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Has the Big Corporate Unwind Gone Too Far?


Contrary to the lyrics, breaking up is quite easy to do, at least on Wall Street. But it often leaves investors with long-term heartache.

Companies with unrelated or loosely related businesses have long been out of favor with investors and have increasingly become the targets of activists. The latest to see their corporate structures come under attack are

AT&T,

Marathon Petroleum

and

Emerson Electric.


EMR 1.23%

While academic research suggests that complicated companies such as conglomerates detract from value, demerging can pose problems of its own.

In the first nine months of this year, there was a record high in spinoffs and split-offs globally as volume reached $205.4 billion, almost doubling the volume of $114.2 billion for the same period a year ago, according to Dealogic.

The industrial sector in particular has embraced breakups.

General Electric’s

big unwind was triggered by cash needs. The company plans to reap some $38 billion from divesting assets including its biotech division to

Danaher

and selling its controlling stake in Baker Hughes.

United Technologies

said it would break apart, though it recently bulked up again with a deal to buy

Raytheon.

Arconic

and Danaher have both undergone splits. DowDuPont undertook a multiyear review process before its final split into three parts this past spring.

Emerson Electric may be the next to hive off parts of itself. Hedge fund D.E. Shaw, which only recently dipped a toe into activism, is pushing for a split at the company that makes everything from flame arresters to oil storage tanks. Its two main businesses are automation solutions, selling instruments and parts to industries including energy and pharmaceuticals, and commercial and residential solutions, providing appliances including air conditioners.

Emerson is under the microscope for good reason. Its shares have significantly underperformed the S&P 500 over the past one, three, five and 10 years. The company said this week that it would undergo a strategic review.

Corporate chiefs often give at least one of three justifications for building conglomerates. They can achieve cost savings from merging headquarters, for example. But it helps if there are other overlapping costs as well. Executives might be able to cross-sell or upsell products. Or perhaps their business lines are similar but on different cycles. Aligning them can smooth out lumpy cash flows and enable a business to take on more debt.

GE plans to reap some $38 billion from deals including the sale of its controlling stake in Baker Hughes.


Photo:

brendan mcdermid/Reuters

But promises of synergies can prove ambitious, and the market often doesn’t reward companies for mergers. Conglomerates trade at a 13% to 15% discount to the sum of their various parts, says Emilie R. Feldman, associate professor of management at the Wharton School.

According to Donna Hitscherich, senior lecturer at Columbia Business School, investors like simplicity. Moreover, diversification is something that investors can do themselves. If an investor wants to own a hotel company, for example, she could buy shares in one without its being warehoused in a big corporate structure.

Opacity is another problem. Marathon Petroleum has three main businesses and a separately listed master limited partnership. Emerson makes thousands of industrial products, many of which don’t overlap. Investors don’t like what they don’t know, and often discount it.

So as any conglomerate comes under pressure from investors to split up, theoretical models will tend to show that they should. But reality can be different. While the first step is recognizing the market isn’t valuing an asset, the second issue is how, and whether, to get rid of it, Ms. Hitscherich says.

Share Your Thoughts

Which factors support the breakup of a conglomerate? Join the conversation below.

Indeed, many companies that have recently broken up haven’t delivered benefits. DowDuPont’s three successor companies, