Conglomerates, monuments in danger

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04/04/2019 | 05:26 pm
Conglomerates have become obsolete. And the resilient ones, with a few exceptions, are unlikely to change investors' minds. General Electric shareholders know something about this. Let it be said in the 21st century, a well-valued company is a company that focuses on a core business.

"Conglomerates are in structural decline," says Jefferies Bank, which has conducted a study on them based on the work of several of its analysts. This disaffection can be explained by several factors, but above all by poor stock market performance. “Investors tend to overlook illogical structures, unsatisfactory governance and poor disclosure if the investment performance is above average; one can argue that the entire private equity industry is built on this premise, i.e. superior performance and inferior governance. This is just human nature. People will put up with poor behaviour, both by individuals and companies, if overall performance, however defined, is good.”

An empirical definition of the conglomerate would define it as a group comprising several activities that have no or few operational synergies between them. Their supporters believe that they make it possible to obtain better financing conditions, optimize capital allocation or reduce risks (due to diversification). On the contrary, their critics point out their lack of transparency, high management costs, the risk associated with incessant external growth operations and many other factors. Overall, Jefferies is more on the side of the critics: the disadvantages outweigh the advantages. At least at the moment.

A stock market underperformance

To gauge the stock market interest of the conglomerates, the bank selected a representative panel of ten well-known stocks from both sides of the Atlantic: AAB, Daimler, Danaher, General Electric, Honeywell, Philips, Siemens, ThyssenKrupp, United Technologies and Volkswagen. Over 10 years, seven did less well than the indices, often with large gaps. Danaher and United Technologies are the exceptions, since their stock market careers are exceptional. This did not prevent the second nominee from announcing its demerger into three entities (see here an inventory of UTIs before the demerger). Volkswagen is the third case in positive territory, but it presents an atypical profile: the title progressed a lot after the financial crisis thanks to the simplification of the capitalist links with Porsche, but it has lost a lot of ground since 2012. Jefferies' work shows that the poor stock market performance of other players is generally explained by negative or chaotic earnings per share trajectories. On average over 10 years (2009/2018), the 10 conglomerates gained 46%, compared to 120% in DAX, 151% in STOXX EUROPE 600 Industry and 193% in S&P Industrial.

MarketScreener from Jefferies data

But all may not be lost for conglomerates, since historically, they have repeatedly seduced and then driven investors away. “Standing back and taking a very long-term view, we think it is inevitable that conglomerates will come back in fashion; it's only the timing that it hard to forecast," Jefferies continues. The cocktail for a comeback could consist of very limited organic growth prospects, easy access to financing and the possibility of using IT and artificial intelligence to reduce management costs. The day the planets are aligned, new groups of companies could emerge, the bank concludes.
Anthony Bondain
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