From 2015 to 2020 the Marks and Spencer (LSE: MKS) share price had only gone down. The company’s revenue growth either did not match inflation or was negative during those years. Margins were shrinking and profits were falling. So, the price slide seemed justified.
Sensing the needs for change Marks’s management put a series of plans to turn things around were put into action before the pandemic. When the pandemic hit it spurred the company on to accelerate the pace of the turnaround. And it does look things are improving. If the business improves then one might think the Marks and Spencer stock price is due a turnaround as well.
Speaking then of a turnaround, management went down many avenues in an attempt to revive its business. But, here I want to take a look at one of them: vertical integration.
Get the Gist
In July 2022 MSK acquired Gist from Storeshield, a subsidiary of The BOC Group. It paid £145m in cash up front A further £85m plus interest is due by the the third year anniversary of the deal or after the disposal of certain freehold properties, whichever comes sooner. An additional £25m is due under certain conditions.
Gist provides the majority of M&S Food logistics. In turn MKS is by far Gist’s biggest customer. Buying Gist means MKS is taking control of part of its supply chain. This is an example of vertical integration.
Vertical integration
Vertical integration is a business strategy in which a company controls multiple stages of its supply chain. This can include owning suppliers, distributors, and retailers. By doing so, the company can reduce costs, improve efficiency, and have greater control over the quality of its products or services.
It is different from horizontal integration, which is where a company takes over another company that is on the same level of the value chain. As an example, if MKS bought Next or Tesco, that would be a horizontal integration move. Both horizontal and vertical integration are distinct from conglomerate building, whereby a company buys businesses at various points along very different value chains.
Walmart vertically integrated in 1991 by buying McLane Company, a grocery distributor, for 10.4 million shares and an undisclosed amount of cash. Although I can say the shares were worth $120m, the total purchase price is anyones guess. But, after the purchase Walmart’s costs reduced. In 2003, Walmart sold McLane to Berkshire Hathaway for $1.45bn, which might have been a significant gain. Apple brought processor manufacturing in-house in 2010 and went on to be the first $1trn market capitalisation company: although it would be folly to pin this success on that one decision.
On the other had Ford was buying up steel mills, iron mines and rubber plantations in the early 20th century in an effort to control its entire production process. This did not work. Its financial performance tanked and it had divested and as focused in its core automotive business by the 1960s.
Not like Ford
I think that the purchase of Gist by MKS will be more like the Apple and Walmart examples than the Ford one. Gist already does most of its business with MKS, and M&S Food. It won’t be difficult to integrate. There won’t be a lot of set up costs to get Gist ready to handle M&S Food because it already does the overwhelming majority of it.
Trouble might have arisen if Gist got the bulk of its revenue from other supermarkets. They might not want to contract with a company that is owned by a rival. They look elsewhere for logistics. Demand for GIST services falls and Marks and Spencer is forced into selling a lot of assets that are no longer required. But, that is not the case. This is just an illustration of what would have been a potential bad move highlighting why Marks and Spencer buying GIST is probably a good one.
Buying Gist will eliminate a layer of profit once commanded by Gist when it done work for M&S Food. That should mean higher margins for MKS. But will the cost savings justify the purchase price. If MKS is spending £225m to save £2m per year in charges, then that’s not good business, if its £25m then that is different.
I don’t know what it is saving, so I can’t say for sure if this is a good deal on those grounds. However, there is evidence that MKS did get a good deal.
Low EBITDA multiple
The deal for Gist could cost £255m. Gist has an EBITDA of £55m according to MKS, so it is paying 4.6 that amounts for the company. Prof. Aswath Damodaran found that the average enterprise value (EV) to EBITDA multiples for the ground freight and logistics and food retail and distribution industries was 7.18 and 9.31 respectively as of 2023.
An EV to EBITDA multiple of about half the norm is sign of a very good deal. I think MKS got a good deal because it was (is) Gist’s biggest customer. Its fixed price contract was coming to an end in 2027. MKS was making sounds that this was onerous. It probably suggested that this would not be renewed unless it was significantly cut. Or, instead of worrying about renewing at a lower price inn four years, especially with all this inflation about, or finding another supplier, they could take a structured deal to buy them out: Whadya say?
DISCLAIMER: James J. McCombie owns shares in Marks and Spencer. The Storied Investor has no beneficial position in any of the shares mentioned.
The Storied Investor 
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