Conglomerates — companies with entities operating in different industries or lines of business ― were in vogue for most of the 20th century. History buffs are surely familiar with the large conglomerates of the 1960s and 1970s, like Ling-Temco-Vought (LTV) with its dozen different lines of business (consumer electronics, tennis rackets, packaged meat, aircraft, steel, etc.), ITT Corp., and Litton Industries. A reporter at the time even gushed that “it is theoretically possible for the United States to become one vast conglomerate.” This came about because most of the mergers in the 1960s and 1970s were conglomerate (buyer and seller operating unrelated businesses), since horizontal (same industry) and vertical mergers were closely scrutinized and often rejected by FTC regulators.
Contrary to the hype, all those conglomerates petered out sooner or later for the simple reason that there was no economic justification for their existence. If an investor wishes to diversify and have stakes in, say, airlines, oil and gas, and insurance, he or she can simply buy shares in companies operating in these industries. Investors don’t need conglomerate companies to do the diversification for them. The alleged synergies and the benefits of “internal capital markets” touted by conglomerate executives turned out to be chimera. Conglomerates didn’t create any efficiencies and they were very hard to manage. They were, in fact, power grab and empire building by executives at the expense of unsuspecting, easy-to-hype investors.
Worse yet, researchers identified a substantial “diversification discount” (loss of value) when they compared the market value of conglomerates with that of similar “stand-alone” (single industry) enterprises. A negative synergy, so to speak, destroying shareholder value. (See, for example, Rajan, R., H. Servaes, and L. Zingales,” The Cost of Diversity: The Diversification Discount and Inefficient Investment,” The Journal of Finance, March 2007. The researchers estimate the mean diversification discount to be almost 10% dead weight.) The researchers estimate the mean diversification discount to be almost 10% dead weight. The only large U.S. conglomerate which seemed to defy economic logic was General Electric (GE), which under the astute management of Jack Welch kept rising in value during the 1980s and 1990s. But after Welch, GE’s value plateaued, then gradually decreased and in recent years met the inevitable fate of conglomerates and became a shadow of itself.
So it seems that the days of the large industrial conglomerates are over in the U.S. and other major economies. The remaining conglomerates are shrinking, breaking up or spinning off unrelated operations to remain viable: GE, United Technologies, Hewlett Packard (HPQ), Honeywell (HON), and DowDupont (NYSE:DD) in the U.S., ThyssenKrupp (OTCPK:TKAMY), Siemens (OTCPK:SIEGY), and ABB (ABB) in Europe, among others. Economic logic finally reigned: There is really no reason for corporate managers to do what investors can do cheaper on their own.
But just as it seemed that the corporate dinosaurs met the fate of their biological kins, a new type of conglomerates emerged during the past 10-15 years. I became aware of this when I analyzed a sample of 36,000 corporate acquisitions which I assembled for a book on M&As. To my great surprise, I found that the historical percentage of conglomerate (unrelated) acquisitions — 35% ― jumped to 47% just in the past decade. The dinosaurs are back, but they are different. They are now the fashionable, high-growth tech and media companies venturing far out of their core business to acquire unrelated enterprises.
Examples abound: Amazon (AMZN) buying Whole Foods, PillPack (online pharmacy), or Wondery (podcasts), Alibaba (BABA) acquiring Ele.me (food delivery), Lululemon (NASDAQ:LULU) purchasing Mirror (sports instruction), AT&T (T) acquiring Time Warner, Comcast (NASDAQ:CMCSA) buying Sky (a European broadcaster), Disney (DIS) merging with 21st Century Fox, and the list goes on. Are these modern conglomerates different from the failing industrial dinosaurs of old? That’s an important question for investors.
A few of the tech conglomerate acquisitions, like YouTube by Google (NASDAQ:GOOGL) (GOOG), are very successful, and some ventures into unrelated operations, like Microsoft’s (MSFT) and Amazon’s (AMZN) cloud operations work very well, but those unrelated operations are largely managed separately. They aren’t merged into the parent company to achieve synergies. They really resemble Warren Buffett’s unrelated investments, rather than true conglomerate acquisitions.
But many of the tech and telecom acquisitions still have questionable economic justification. For example, AT&T’s CEO praised its Time Warner’s acquisition as a necessary vertical integration: content into distribution. Perhaps, but I am old enough to recall that a similar justification was given 20 years ago for the ill-fated acquisition of Time Warner by AOL, an internet services distributor. Moreover, Verizon (VZ), for one, seems unconvinced by the vertical integration logic, nor are AT&T’s shareholders so far.
Are the new tech conglomerates different from their erstwhile and ill-fated industrial behemoth? I doubt it. Many of the conglomerate acquisitions, even by highly successful firms, didn’t live up to expectations. Microsoft’s acquisition of Nokia for $7.9 billion in 2014, Hewlett Packard’s $11.1 billion acquisition of Autonomy in 2011, Yahoo! $1.1 billion acquisition of Tumbler (social networking), Alcatel’s $13.4 billion purchase of Lucent (telecom equipment) in 2006, eBay’s (EBAY) $2.6 billion purchase of Skype in 2005, News Corp. (NASDAQ:NWSA) purchase of MySpace also in 2005 for $580 billion, and let’s not forget GE’s $9.5 billion acquisition of Alstom (coal turbines) in 2015. This is a very partial list of many billions of dollars conglomerate disappointments.
So count me skeptical regarding the economic viability of the modern conglomerates. Some, like Google, Amazon, and Microsoft, have an enormously profitable core operation which can absorb failing acquisitions for a long time. Smaller, less profitable tech and media companies engaged in conglomerate acquisitions are more vulnerable. In the final analysis, most of the conglomerates of old and their new brethren still lack economic justification.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Note: This post was first published here at SeekingAlpha.com on Jan. 15, 2021.
Lev End Of Accounting Blog 