Loading...

Over the past year, the characteristics of the funeral services industry have remained largely unchanged. Revenue growth has improved at a pedestrian rate, and much of the credit for generating shareholder value can be attributed to acquisitions and the improvement of cost structures. Slow growth is typical in this defensive industry. All told, increasing geographic coverage and new product offerings will always be the primary vehicles of expansion for these organizations, as increasing demand is difficult.

It is for that reason that a recent merger between two of the industry’s largest competitors is so significant. In late May, Service Corp. International (SCI) reached a definitive agreement to purchase all of the Class A and Class B shares of Stewart Enterprises’ (STEI) common stock for $13.25 a share in cash. The deal was approved by the boards of both companies and carried a net enterprise value of $1.4 billion. Board members expect the deal will close in late 2013 or early 2014, at which time the combined company would have an operating presence at 2,168 locations in 48 states, eight Canadian provinces, and Puerto Rico.

Prior to the agreement, Service Corp. had been considered the largest death care products and services provider in the nation, with more than 1,800 funeral service and cemetery locations to its name. Meanwhile, Stewart Enterprises, whose history dates back to 1910, had been considered the second largest funeral and cemetery products provider in the United States. Its funeral segment generated more than $260 million in sales during the 2012 period. Now, as one unit, Service Corp. is set to take a big piece of the market and stake its future endeavors with the addition of these assets.

But market dominance is not the only benefit these enterprises expect to realize from the deal. Service Corp. management expects to recognize annual cost savings of $60 million as soon as 2015, as a result of synergies in back office systems, scaling, and reduced infrastructure costs. To achieve this goal, the company will take a one-time cash charge of roughly $30 million over the next two years. But the ability to improve the company’s purchasing power for years to come in this highly fragmented market is certainly worth the bill.

Both stocks had been performing well on the market prior to the merger. In fact, since the beginning of the calendar year Service Corp and Stewart Enterprises shares had advanced 28% and 27%, respectively. Then, immediately following news of the deal, shares of Service Corp. rose another 7%, and shares of Stewart jumped 33% more.

This power move will force competitors to rethink their respective market strategies, and could drastically change the industry as we know it. Manufacturers such as Hillenbrand Inc. (HI) have already noted in recent earnings statements their intent to pursue business ventures outside of traditional casket making. Hillenbrand also operates a Process Equipment Group, which designs, sells, and services feeders and pneumatic conveying equipment, and size-reduction products. And it, too, made a recent acquisition of Coperion Capital, a bulk materials handling equipment manufacturer, which is focused away from its core business. This move displays its intent to focus on a less competitive market in the near term.

Indeed, the proposed combination of Service Corp. and Stewart Enterprises may change the face of the industry. But for investors, it represents a merger worth the attention of long-term accounts. The aforementioned geographic coverage this new company stands to possess is hard to ignore. What’s more, the economies of scale it has the potential to generate in the cemetery market ought to provide significant upside with respect to cost savings. Intangible synergies like the proven management team that Service Corp. expects to absorb could be the most treasured asset of all. But we will have to wait until the deal closes completely to quantify its true value on the market. Investors should monitor its progress, as it is one of the largest mergers in the industry’s history and, all told, could generate much greater investing potential than other income-oriented options on the market.

At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.