Conglomerates have always been a part of India’s corporate culture, though the trend has strengthened over the last few years. We draw parallels and differences between India’s recent “conglomerization” and two countries that have had a history of conglomerates—the US and South Korea.
The 1960s in the US were characterized by the unparalleled rise of conglomerates. In the world’s largest economy, conglomerates have been purely acquisitive in nature, perhaps best explained by mangers’ compensation being tied to revenue growth. The most favourable argument for conglomerates was diversification, where in a recessionary environment business segments would complement each other, but more often than not, the purchased frog never turned into the promised prince. Over time, these elusive synergies became harder to realize.
In India, nowadays, it’s impossible to find a pure-play company that is content on focusing on just one business. In the Indian context, however, the “jack of all trades…” argument doesn’t quite hold true. Contrary to the US, conglomerization in India, in the general sense, is not acquisitive. Perhaps that speaks of a nascent economy with a dearth of specialist operators in niche areas. Since most of these businesses are built ground up, the expertise has ample opportunity to develop.
While the older conglomerates in India, such as Grasim Industries Ltd, or ITC Ltd were more along the lines of the diversification model, the newer effort has been more strategic in nature. It isn’t really intuitive, for example, for a retail company to develop an expertise in advertising, or logistics. However, Pantaloon Retail (India) Ltd has been opportunistic, yet strategic in having an advertising company utilizing its mall space and in developing logistics capability to deal with the unavailability of an off-the-rack solution. Not all newfangled managements will, of course, have real vision. Indiabulls group moving from a retail brokerage to microlending to real estate development doesn’t necessarily speak of a strategy, but more of easy access to capital.
The history of conglomerates, or chaebols, in South Korea traced a slightly different path compared with those in the US. The entrepreneurs that formed the eventual chaebols had strong political roots in the 1940s and 1950s. These businesses essentially partnered with the government to develop the state’s vision of converting Korea into an industrial power. The chaebols received priority funding from the banking sector to further the state’s ambitions.
Turning back to the US, with every new acquisition, conglomerates got more unwieldy and it became apparent that there was no genie to be had from this lamp. This led to the era of divestitures, spin-offs—an “unlocking” of shareholder value. So after having been the patient bystander, while the management muddled with mergers and explained how the whole was worth more with the parts, the shareholder was now informed that the parts were worth more than the whole!
While the US managements traced and retraced their definitions of “sum of the parts”, this too is less of an issue in India. Since most businesses tend to be family-run, the entrepreneur invariably continues holding a sizable stake in the company, and generally the interests of the shareholders are aligned with those of the management. The enthusiasm, a tad overzealous, to monetize individual businesses was evident when Jaiprakash Associates Ltd listed a single hydro power plant as a public entity. Although investors don’t like illiquidity, or a lack of scale, monetizing an asset, albeit a good one, that generates a 20%+ROE (return on equity) at three times book value is definitely shareholder friendly (price to book valuation should be directly proportional to ROE).
Of course, not all conglomerates were unsuccessful—while General Electric Co. and Time Warner Inc. have muddled along, a word has to be put in for Berkshire Hathaway Inc. Maybe the secret sauce was in operating like a closed-end mutual fund with a portfolio of firms having independent managements with core expertise, instead of an all encompassing management that dilutes core competency.
In Korea, it is undeniable that the conglomerates have had an enormous role in its development, to the point that they were almost single-handedly responsible in turning Korea into an export powerhouse. However, easy capital accessibility meant high leverage in cyclical industries, leading to a history of solvency issues.
Not unlike the Koreans and the Americans, some herd mentality is just human nature. The stampede into structured retail in India even as commercial rentals were soaring, or the likes of Bajaj Auto Ltd, Exide Industries Ltd, or Max India Ltd originating life insurance, is hardly justifiable.
All in all, conglomerates in India will likely fare better, at least for the time being, than the US where execution was suspect, and in Korea where cyclicality and high leverage is still an issue. The entrepreneurial spirit of Indian businessmen and strategic expansions will mean that these conglomerates will flourish at least until the respective areas mature.
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Rajeshree Varangaonkar and Bharat Indurkar have day jobs with US-based hedge funds. They write every other week. Send your comments to firstname.lastname@example.org