August 15, 2024 Unionization and Valuation

Tight labor markets are prompting union activity, but what are the implications?

By Andrew Silver, Managing Director, Oberon Securities

Amazon has the Amazon Labor Union, Starbucks has the Starbucks Workers United.  Even graduate students at universities are unionizing.  Tight labor markets are providing workers with an opportunity to organize, but what are the implications? 

Unionization can significantly influence a company’s profitability and valuation, with effects that vary based on industry, company size, and the nature of the labor agreements. A study by the National Bureau of Economic Research found that:

“Profit, and return on assets, appears unaffected by unionization…[However], relative to cases in which unions lose organizing votes, organizing victories reduce growth in assets, because of decreased growth in plant, property, and equipment. The decrease in equity value associated with unionization begins at the time the union wins its election and continues for about 15 months afterward. Calculations of the effects of a union victory suggest that it produces large negative returns of 10 to 14 percent. The authors also find that the effects are quite variable, depending on the degree of support for the union. When unions win elections with a bare majority, there is almost no union effect. But when unions win by a large margin, the effect can be as large as 25 to 40 percent.”

In other words, the decline in equity value associated with unionization appears to be a self-inflicted corporate wound:  fearing the effects of a union, companies will disinvest in unionized operations and, by curtailing growth, reduce equity value despite there being no effect on profitability.

A current example of the effects of unionization on valuation can be seen in the steel industry. While many factors influence valuation, it is noteworthy that there appears to be a direct, inverse correlation between unionization and valuation. At Cleveland Cliffs, which is approximately 70% unionized, the Total Enterprise Value over EBITDA multiple is 5.8. US Steel, 50% unionized, has a multiple of 6.0. And Nucor, which is not unionized, enjoys a multiple of 7.0.

It’s been clear for a long time that unionization can have an impact on companies’ financial performance and both corporate leaders and rank and file employees should understand what in some cases are unforeseen consequences – positive and negative – for both sides. Here’s a look at how unionization impacts several key financial metrics:

Increased Labor Costs: One of the most immediate impacts of unionization is the potential increase in labor costs. Unions often negotiate higher wages, better benefits, and more favorable working conditions for their members. While these improvements enhance worker satisfaction and retention, they can also lead to higher operating expenses for companies. For some businesses, higher worker satisfaction can lead to better customer service and higher customer satisfaction, which can allow them to pass along their increased labor costs. But for many companies, especially those with slim profit margins, such as those in the retail or hospitality sectors, increased labor costs can be particularly burdensome.

In a highly unionized industry, e.g., autos, the playing field is fairly level since virtually all of the competitors face the same labor costs.  However, many unionized businesses are facing increased competition from non-union concerns, which may operate with 20-30% lower labor costs.  In such industries, the unionized competitors will need to map a strategy that minimizes their labor cost disadvantage by focusing on customer relationships, safety records, or other non-monetary factors. These strategies are clearly at play in the auto industry, where legacy automakers with plants in Michigan may be selling against competitors with nonunion plants in Tennessee or other southern states.

Productivity and Efficiency: The effect of unionization on productivity and efficiency can be mixed. On one hand, unions may advocate for better training and safer working conditions, which can enhance employee productivity and reduce turnover. On the other hand, unions can also impose strict work rules and procedural constraints that may hinder managerial flexibility and operational efficiency. The net impact on productivity often depends on the effectiveness of the union-management relationship and the specific industry context.

Employee Relations and Morale: Unionization can improve employee relations by providing workers with a formal mechanism to voice concerns and negotiate with management. This can lead to higher job satisfaction, lower absenteeism, and a more motivated workforce. However, unrealistically high expectations, which are sometimes raised by union leadership in their unionization efforts, can lead to frustration down the line. Also, contentious labor negotiations and strikes can disrupt operations and lead to decreased productivity, affecting overall profitability.  Certainly, newly-unionized companies like Amazon and Starbucks feel the costs outweigh the potential benefits and appear to be countering labor’s efforts aggressively.

Valuation and Investor Perception: From a valuation perspective, investors often view unionization through a lens of risk and stability. Companies with strong, positive labor relations and efficient operations may not see a significant negative impact on their valuation. However, as the illustrations above show, impacts including the potential for frequent labor disputes or high labor costs due to union agreements are likely to experience valuation pressures. Investors might be concerned about the potential for increased operational costs and the impact on profitability.

A significant destroyer of value is underfunded multi-employer pension plans, common in heavy industry.  Participants cannot leave a multi-employer plan without paying a large penalty, and all participants are required to make up any funding shortfall.  Underfunded multi-employer plans exacerbate the labor cost disadvantage faced by unionized companies.

Long-Term Impact: In the long run, predicting the impact of unionization on a company’s valuation may require a more nuanced approach. Companies that manage to integrate unionized workforces effectively may benefit from enhanced employee loyalty and productivity, which can positively influence customer relations, sales, profitability, market valuation and a company’s brand.

However, the typical experience we’ve seen over time demonstrates the number of threats unionization poses to corporate profitability and market value that are core to the company’s future.

We are currently in a social environment where external stakeholders take note of – and often act upon – the behavior of companies whose products and services they use. Corporate leadership needs to factor that into their calculations about unionization, along with the more straightforward business issues we’ve discussed. That is just one example of the ways in which the impact of unionization on a company’s profitability and valuation is multifaceted, involving both direct costs and indirect effects on productivity and employee relations. While higher labor costs and potential operational disruptions are notable concerns, effective management of union relationships and positive workforce outcomes can mitigate these challenges. Ultimately, the success of unionization in affecting a company’s financial performance depends on how well these factors are managed and balanced.

About the Author:
Andrew Silver is a Managing Director at Oberon Securities, an investment bank that advises middle market companies. He specializes in the industrial sector, including machinery, building products and construction, environmental, metals, general manufacturing and distribution.

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