Vertical Merger Examples
In this article, we discuss examples of the vertical merger to get a conceptual understanding of such mergers. Vertical Merger means the merger of companies that are in different levels of the same industry value chain leading to forward integration or backward integration of business. Vertical Merger increases synergies, increase control over the value chain and increase productivity and efficiency of the business.
Top 4 Real-Life Vertical Merger Examples
There are hundreds of vertical mergers having multiple variations. The following are real-life examples of vertical merger which provides an outline of the most common vertical mergers.
Company A is a manufacturer of inorganic chemicals viz caustic soda lye (CSL) with the byproducts Hydrogen (H2) and Chlorine (Cl2). The product CSL can be further processed into CSL Flakes and sold in the market with higher realizations. Hydrogen and Chlorine can be further processed into Hydro-Chloric Acid (HCL). The major raw material for the manufacturing of CSL is Industrial Grade Salt which is called sodium chloride (NACL).
The following are the key financial parameters of A:
Amount Rs. In 1,000,000
- Capital Employed – 200
- Net Sales – CSL – 100, Cl2 – 30, H2 – 20. Total = 150
- EBIDTA margin – 30%
- ROCE – 20%
100% of Salt procured from third party manufacturers which are manufactured in a season of March to October.
EBIDTA margin on Cl2 and H2 is negative 10% due to a lack of market demand. A does not have an efficient sales team.
With the above profile of A, let’s see various vertical mergers the company can look into with companies in the same industry of inorganic chemicals:
Example #1 – Merger Leading to Improvement in EBIDTA Margins
Company B is a manufacturer of HCL with a turnover of Rs. 40 Cr per annum. B procures H2 and Cl2 from the market at the cost equivalent to 50% of sales of HCL. Further processing cost incurred is 40% of sales and thereby B makes an EBIDTA margin of 10%.
Here A and B can merge with which B will get raw material viz H2 and Cl2 from A at production cost which is lower when purchased from market thereby margin increase to 15% and A will be able to further process H2 and Cl2 into profitable product HCL and thereby improving overall profitability.
EBIDTA margins will thus shape as below:
Before the Merger
After the Merger
Example #2 – Merger Leading to a Reduction in Costs and Improvement in ROCE
Let us say Company C is in the manufacturing of Caustic Soda Lye. The company has very good sales and marketing team. However, C could not increase production due to a lack of funds and process expertise to implement a project for production expansion. C could expand production at an existing site by 30000 MT per annum with an investment of Rs. 100 (‘000,000) and gestation period of 1 year.
For A, to set up a manufacturing unit of this size, the investment required would be Rs. 200 (‘000,000) and gestation period of the commencement of operations would be 3 years.
Here it makes a good opportunity for A and C to get into a vertical merger and gain economies of scale of size and savings in investment through a brownfield project instead of a greenfield project.
ROCE and IRR for greenfield project by A:
Say, EBIT per annum for 30000 MT plant would be Rs. 40 (‘000,000). A has to spend extra on marketing to sell the higher production say Rs. 5 (‘000,000) per annum.
ROCE per annum for A would be 35/200 = 17.50%.
- Terminal value = Last projected FCF * (1+Growth rate) / (WACC – Growth rate)
- The growth rate is assumed to be 0, WACC at 15%.
Terminal value = 35/0.15
Terminal Value = Rs. 233 (‘000,000)
IRR will be –
IRR = 13.95%
ROCE and IRR for brownfield project with C:
C will not have to spend extra on marketing costs. However, the maintenance cost of the plant would be high viz Rs. 10 (‘000,000) per annum due to the poor design of the existing plant and to hire expertise from outside for running the plant. EBIT would be Rs. 40 – 10 Cr = Rs. 30 (‘000,000)
ROCE per annum would be 30/100 = 30%.
IRR will be –
IRR = 34.86%
Thus merger synergy benefit could be seen in significantly improved IRR for a project when implemented along with C instead of A doing it alone.
Example #3 – Merger Leading to Diversification of Sourcing Risk of Raw Material
The major raw material – Industrial grade salt is procured by A in the market and the production of CSL by A is entirely dependent on the availability of salt in the market. A has to buy salt at any price it can procure and has no bargaining power due to its dependability.
Thus while during peak season the salt is available in abundance and prices are low whereas, during offseason of salt production, the prices paid by A are very high. Also in the case of no salt available in the market then A has to stop its CSL production. This leads to a loss of predictability and stability of the day to day profitability and cash flow.
A can here enter into a vertical merger with companies having salt fields producing salt and thereby get assured sourcing of its raw materials. Further, the salt-producing companies can also get an assured supply chain for its salt produced and a steady cash flow leading to a win-win situation.
Example #4– Merger Leading to Improvement in Sales Mix and Realizations
A is producing CSL which has a realization of Rs. 35000 per MT. CSL can be further processed into CSL flakes with the realization of Rs. 45000 per MT. The cost of further processing is Rs. 5000 per MT.
Company D is manufacturing CSL and CSL Flakes. However, due to lower production of CSL, the CSL Flakes capacity is lying idle for D.
This situation provides the idle opportunity for a vertical merger of A and D leading to better sales mix in terms of further processing CSL into CSL Flakes and thereby increasing the sales realizations and profits.
Thus vertical mergers can provide synergy benefits for companies in the same industries by removing bottlenecks, better coordination, and efficient use of resources. However, other aspects of a merger like cultural alignment, legal issues, sharing of profits in terms of valuation of shares for a merger, shareholders agreements, etc play a crucial role in a successful merger.
This has been a guide to Vertical Merger Examples. Here we discuss the top 4 real-life examples of vertical mergers along with a detailed explanation. You can learn more about finance from the following articles –