In today's Finshots we see why conglomerates across the world are breaking up
A couple of weeks back General Electric (GE) decided to split its business into three separate publicly listed companies. The three new companies will now focus on three different lines of business — aviation, healthcare and energy. One company will make jet engines — a behemoth in its own right. The second will focus on healthcare — more specifically manufacturing critical life saving medical equipment. And finally, the third company will continue to light up the power business — GE’s bread and butter. Within a couple of years, these offsprings are expected to operate independently with distinct management teams and their own board of directors. And if all goes according to plan, one of America’s largest and most valuable public company will cease to exist as a conglomerate in a few years.
But here’s what’s interesting — It’s a trend that we are seeing across the board.
In a matter of weeks after GE announced its split, Johnson & Johnson (JNJ) did the same thing. They split their business into two — a consumer products company and a separate company to market drugs and medical devices. And then, in the same week, Japanese electronics giant Toshiba also announced it would split itself into three separate parts.
Three iconic 100+-year-old companies pushing the ‘kill conglomerate’ button. At the same time.
Makes you wonder, doesn’t it?
Is bigger no longer better?
Why are these multi-billion-dollar conglomerates devolving into simple enterprises?
Well, first off, we must define conglomerates. These are large companies that own a controlling stake in several different, seemingly unrelated companies. And for a long while, academics and entrepreneurs believed these larger businesses held tremendous potential. For instance, when you have multiple lines of businesses, all operating under the same banner, you can diversify risk to a large degree. Imagine running an extremely profitable petrochemical business and then realising you could do so much more in the commerce and telecom industries alongside it. You could build these businesses separately or merge and acquire companies that seem like a right fit.
In the event you’re short of funds, you could funnel money between businesses and help ease the load. You could also benefit from economies of scale i.e. You could work with the same contractors, maybe rely on the same talent pool and share resources at a bargain price. In other cases, you could actually tide over a crisis when you’re all part of one big family. A steel tycoon could have a few bad years when the commodity cycle bottoms out. In such cases, the consumer goods business could come to the rescue and help stabilize things. So, for decades, companies have either lined up to acquire unrelated businesses or raise them from the ground up. It is the reason why Coca Cola acquired Columbia Pictures in 1982, or why Disney ventured into building theme parks and hotel resorts.
They pursued this strategy in a bid to limit their downside and it worked pretty well for almost an entire century. Cut to the 21st century, however, some of these mega-companies are crumbling under their own weight.
GE for instance has been encumbered with enormous debt and underperforming operations. The company has lost a lot of its value over the past few years and shareholders are looking for a silver lining. That silver lining, believe it or not, may appear when these businesses split up and start doing their own thing without being in anybody’s shadow. In fact, when companies split up and go public, they almost always trade at a premium and so there’s some immediate value unlocking here. There’s also the fact some of these companies now believe that they may need to be nimble — especially in an age where disruptions are commonplace. So the idea is to pop a bitter pill right now in the hopes of safeguarding shareholder interest over the next few decades perhaps.
But here’s the final kicker — While conglomerates are breaking up in the US and some parts of Asia, Indian conglomerates still seem to be going stronger than ever. What’s the reason for this resilience? Well, we don’t know. But it would make for a good story, wouldn’t it?