Conglomerate and conglomerate discount: When a corporate structure can make sense

Three levers of value generation in a conglomerate

In a conglomerate or conglomerate, the corporate headquarters or corporate center (there is probably no clever German translation) has essentially three options for creating value for the individual businesses or business units and the entire group. These are three levers

Leadership: Managing the individual businesses through efficient capital allocation, setting the right incentives for the management teams, active management, if necessary, providing methodological expertise and tools, etc.

Synergies: Benefits from the relationship of the businesses or subsidiaries with each other. Here it can be e.g. to buy together raw materials, transfer knowledge or share a strong corporate brand

Services: Essentially the central provision of certain services, such as the preparation of the tax declaration, the IT-Helpdesk, the central further education institution etc.

The fact that the vast majority of conglomerates in the market is valued at a discount (the so-called conglomerate discount or conglomerate discount) suggests that the market usually does not believe in the existence of these value levers or that management can raise these values ,

Of course, it could also be that the market does not understand the advantages of the corporate structure. But value investor may not be the best idea. Not because it could not be true, but above all because, due to the current trends in the capital market, no catalyst or catalyst will presumably exist, which will cause the share price to rise again in an unchanged structure and reflect the value correctly.

But let’s have a look at the individual value levers.

Services

I believe that the provision of centralized services, e.g. the preparation of a joint tax return or the provision of a uniform IT infrastructure, which are the most clearly defined and understandable value drivers for a conglomerate.

But here too, not necessarily a cost-efficient provision can be assumed. Unfortunately, there are also very often cases where the business units or subsidiaries are virtually forced to source centralized services from the Group which could be purchased much more cheaply via the free market – that is, from external sources (even observed several times).

The topics of leadership and synergies, on the other hand, are not only difficult to grasp. As an investor you have to be able to understand these points based on outside-in information.

guide

Leadership can be a significant value driver for a conglomerate. In fact, there are some conglomerates that are not given a conglomerate discount, mainly because of the leadership aspect of the market, but instead even with a premium.

Berkshire Hathaway is probably the best and best known example. CEO Warren Buffett gives the management of the individual businesses a great deal of freedom and uses an incentive system that links the remuneration of the managers very closely to the company’s success. This has worked well in the past and resulted in a premium rating.

Another example of a conglomerate that is typically premium-rated by the market because of its leadership is Danaher (DHR). Danaher is kind of like a grocery store. Danaher owns approximately 30 essentially independent individual companies, which are assigned to 4 different segments (Life Sciences, Dental, Diagnostics, Environmental).

You can already guess that this is not about synergy effects or central services. Instead, Danaher’s great value contribution is in providing management expertise. Accordingly, it is only invested where Danaher can provide significant added value with his management skills.

The Danaher Management System is a kind of holistic system consisting of a number of methods and tools that address, among other things, the topics of processes, lean supply chain, growth and leadership. Especially for the smaller companies that Danaher typically acquires, these methods and tools can be a significant value generator.

The premium valuation of a conglomerate is therefore no coincidence and a conglomerate discount is not always justified (even if there are no great synergy effects).

synergies

The term synergies is something like the secret weapon of the CEOs of conglomerates. Whenever the alleged advantages of conglomerates come up against independent business units, the concept of synergy also regularly occurs. Incidentally, this also applies to planned acquisitions and takeovers. For here, the synergies that can be achieved after a merger are actually always an essential part of the justification for a deal … and that synergies do not necessarily always exist in the corresponding order of magnitude, you can also read in my article on acquisitions (and why they usually do not work). read.

Synergies can be addressed as already mentioned above, e.g. arising from the joint purchase of raw materials. But also from a more efficient use of production capacities (which need not necessarily be the same product), the transfer of knowledge and / or technology and so on. The use of a common platform across the various brands (Audi, VW, Skoda, Seat, etc.) is e.g. a significant cost advantage for the car manufacturer Volkswagen (VOW).

But even in the universe of conglomerates there are companies in which there are synergies on a larger scale and therefore no conglomerate discount exists. One example is the company 3M (MMM). The keyword here is innovation. By exploiting synergies, 3M is able to develop tremendous innovative power. As a result, a large proportion of 3M products (approximately 40%, if I remember correctly) are less than a few years old. With more than 55,000 products this is quite remarkable and a big driver of the premium rating.

Conglomerate and conglomerate discount

In most cases, synergies in conglomerates are not necessarily very pronounced, central services are too expensive, and the management of businesses or business units is not strong or consistent enough. Active portfolio management (for example through an efficient allocation of the investment capital or consistent portfolio adjustment) and also a clear incentive (for example, coupling a large part of the manager’s remuneration to the company’s success) usually only take place to a very limited extent. No wonder then that the market often rates such conglomerates only at a discount to the intrinsic value