C Gopinath

Why conglomerates are breaking up

C. Gopinath | Updated on November 17, 2021

Some conglomerates are splitting to add shareholder value

Johnson & Johnson, the US health products company, announced last week that it plans to split into two publicly traded companies. One will deal with the consumer products that includes brands like Neutrogena, Tylenol and Listerine, and the other with the medical devices and prescription drugs business.

One of the justifications given by the company was that the two businesses were diverging; the former with lower margins and growing more slowly and the latter with higher margins and less predictable. According to the company, by being independent they will be better able to allocate resources directed towards innovation and make tailored decisions, which means the corporate office of the combined company had not done a good job of that. We’ll get back to that later.

GE’s move

GE also announced it wants to split into three companies. It was the text book example of a conglomerate, and was at one time into consumer products, energy and power, financial services, infrastructure, technology, media and entertainment, and so on. With stock value at a low stand still for many years now, the company kept getting out of its various businesses one by one. Now, it would split into independent companies focused on aviation, healthcare and energy.

GE, under CEO Jack Welch (1981-2001), kept adding businesses and charmed the investors. Stock price kept rising and his annual statements to shareholders were lectures on management concepts about leading segments, how to evaluate personnel, and so on. It was the most valuable company by capitalisation for awhile and could do no wrong. It provided its stockholders smooth earnings growth and a steady dividend. It was considered the epitome of good management, and those who lost the race to senior leadership in the company went on to become CEOs at other major enterprises. But some acquisitions went wrong and many segments the company was operating in were not so benign anymore. Toshiba, the Japanese conglomerate, also said it would split into three: one focused on infrastructure, a second on electronic devices and the third on flash memory and said it is facing pressure from shareholders for a more focused structure.

Multi-business companies justify their existence by arguing that they provide good returns due to their diversification, and the ups-and-downs of different businesses compensate each other. But increasingly, it has become obvious that the individual stockholder can diversify his or her portfolio more efficiently than the company can.

Multi-business companies also argue that good management is transferable across businesses. That is arguable and often depends on the kind of industry. They then argue that they generate synergy and can wring out functional efficiencies by combing businesses. But few have integrated their businesses effectively to make that work. The problem with these conglomerates is that sooner or later, their diversification exceeds the capacity of their corporate office to provide efficient leadership and market-efficient resource allocation. Moreover, analysts who follow these companies cannot often make out the future prospects of these entities that mix apples and oranges together. So their stock value ends up suffering from what is often referred to as a ‘conglomerate discount.’

That’s when another white knight will enter the scene and show how he or she can provide grater value by breaking them up.

Do these splits mean that the era of conglomerates is over? No, there are other white knights who are convincing their boards otherwise. The desire for faster growth will always lead ambitious CEOs to pursue different businesses that they can acquire and quickly add to their top line. Consultants will always be available to provide a justification for the acquisition, using meaningless terms like synergy. And let’s not also forget that some CEOs do make the multiple-businesses work at least for some time while they cash their stock awards.

The writer is an emeritus professor at Suffolk University, Boston

Published on November 17, 2021

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