Industrial Gas Majors TRIAS CORPORATION Profitability Comparison of Global Leaders August 24, 2017

Industrial Gas Majors TRIAS CORPORATION Profitability Comparison of Global Leaders August 24, 2017 Industry Analysis Why are margins for Japan majors somewhat lower than global peers? INTRODUCTION In the simplest terms, air separation, the process of extracting high purity gas and liquid forms of the components of dry air: oxygen 20.9%, nitrogen 78.1%, argon 0.9%, through cryogenic distillation (liquefying air through cooling) is at the heart of industrial gas business. Leading players provide comprehensive solutions for manufacturing, storage and transportation of industrial gases to a Companies covered wide range of industries, including steelmaking, petroleum refining, petro‐ chemicals, pharmaceuticals, food & beverages, medicine/healthcare, elec‐ in this report: tronics, aerospace etc. AI FP Air Liquide LIN GR Linde Group The largest industrial application of oxygen is as an accelerant to raise the PX US Praxair combustion temperature for blast furnaces in steelmaking. Nitrogen is used in Air Products & refining and petrochemical production to purge dangerous vapors after APD US Chemicals production runs, in cooling reactors for pharmaceuticals, and for film deposition 4088 JT AIR WATER in the manufacturing process of semiconductors. Argon is used as an inert shielding gas for high temperature applications like welding and graphiteelectric 4091 JT TAIYO NIPPON SANSO furnaces. 2168 HK Yingde Gases Industrial gas business is inherently capital intensive, and profitability is often a function of raising operational efficiencies through scale merits. As seen in Table 1, it is therefore not surprising that profit margins for the top players are somewhat higher than those of Japan’s big 2, with significantly larger, globally diversified operating structures. However, not satisfied with this as an overly simplified explanation, we examine three specific aspects that shed more light on the differences in profitability. PART ONE looks at differences in synergies achieved from M&A, PART TWO looks at Japan‐specific factors, and PART THREE looks at differences in exposures to global markets. Through these examinations we consider here possible growth directions of Japan’s two majors. [Table 1] Overview of Global Industrial Gas Majors (Local Currency and Translation into USD ) Company Name Currency Rank FY Sales 5‐year Sales GPM OP 5‐year OP OPM Local Local CAGR USD mn CAGR USD mn currency currency Linde + Praxair (scheduled to merge) EUR (mn) (reference) 12/16 27,482 ‐ 29,623 ‐ 4,421 ‐ ‐ 16.1% Air Liquide EUR (mn) 1 12/16 19,712 4.3% 19,089 N.A . 3,024 4.3% 3,183 16.7% Linde Group EUR (mn) 2 12/16 18,422 1.7% 17,840 36.2% 2,099 0.3% 2,209 12.4% Praxair USD (mn) 3 12/16 10,534 ‐1.6% 10,534 44.4% 2,322 ‐1.2% 2,322 22.0% Air Products & Chemicals USD (mn) 4 9/16 9,524 ‐0.2% 9,524 32.8% 2,199 10.5% 2,199 23.1% Air Water JPY (bn) 5 3/17 6,096 5.6% 6,096 22.9% 41 10.3% 376 6.2% Taiyo Nippon Sanso JPY (bn) 6 3/17 5,287 5.6% 5,287 37.1% 54 21.2% 488 9.2% Yingde Gases Group CNY (mn) 7 12/16 1,261 14.1% 1,177 30.4% 1,932 15.1% 271 23.0% Source: Compiled by Trias Corporation from Bloomberg L. P. data Forex rates used for conversion to USD are: JPY/USD 110 (at March‐end), EUR/USD 0.95 and CNY/USD 0.14 (at December‐end). Copyright © 2017 Trias Corporation. All rights reserved. 1 Industrial Gas Majors TRIAS CORPORATION PART ONE: Differences in synergies achieved from M&A Industrial gas business is inherently capital intensive business, and consolidation of global leaders driven in part by the trend toward larger projects has proceeded at a breathtaking pace over the last decade, with mega‐deals occurring one after another. In PART ONE, we examine differences in the M&A strategies of Japan’s two majors, which are in fact quite different, and then compare differences in the scale of synergies achieved from M&A with those of global leaders. During the 1990s after the collapse of Japan’s bubble economy, consolidation proceeded within the industry, creating the two major groups of TAIYO NIPPON SANSO (Nippon Sanso, Taiyo Sanso and Toyo Sanso) and AIR WATER (Kyodo Sanso, Daido Sanso and HOXAN) which together accounted for some 70% of the domestic market for industrial gases including medical use. However, due to the hollowing out of Japan’s industrial base with production for key manufacturing industries being steadily shifted overseas, the domestic market for industrial gases peaked, forcing each to develop new sources of profit, which led each to pursue M&A strategies. However, the strategy objectives for the two are very different. TAIYO NIPPON SANSO CORPORATION (TNSC) has focused its M&A strategy on expanding industrial gas business overseas, mainly in North America and Asia. Last September, TNSC’s US subsidiary Matheson Tri‐Gas, Inc. acquired