In 2021 we saw the culmination of a multi-year process where conglomerates massively slimmed down and essentially stopped being conglomerates. In the last few years we have seen the dismantling of General Electric, Toshiba, Johnson & Johnson, Siemens, DowDuPont, and United Technologies. At the same time we have seen the expansion of companies like Amazon, Microsoft, Alphabet (parent of Google), and Apple rise and expand into multiple business lines. How did one kind of conglomerate fall while another rose? Where are the differences and similarities? Let us take a deeper look.
Perhaps the best known conglomerate of the past is General Electric (GE). In 2003, GE had 13 operating units covering various businesses such as Finance, Technology, Energy, Media, and Consumer Goods. In the first three quarters of 2021, GE had five business units covering only Energy, Technology, and Energy. In 2003, GE had an average market capitalization of $280B, while GE ended 2021 just under $104B in market capitalization. Or consider Sears and how it went from focusing on retail stores, power tools, and appliances to a conglomerate that encompassed insurance (Allstate), credit cards (Discover), and real estate (Coldwell Banker). Why was the conglomerate such a useful construct? What was their secret?
Conglomerates of the past were thought to be a superior business model because of the following: capital (money) and management. With strong cash flows from existing lines coupled with the ability to raise capital from lenders and investors alike, conglomerates were able to go on buying sprees that added new and purportedly complementary business lines. Also, with a refined acquisition process, conglomerates were supposed to quickly integrate new acquisitions, and if things did not work out, management was supposed to be clever enough to shut things down before they became a drain to the company as a whole.
In the long run, investors reward growth of earnings, and for a time this business model was successful. Perhaps too successful. The desire to become “a conglomerate” permeated the areas of both public companies and private equity. As the number of companies able to marshal vast sums of capital grew, each acquisition candidate found it had a number of bidders. Thus, acquisitions became more expensive and the marginal addition of earnings became less. Conglomerates found they needed to divert resources from stronger business lines either to prop up weaker business units or to pay the corporate dividend. Many began to see that the sum of the parts was greater than the whole, and there was a call to break up the conglomerates and allow the different business units to function on their own. It was the beginning of the end. In the case of GE (and to a lesser extent other conglomerates with financial divisions), the 2008 financial crisis was a further blow that hastened the call to break up these companies.
At the same time we saw the rise of a new type of conglomerate, such as Amazon, Microsoft, Apple, and Alphabet (Google). Like the prior generation of conglomerates, they would subsidize new divisions and acquisitions from more profitable areas, the same way Alphabet has been funding its autonomous driving car company. However, instead of management serving as the unifying theme, the techno-conglomerates of the present day are utilizing the network effect. Today’s conglomerates integrate different products together into “platforms” which potentially makes them longer lasting and more congruous than the conglomerates of the past. Also, with the internet underpinning so many businesses, the techno-conglomerates may be able to reach into various business lines and still deliver earnings growth in a way that separated companies cannot.
The techno-conglomerates of today are just the latest iteration of the dynamic throughout human history where power or dominance amasses to a few (oligopoly), only to give rise to an innate lethargy and inertia that such consolidation creates. In terms of business in the U.S., anti-trust laws are the expression of the balance sought in this dynamic. What must be remembered is that anti-trust laws exist, at the end of the day, to protect the consumer.
Anti-trust laws have taken on a new interpretation in the twenty-first century from the economies of old. We sue tech conglomerates over search engine ad placement and the price of generic smart phone chargers – not the dissolution of a controlling oil empire (Standard Oil) or telecom giant (AT&T). Acquisitions from tech giants (such as Microsoft buying LinkedIn, Google buying YouTube, Facebook buying Instagram, and Amazon buying Zappos) do not fundamentally threaten the way we live day to day. As consumers of their goods and services, we welcome and demand their interconnectedness at zero cost (with the exception of upgrades like Amazon Prime).
The expectation of the “now” economy has been set by the likes of Amazon and Google. They are capitalized to buy up competition, and do so at a rapid pace, with open arms rather than hostility. Most startups saw an Initial Public Offering (IPO) as the pinnacle of their business cycle. More often, an acquisition by a Facebook, Amazon, Apple, Google, Microsoft, or Salesforce is just as sweet. It allows a new technology to plug into a platform that is already used by billions at practically no cost to the consumer. As long as the internet continues to remain neutral and connect businesses and their consumers from local markets to across the globe, there is no telling how far the network affect can reach. However, should any company lose sight of the need to efficiently deliver what was promised to customers, we expect competitors to arise.
Recent Market Volatility
In the first part of 2022, equity markets have been volatile, and we recognize that can be disconcerting. We do encourage you to reach out to your relationship manager and have a discussion. We are here to help you navigate the financial markets, and we appreciate the trust you have placed in us.
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