Expansion is often seen as a sign of strength and future growth for companies. However, this isn’t always the case.

When a company decides to acquire a business that operates with much thinner margins, it raises immediate questions for investors

Will the new, less profitable segment drag down the overall financial performance of the acquiring entity?

This scenario played out this week.

Chart Industries (GTLS) and Flowserve (FLS) announced this week that they plan to merge in an all-stock deal valued at about $19 billion, including debt, to combine their oil and gas equipment and services businesses.

Chart makes cryogenic and process equipment like storage tanks, heat exchangers, and valves for liquefied natural gas, hydrogen, and industrial gases.

Flowserve supplies pumps, seals, and valves across multiple industries, including oil and gas, chemical processing, and power generation.

By joining, Chart’s expertise in low-temperature equipment and Flowserve’s broad pump and valve portfolio could allow the combined company to offer more complete solutions to customers that need both cryogenic and fluid-handling systems.

The companies believe they can achieve about $300 million in annual cost synergies within three years.

Those savings should come from materials and procurement efficiencies, combining certain overhead functions, and eliminating duplicate public company costs.

Over time, they also expect at least a 2% incremental lift to revenue from cross-selling efforts. In the past, Chart’s growth was driven not just by cost savings but also by sales synergies, gaining access to customers that previously had to deal with multiple suppliers.

For example, a company building a liquefied natural gas plant might now source both cryogenic storage tanks and pumping systems from a single vendor, simplifying procurement and potentially lowering total project costs.

Despite these potential benefits, the markets have not reacted warmly to the deal announcement.

Chart’s stock is down more than 10% since the merger was revealed, suggesting investors worry about how the two businesses will fit together.

Uniform accounting can help explain that concern.

Chart has delivered strong Uniform returns on assets ”ROA” north of 30% in recent years, reflecting the high margin and long-lead-time nature of its cryogenic equipment business.

In contrast, Flowserve has posted Uniform ROAs closer to 10%, driven by more commoditized pump and valve products.

When a higher-performing company acquires a lower-performing one, it often dilutes the acquirer’s overall profitability.

The market recognizes this potential impact on Chart’s financial health.

Investors anticipate that integrating a business with a significantly lower ROA like Flowserve will inevitably weigh down the company’s strong returns.

Our EEA model clearly shows this.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s Uniform ROA to decline to 22% from 35% last year.

This expectation is a key driver behind the recent sell-off in Chart’s stock.

The market’s current assessment is that the company’s profitability will likely decline in the coming years due to this acquisition, and this appears to be a valid concern given the disparate profitability of the two companies.

For investors, this situation serves as a reminder that growth for growth’s sake does not always equate to value creation.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research

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