Is This Really the End of the Conglomerate?

In November, General Electric made headlines when it announced that it would split into three separate public companies (focused on aviation, energy and health). It marks the end of one of North America’s most powerful conglomerates—famous for its appliances and light bulbs. 

It’s not the only conglomerate heading for divorce. A few days after the GE news broke, Johnson & Johnson said it would separate into two companies. And although it wasn’t a classic split, George Weston Ltd. sold its Weston Foods bakery business in October to focus on its Loblaw retail and Choice Properties real estate businesses.

These breakups and others have caused analysts, journalists and researchers to speculate. Are we witnessing the end of the conglomerate? Or are these just isolated cases of corporations that stretched themselves too thin?

Synergy or focus?

On the day of the GE breakup, chairman and CEO Larry Culp was asked if his company was giving up on the positive synergistic effects that can come from conglomeration. His response: “I will bet on the benefits of focus every day far more than the often illusory benefits that come from synergies.” That bet appears to be paying off. Following multiple sell-offs, GE’s stock was up 30 per cent this year and its share price rose six per cent on the day of the breakup announcement.

Other companies have seen similar benefits. Danaher Corp., for instance, where Culp was previously CEO, saw its stock climb 273 per cent in the five years following its split. And while the S&P 500 has risen 117 per cent over the past five years, conglomerates like Loews Corp. and 3M Company have only gained 34 per cent and 6.4 per cent over that period, respectively, Bloomberg reports.

Such figures aren’t surprising, says Lynnette Purda, RBC Fellow of Finance at Smith School of Business. “People often refer to a ‘conglomerate discount’ where the sum is worth less than its parts. Whether this is due to the difficulty in managing a group of very diverse businesses or because the lack of transparency doesn’t allow for a refined valuation of the different pieces is difficult to say. But we do know that, in general, the stock market tends to respond quite positively to news of these sorts of breakups.”

The circle of life

RBC Capital Markets analyst Deane Dray recently said the “pendulum is still swinging towards the ‘urge to demerge’ trend.” Yet some aren’t so sure. Purda, for example, doesn’t believe conglomerates are generally doomed.

Barry Cross, Distinguished Faculty Fellow of Operations Strategy at Smith, points to successful conglomerates here in Canada like Brookfield Asset Management and Telus. “I think breakups will always happen,” Cross says. “They’re based on individual organizations not getting done what they want to get done. So whether it’s a leadership problem or an area that they’ve been focusing on that’s not part of the way today’s marketplace is emerging, they’re just saying, ‘OK, time to shut that down.’ We’ve seen that happen for some time, and I don’t think it’s going to go away, but I don’t think it's the end of the conglomerate either.”

Indeed, conglomerates tend to come and go. In the 1980s, the number of corporate breakups rose. Then, in the 2000s, came a wave of acquisitions. What we’re witnessing now could be part of what Wharton professor Emilie Feldman calls “the circle of life” in business.

“Companies articulate this logic that there is value to be had by combining these different businesses in the same organization because it makes their transactions simpler, more straightforward, easier to execute,” Feldman said recently. “Eventually, some of that logic deteriorates, so they separate. Then, at some later point in the future, there might actually be a resurgence of the logic.”

All about value

So why might we be seeing more breakups now? One reason could be poor acquisition decisions, says Michelle Lee, assistant professor of strategy and organizations at Smith. “GE’s former CEO, Jeffrey Immelt, for instance, bought and sold over $100 billion in businesses during his time there—and there were more failures than successes with those acquisitions. That was a fatal flaw because conglomerates usually have access to a large amount of internal capital. They need to be able to allocate their capital really well when making acquisition and investment decisions.”

A rise in shareholder activism may also play a role, says Lee. Some of these activists pressure companies to divest businesses to bolster shareholder value. “And today, there’s more pressure on conglomerates to create value, so if they’re not able to do that, they may have to break up.” 

In some cases, creating value means a refocusing of skill sets, which is what some conglomerates hope to do by spinning off businesses, says Cross. “They’re saying, ‘We have to divest ourselves of some of these distractions out there. These business units aren’t doing what they’re supposed to be doing for us while we focus on these [other] areas where we know we can excel.’”

Still, as older industrial conglomerates break up, newer tech giants are turning into conglomerates. A prime example is Amazon, which now operates grocery stores and has expanded into health care. These additions may not appear to be part of Amazon’s core business, but they can be natural byproducts of its operations, says Lee. “Amazon’s huge investment in web services, warehouses, logistics, distribution and cloud services, for example, actually makes it easier to diversify into these other areas since these large upfront fixed costs lower their costs of diversifying into businesses that leverage these core capabilities.”

Whether it’s GE or Amazon, however, organizations need to create value, says Cross. “Just because you’re big doesn’t mean you can’t fail. The organizations that realize the more they focus on developing a skill set or core assets that are going to differentiate them, the more they’re going to be able to succeed and prosper going forward.”