Olympic Steel (ZEUS) has seen steady bottom line growth over the last four years before taking a slight dip in QoQ net income in Q1 2019. Olympic Steel has a steady business model as well as a strong reach across the United States. However, if they want to take the next step and compete with the likes of Reliance Steel & Aluminum (RS) and Ryerson Holdings (RYI), I believe that they need to expand globally. A merger with Oak Brook, Illinois’ A.M. Castle & Co. (CTAM) would be mutually beneficial to both companies. Olympic Steel would expand outside of the United States and A.M. Castle would be able to pay off their debt and decrease their overhead expenses.
As can be seen in the comp breakdown below, Olympic Steel is losing at the top line as well as EBITDA to its competitors. This has led to a less desirable valuation of 6.88 EV/EBITDA in relation to its competitors. A change needs to be made in order to accelerate top and bottom line growth. I believe that acquiring A.M. Castle is the perfect opportunity to do so.
Olympic Steel will benefit from A.M. Castle’s global reach. A.M. Castle currently has locations in Europe, Mexico, Asia, and California. These are all locations where Olympic Steel has none and could certainly benefit from entering these high grossing regions. When looking at competitors such as Ryerson Holdings and Reliance Steel & Aluminum, Olympic Steel can compete in America but these other companies blow ZEUS away abroad. Olympic Steel’s quality financial standing at A.M. Castle’s pre-existing warehouses abroad provides a synergy that will certainly increase Olympic Steel’s top and bottom lines.
A.M. Castle features increasing debt levels which are not sustainable under their current business operations. The company flaunts an impressive TTM gross margin of 25.2% while Olympic Steel is only generating a gross margin of 19.1%. This is one of the significant benefits that A.M. Castle can bring in the merger with ZEUS. A.M. Castle is not able to take advantage of their impressive gross margin because they have very high overhead expenses. As can be seen in the chart below their warehousing/delivery expense and SG&A expense are 14.3% and 11.8% of sales, respectively. Olympic Steel’s warehousing/delivery expense and SG&A expense are 8.4% and 6.8%, respectively.
A.M. Castle’s high overhead expense is the reason that they are not able to generate a profit. In a merger, Olympic Steel would be able to influence the operations of A.M. Castle and decrease their overhead. It is very possible that a merger could completely eliminate A.M. Castle’s $68.8 million in SG&A expense, however, I took a more conservative approach and simply decreased the expense down to the percent of sales that Olympic Steel’s SG&A is responsible for, 6.8%. I also deployed another layer of conservatism in my prediction of A.M. Castle’s operating income post-merger by keeping their warehousing/delivery expense exactly the same as it was before the deal. I believe that this expense could see a decrease as well due to the duplicate warehouse locations of the two companies. Both companies have warehouses in Bedford Heights OH, Charlotte NC, and Hammond IN. If a merger is completed by the two companies, A.M. Castle could get rid of these warehouses and further decrease their overhead expenses.
In the model below I determined the income statement of the consolidated company following the acquisition of A.M. Castle by Olympic Steel. As part of the synergy explained previously, I decreased A.M. Castle’s SG&A expense to represent 6.8% of sales. By doing so I was able to eliminate approximately $39 million in overhead expenses. The consolidated company operates at a gross margin of 20.6% and generates $27.3 million in net income. This is a decrease from Olympic Steel’s current bottom line but the model does not account for the increase in sales that would come from Olympic Steel operating abroad in A.M. Castle’s pre-existing warehouses. I believe that Olympic Steel would be able to generate greater revenue than the current levels from these locations due to their stronger financial standing, strong reputation, experienced management team, and overall larger size. This is where Olympic Steel would benefit from the deal. In the current model we recognize an increase in EBITDA for Olympic Steel of approximately $39 million due to their ability to decrease the overhead of A.M. Castle while maintaining the sales of the company and efficient gross profit generation.
A significant increase in sales from A.M. Castle’s current business as well as the global opportunities for Olympic Steel will lead to an increase in Olympic Steel’s top and bottom lines.