C Gopinath

Too big to succeed

C GOPINATH | Updated on March 09, 2018 Published on February 19, 2015

Why it’s downtime for conglomerates

WR Grace, a company that used to be in many diversified businesses such as banking, shipping and fertiliser inputs, and began focusing on chemicals in more recent times, has announced a further narrowing.

It is going to split itself into two companies, one dealing with construction-related products such as cement additives and sealants, and coatings for metal cans; and the other focused on specialty chemicals. The (market) value of the two parts are expected to be greater than the combined whole. This turns synergy on its head!

Conglomerates pose particular challenges in the marketplace. CEOs love to head companies that span multiple businesses because a lot of prestige comes with size and reach. Scholarly research, which calls this vainglorious behaviour ‘hubris’, has found it to be a relevant variable explaining the formation of conglomerates.

In the old days, conglomerates would be justified on grounds that different businesses go through different cycles and so the combination reduces volatility in performance. More recently, the popular explanation is synergy. Combinations of businesses are supposed to generate mystical savings and other benefits that have rarely been established in good research.

Many is not cool

One major disadvantage that has been established is the so-called conglomerate discount. It becomes difficult for analysts to evaluate a company in different lines of business, often because the analyst is an expert in only one of them! So, the overall value of the company lags. Ask Jeff Immelt, CEO of the classic conglomerate, GE. After the heyday of his predecessor Jack Welch’s leadership (and some would say, hype), GE stock has languished, not rising above $30 in recent times, almost half that of its heyday.

Unlike in the case of Grace where the drive to split was internal, many other diversified businesses have been facing external pressures to divest and/or split.

One current churn is at DuPont, being challenged by Trian Fund Management, a large investment fund. Actually, performance has not been an issue at DuPont, which has done better than comparable firms. However, Trian, which holds 2.7 per cent of the shares, wants four seats on the DuPont board and wants the company to be split into three companies focusing onagriculture and nutrition, industrial materials, and performance chemicals.

Another activist investor, Dan Loeb, is targeting Sony, a company that has been languishing for a long time. Loeb argues Sony’s entertainment division, which forms 40 per cent of the company, needs to be separated from the rest of the electronics, so it can fly free.

Under pressure

Indian conglomerate businesses have been singing a different tune, though. For one, many emerged in an era when stock market performance was not the issue but one of access to licences, and access to capital. This allowed them entry into different lines of disparate businesses, which they were able to build ground-up often with sound collaborations.

They continue to leverage their brand names to move into different areas, but as stock markets and the nature of competition become more sophisticated, it remains to be seen whether they can withstand the pressure to focus on separate lines of business and demonstrate better performance.

The writer teaches at Suffolk University, Boston, and Jindal Global Business School, Delhi NCR

Published on February 19, 2015
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