assets divested by Air Liquide SA (ALSA) in the U.S. pursuant to its acquisition of Airgas in the U.S. as mandated by the Fair Trade Commission (market shares in the Northeast and Midwest became extremely high), including 18 air separation units (ASUs), two nitrous oxide plants, four CO2 plants etc. This acquisition for over ¥60bn (over USD550mn) was the largest in its history. According to a financial news agency Toyo Keizai,TNSCexecuted25M&A transactions in the 10 years through FY3/16, deploying total investment of roughly JPY220bn. In the U.S. in particular, the company acquired 15 companies, 9 in the last 5 years. The decision to focus on the US market is due to it having the largest consumption of industrial gases, and ongoing growth driven by population increases. Until now, the majority of acquisitions were for sales distribution networks that don’t have manufacturing assets, which purchase product from major manufacturers, and distribute the products to final customers in cylinders. The basic strategy is to raise its distribution share in a certain region, and after sales exceed a certain level, to build its own ASUs. Currently its share in the US market is still low at several percent, having strength in bases in California, Texas and Florida. Nevertheless, Gas Business in the U.S. in FY3/16 under IFRS generated revenue of JPY149.5bn (JPY147.2bn in FY3/17), and together with Gas Business in Asia and Oceania where M&A is similarly proceeding, generating revenue of JPY89.3bn (JPY85.8bn in FY3/17), combined overseas gas revenue reached JPY238.8bn (JPY233.0bn in FY3/17), or the overseas revenue ratio roughly 40%. Copyright © 2017 Trias Corporation. All rights reserved. 2 Industrial Gas Majors TRIAS CORPORATION Since US majors are thoroughly entrenched in the Northeast and Midwest regions due to long history of industrial clients there, this was a major coup toward making inroads. There is high medium‐term growth potential for TNSC in the US market given its low overall share. While it’s immediate priority is to upgrade energy conservation and efficiency of acquired manufacturing assets, its new 4‐year Medium‐Term Plan (MTP) “Ortus‐2” through FY3/21 (announced in March 2017) targets allocation of 70% of total investment of JPY340bn into strategic investments in overseas M&A and capacity expansion (nearly JPY60bn per year), including in North America ongoing M&A of distributors and capex in ASUs and CO2 facilities, in China investments in facilities to produce material gases for semiconductors, and in Southeast Asia and South Asia M&A of local gas manufacturers and capex in ASUs, CO2,H2 hydrogen gases and specialty gases manufacturing facilities. At the same time, the main focus of M&A for AIR WATER INC (AWI) has been diversification of its mainly domestic business. According to Toyo Keizai,the company invested roughly JPY60bn in the ten years through FY3/16 in M&A acquisitions and taking stakes in companies, in over 50 transactions. While this targeted a wide range of businesses, the strategic emphasis has been on Agriculture and Food Business and Medical Business. The main attractive point of these two industries is being less susceptible to cyclical fluctuationsinthe business cycle and generating stable cash flow with steady growth. AWI made full‐fledged entry into food business in 2002 through acquisitionof the Hokkaido Plant of ham and sausage maker Snow Brand Foods forced into liquidation as a result of the scandal of falsely labeling imported beef as Japanese beef. Then in 2012, it acquired Sagami Ham which has high brand recognition in the Kanto region, merging it with Saveur SS Inc, whose predecessor was the former Snow Brand Foods. Then in July 2016, the company acquired all shares of Daisen Ham/Tottori Prefecture from the Nisshin Flour Group, adding to the Saveur nationwide brand, Hokkaido retail brand SHUNSETSU,andSagami Ham brand. AWI is also focused on M&A in agricultural distribution and processing. In 2012 it acquired Tomiichi in Hokkaido mainly engaged in aggregation and wholesale of vegetables such as potatoes and pumpkins, and Hokkaido frozen vegetables maker Hayashiya Group. Then in 2015, it also entered the downstream market through acquisition of Kyusyuya in Hachioji, Tokyo, which operates a chainof90 vegetable and fruit (fresh produce) retail shops mainly in department stores and station buildings. In 2016 it acquired the frozen vegetables Tokachi Plant/Hokkaido from Maruha Nichiro Northern Japan. Medical‐related ranks alongside Agricultural and Food Business as an M&A target. In 2005, the company acquired Kawasaki Safety Systems, a maker of medical respirators and fire extinguishing systems. Then in 2010 it acquired Miwa Electrical Medical/Nagoya engagedindesignandconstructionof hospital Copyright © 2017 Trias Corporation.

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