P&L Check Linde: Better Off Together

The industrial-gas company Linde is lagging behind the US competition. Only a merger with Praxair, fiercely opposed by trade unionists, can close the gap.
Quelle: dpa
Can Linde really afford to lose a merger with US rival Praxair?
(Source: dpa)

Linde and Praxair's love affair has been the subject of fierce debate for months, under attack from all sides. Works councils and trade unionists question whether the merger makes sense and fear significant job cuts. Linde's shareholders, on the other hand, criticize management for "chaotic leadership" and complain they aren’t even allowed a vote on an alliance that will create the world's largest industrial gases company.

The protests have only grown louder as Linde headed into an annual shareholders' meeting Wednesday. "Rarely has a company been plunged into such chaos as Linde through its sought-after merger with Praxair," Ingo Speich of German fund manager Union Investment thundered at the meeting. And so, for the German gas giant, the big question now is: Does Linde really need its US rival, or can it survive through difficult times for the industry on its own?

Chief Executive Aldo Belloni is walking a fine line. The company is currently in good shape, he said in presenting the Linde's annual results this year. "Our efforts to make Linde even more profitable are already having an effect." But by tooting his own horn Mr. Belloni also risks shooting himself in the foot: Why not cancel the merger if the company is doing so well on its own? After all, opponents pounced, there are plenty of other blue-chip DAX companies that would be pleased to have profit margins like Linde’s.

Together with Praxair, the company aims to become a global champion – one equipped for these more difficult times.

It is still unclear whether the merger will be successful. Contrary to the original plan, Mr. Belloni will only announce preliminary results of the negotiations at the shareholders' meeting. The final agreement could be delayed until June. According to industry insiders, this is due to legal details. But some investors are pleased the showdown with workers, who oppose the merger, won't happen until after the shareholders' meeting as a result.

And yet there are good reasons to see it through. The fact is, the days of high growth in the sector are over. Industrial gases include things like oxygen, nitrogen, acetylene, carbon monoxide or argon. They are used in everything from manufacturing to medicine. Linde, for example, makes hydrogen for fuel cells that power emission-free cars, or helium that is used to cool superconducting magnets like those used in the Large Hadron Collider at CERN. Linde not only "manufactures" these gases by separating them in its plants, it also sells the equipment for such processes to other firms -- in the welding industry, for example.

For years, the industry and Linde were accustomed to automatic growth, driven by the emerging economies. But of late this growth has stalled. This has affected all players, and the outlook is bad. The mature markets are saturated and there are problems in emerging economies. Promising developments like gas liquefaction and natural gas vehicles have so far failed to live up to expectations.

Linde has felt the effects, too. Sales declined last year (see chart), with little sign of future growth. Earning still increased by 7 percent to €3 billion, but only because it paid less interest on debt. Operating profit, which Linde uses as an important key figure, has been stangant (see chart).

09 p23 Linde in Numbers 1-01

Gas companies are responding in two ways. They are focusing entirely on their core business, and merging with the competition in order to strengthen their distribution networks and to reduce costs. Rival French producer Air Liquide has already completed its own growth spurt with its acquisition of US-based Airgas – a move that has pushed Linde to respond.

Linde also has some weaknesses in terms of profitability. Supervisory Board Chairman Wolfgang Reitzle wants to fix those through the merger with Praxair. One of his goals is to cut costs by a total of €550 million. This is only possible through a combination, because Linde and Praxair expect €1 billion a year in synergies (meaning overlap). But this means layoffs – exactly what trade unions are worried about.

09 p23 Linde in Numbers 2-01

But why not simply tough it out solo? Compared to other companies listed on Germany's blue-chip DAX index, Linde's profitability is indeed respectable. The profit margin, based on the EBIT, is slightly higher than that of Siemens and just below that of BASF, for example. However, returns are traditionally high among gas companies, partly because they offer advance services at customer locations. This is why comparisons within the industry make more sense.

And among its peers Linde has catching up to do. Even if different definitions of operating profits make such comparisons a challenge, American competitors are well ahead of the two large European providers, with better margins. Thus Linde's profit margin in its gas business improved from 27.4 percent to 28.3 percent in 2016, and yet still lags behind Praxair's EBITDA margin of close to 35 percent in 2016.

09 p23 Linde Gas Business Segment-01

The Americans perform consistently better when it comes to cash flow, too. They get far more money out of their business, as shown by the ratio of free cash flow to sales, where Linde achieves a margin of 9.5 percent compared to 12 percent at Praxair. Air Products, for its part, generates as much free cash flow as Linde with only half the sales. At Linde, cash flow fell to €3.4 billion in 2016.

Mr. Belloni, the CEO, stresses that "Linde is by no means a case for restructuring." But he still supports the merger and, together with Supervisory Board Chairman Reitzle, is likely to conclude that Linde is good but not good enough to survive on its own. Employee representatives acknowledge that Linde's cost structure still needs improvement. The difference is that they believe this can be done internally.

Whether the €60-billion merger goes through or falls apart, it's looking likely that Linde will still have to survive 2017 on its own. So far it looks good. In the first quarter, sales grew by 6.6 percent to just under €4.4 billion. On a like-for-like basis, the increase was a good 4 percent. Operating profit rose by almost 6 percent to more than €1 billion. But Linde is still a long way from Praxair's profitability. That means heated debates over whether and how this gap can be closed.

Axel Höpner is head of the Handelsblatt office in Munich, focusing on the state of Bavaria's companies, including Allianz and Siemens. Bert-Friedrich Fröndhoff leads a team of reporters covering the chemicals, health care and services industries at Handelsblatt. To contact the authors: [email protected], [email protected]