To split up or not? Conglomerates should never go by off-the-shelf answers

While ITC has succumbed to shareholder pressure, discovery of the true value of its shares is still some distance away.
While ITC has succumbed to shareholder pressure, discovery of the true value of its shares is still some distance away.

Summary

  • ITC Ltd finally gave in to shareholder pressure and hived off its hotels business. But many diversified companies and groups have successfully shrugged off investor calls to focus only on their ‘core competence.’

Activist shareholders have revived the ‘core competence’ debate and are targeting conglomerates to get more out of their businesses. Heeding long-standing shareholder demands, the management of ITC Ltd has finally carved out its hotels business into a separate entity.

This demerger is expected to unlock some value for the ITC scrip, given that the hotel division’s capital appropriation from the company’s cash flows was disproportionate to its contribution to the total revenue pie.

While ITC has succumbed to shareholder pressure after years of resisting calls for a split-up, discovery of the true value of ITC shares is still some distance away; even after the hive-off, ITC still retains conglomerate characteristics, with consumer goods, its agri-business and paper division co-existing with tobacco products.

Unilever is another conglomerate faced with break-up pressure from restive shareholders. This multinational has achieved top-line growth over the decades through a string of mergers and acquisitions. It now has an eclectic portfolio of nearly 400 brands, with money-spinners subsidizing others.

When Unilever decided a year ago to hive off its ice-cream business, critics said it was not enough. Wall Street activists asked for a complete slice-up by market focus, arguing that the sum of its parts would be worth more than the whole.

Also read: Can ITC’s boosters help it take off?

Time was when conglomerates were the accepted corporate structure. However, the rise of institutional and activist investors since the mid-1980s pitted this structure as antagonistic to emerging standards of corporate finance, which had started taking a closer look at returns on capital invested.

There were two reasons. One, investors felt that managing diverse businesses diffused the management’s focus, with less attention paid to winners; in addition, such a structure allowed the steady build-up of an unwieldy corporate bureaucracy, which hindered productivity and drained resources.

Investors also argued that the consolidated value of a conglomerate not only camouflaged the true value of its constituent parts, but was also depressed by the weight of laggard businesses that soaked capital for meagre profits.

Thus was born the ‘conglomerate discount,’ or the capital market’s way of valuing it as less than the sum of its parts. Core competence became a prominent leitmotif in management pedagogy.

Also read: How India's conglomerates are embracing the ‘power of one’

But, like all things in life, there are no absolute rules. Many companies opted not to abide blindly by the core-competence fad. General Electric under the leadership of Jack Welch stood out as an outlier; it did well by insisting that all constituent businesses figure in the top two or three in their respective sectors.

Even Warren Buffett’s Berkshire Hathaway, with many diversified businesses under its belt, has bucked the trend; it actually enjoys a conglomerate premium. Conglomerates are also common in emerging markets, especially in India.

With the Indian corporate sector dominated by business families, such a structure offers some inherent advantages: clarity in succession dynamics for the next generation, efficiency in the allocation of capital to growth businesses, and proficiency in hedging the top-line against downturns in any one market category. A good example is Grasim Ltd.

It is part of the Kumar Mangalam Birla Group and has a presence in viscose fibre and yarn, textiles, chemicals, insulators, paints and B2B e-commerce. Investors, thus, need to judge a company on its individual merits and not by transient market trends.

Also read: India’s most valuable conglomerate is an odd one. It’s run by a professional

 

 

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