13 percent. In terms of operating cash flow, it outperformed its US partner by 23 percent, and its earnings before interest, tax, depreciation and amortization (EBITDA) were around 30 percent higher.

Most data suggest that a merger ratio of 55-45 in Linde’s favor, or even more, would be warranted.

A look at the balance sheets reveals even bigger differences. Linde is going into this merger with three times more equity than Praxair and similar levels of debt. That means that the Munich-based company is bringing about three-quarters of the book value and two-thirds of total assets into the marriage.

In light of those numbers it seems astonishing that Linde agreed so quickly to a 1-1 tie-up. But Praxair also has its strengths.

The difference in market valuation between the two companies partly reflects the US company’s stronger margins and profit growth. Praxair’s earnings per share growth has outpaced Linde’s in recent years, thanks in part to its share buybacks. Its EBIT margin of 21 percent and EBITDA margin of 32 percent exceed Linde’s by an impressive 8 to 9 percentage points.

To observers, Linde’s agreement to a merger of equals looks like an admission that it doesn’t think it can catch up this efficiency shortfall on its own. That begs the question of whether it wouldn’t have been better for Linde to spend a few years restructuring and then to enter a merger as the bigger partner.

“In that case we would have to do a takeover with a bigger financing requirement,” Mr. Belloni told Handelsblatt. Praxair probably wouldn’t agree to be a junior partner in an alliance, meaning that Linde would have to mount a takeover costing tens of billions of euros.

Given the size of its capital, cash flow and potential for cutbacks, most data suggest that a merger ratio of 55-45 in Linde’s favor, or even more, would be warranted.

But Linde’s management is convinced that the offer is “fair and appropriate.” All members of the management board have said they will be exchanging the Linde shares they hold. So will the supervisory board members who represent investors.

But Anke Couturier, one of the workers’ representatives on the supervisory board, has said she won’t go for the swap. If a sizable number of investors follow her example in the coming weeks, Linde’s management will have a problem.

Siegfried Hofmann is Handelsblatt’s chemical and pharmaceutical industries correspondent. Axel Höpner is head of the Handelsblatt office in Munich focusing on Bavarian companies. To contact the authors: hofmann@handelsblatt.com, hoepner@handelsblatt.com

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