Conglomerate (company)

During the 1960s, the United States was caught up in a "conglomerate fad" which turned out to be a form of an economic bubble.[3]

Due to a combination of low interest rates and a repeating bear-bull market, conglomerates were able to buy smaller companies in leveraged buyouts (sometimes at temporarily deflated values).[4] Famous examples from the 1960s include Gulf and Western Industries, Ling-Temco-Vought,[5] ITT Corporation,[5] Litton Industries,[5] Textron,[5] and Teledyne.[5] The trick was to look for acquisition targets with solid earnings and much lower price–earnings ratios than the acquirer.[6][7] The conglomerate would make a tender offer to the target's shareholders at a princely premium to the target's current stock price. Upon obtaining shareholder approval, the conglomerate usually settled the transaction in something other than cash, like debentures, bonds, warrants or convertible debentures (issuing the latter two would effectively dilute its own shareholders down the road, but many shareholders at the time were not thinking that far ahead).[8] The conglomerate would then add the target's earnings to its own earnings, thereby increasing the conglomerate's overall earnings per share.[7] In finance jargon, the transaction was "accretive to earnings."[6] The relatively lax accounting standards of the time meant that accountants were often able to get away with creative mathematics in calculating the conglomerate's post-acquisition consolidated earnings numbers.[9] In turn, the price of the conglomerate's own stock would go up, thereby re-establishing its previous price-earnings ratio, and then it could repeat the whole process again with a new target.[7][9] In plain English, conglomerates were using rapid acquisitions to create the illusion of rapid growth.[7]

In 1968, the peak year of the conglomerate fad, U.S. corporations completed a record number of mergers: approximately 4,500.[10] In that year, at least 26 of the country's 500 largest corporations were acquired, of which 12 had assets in excess of $250 million.[10]

All this complex company reorganization had very real consequences for people who worked for companies that were either acquired by conglomerates or were seen as likely to be acquired by them. Acquisitions were a disorienting and demoralizing experience for executives at acquired companies—those who were not immediately laid off found themselves at the mercy of the conglomerate's executives in some other distant city.[11] Most conglomerates' headquarters were located on the West Coast or East Coast, while many of their acquisitions were located in the country's interior.[11] Many interior cities were devastated by repeatedly losing headquarters of corporations to mergers, in which independent ventures were reduced to subsidiaries of conglomerates based in New York or Los Angeles.[11] Pittsburgh, for example, lost about a dozen.[11] The terror instilled by the mere prospect of such harsh consequences for executives and their home cities meant that fending off takeovers, real or imagined, was a constant distraction for executives at all corporations seen as choice acquisition targets during this era.[12]

The chain reaction of rapid-growth-through-acquisitions could not last forever. When interest rates rose to offset rising inflation, conglomerate profits began to fall. The beginning of the end came in January 1968, when Litton shocked Wall Street by announcing a quarterly profit of only 21 cents per share, versus 63 cents for the previous year's quarter.[13] It would take two more years before it was clear that the conglomerate fad was on its way out.[13] The stock market eventually figured out that the conglomerates' bloated and inefficient businesses were as cyclical as any others—indeed, it was that cyclical nature that had caused such businesses to be such undervalued acquisition targets in the first place[6]—and their descent "put the lie to the claim that diversification allowed them to ride out a downturn."[14] A major selloff of conglomerate shares ensued.[15] To keep going, many conglomerates were forced to shed the new businesses they had recently purchased, and by the mid-1970s most conglomerates had been reduced to shells.[16] The conglomerate fad was subsequently replaced by newer ideas like focusing on a company's core competency and unlocking shareholder value (which often translate into spin-offs).

In other cases, conglomerates are formed for genuine interests of diversification rather than manipulation of paper return on investment. Companies with this orientation would only make acquisitions or start new branches in other sectors when they believed this would increase profitability or stability by sharing risks. Flush with cash during the 1980s, General Electric also moved into financing and financial services, which in 2005 accounted for about 45% of the company's net earnings. GE formerly owned a minority interest in NBCUniversal, which owns the NBC television network and several other cable networks. United Technologies was also a successful conglomerate until it was dismantled in the late 2010s.

With the spread of mutual funds (especially index funds since 1976), investors could more easily obtain diversification by owning a small slice of many companies in a fund rather than owning shares in a conglomerate. Another example of a successful conglomerate is Warren Buffett's Berkshire Hathaway, a holding company which used surplus capital from its insurance subsidiaries to invest in businesses across a variety of industries.

• Diversification results in a reduction of investment risk. A downturn suffered by one subsidiary, for instance, can be counterbalanced by stability, or even expansion, in another division. For example, if Berkshire Hathaway's construction materials business has a good year, the profit might be offset by a bad year in its insurance business. This advantage is enhanced by the fact that the business cycle affects industries in different ways. Financial Conglomerates have very different compliance requirements from insurance or reinsurance solo entities or groups. There are very important opportunities that can be exploited, to increase shareholder value.
• A conglomerate creates an internal capital market if the external one is not developed enough. Through the internal market, different parts of conglomerate allocate capital more effectively.
• A conglomerate can show earnings growth, by acquiring companies whose shares are more discounted than its own. In fact, Teledyne, GE, and Berkshire Hathaway have delivered high earnings growth for a time.[18]

• The extra layers of management increase costs.[19]
• Accounting disclosure is less useful information, many numbers are disclosed grouped, rather than separately for each business. The complexity of a conglomerate's accounts make them harder for managers, investors and regulators to analyze, and makes it easier for management to hide issues.
• Conglomerates can trade at a discount to the overall individual value of their businesses because investors can achieve diversification on their own simply by purchasing multiple stocks. The whole is often worth less than the sum of its parts.
• Culture clashes can destroy value.[20][21]
• Inertia prevents development of innovation.[22]
• Lack of focus, and inability to manage unrelated businesses equally well.[23]
• Brand dilution where the brand loses its brand associations with a market segment, product area, or quality, price or cachet.
• Conglomerates more easily run the risk of being too big to fail.

Some cite the decreased cost of conglomerate stock (a phenomenon known as conglomerate discount) as evidential of these disadvantages, while other traders believe this tendency to be a market inefficiency, which undervalues the true strength of these stocks.[24]

A relatively new development, Internet conglomerates, such as Alphabet, Google's parent company[25] belong to the modern media conglomerate group and play a major role within various industries, such as brand management. In most cases Internet conglomerates consist of corporations who own several medium-sized online or hybrid online-offline projects. In many cases, newly joined corporations get higher returns on investment, access to business contacts, and better rates on loans from various banks.