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Morningstar | We Expect Praxair-Linde Merger to Deliver Meaningful Cost Synergies

Linde is the largest industrial gas producer in the world and benefits from operating in an industry with a very favorable structure. Despite selling industrial gases, which are essentially commodities, public industrial gas companies have consistently delivered lucrative returns because of their economic moats. Industrial gases typically account for a relatively small fraction of customers’ costs but are a vital input to ensure uninterrupted production. As such, customers are often willing to pay a premium and sign long-term contracts to ensure their businesses are running smoothly. Long-term contracts and high switching costs contribute to industrial gas producers' moats, helping them generate a relatively predictable cash flow stream and lucrative returns.Demand for industrial gases is strongly correlated to industrial production, increasing roughly in line with industrial production growth in developed countries and up to 1.5 times industrial production growth in developing countries. As such, organic revenue growth will largely depend on global economic conditions. That being said, we think Linde can fuel additional revenue growth through M&A opportunities, asset buybacks, and new projects, especially in emerging markets such as China and India.Furthermore, we expect Linde to benefit from strong cost synergies from the Praxair-Linde merger. Prior to the merger, Praxair has consistently delivered industry-leading operating margins and returns on invested capital (roughly 200 basis points above its rivals over the last decade). One of the reasons for Praxair’s strong performance has been its excellent execution of a piggybacking strategy, involving tight integration of the on-site, merchant, and packaged supply modes within a selected geographic radius. If management can achieve its target cost synergies and apply the strategies that drove Praxair’s industry-leading margins to Linde’s asset base, we believe the company will deliver strong returns to shareholders.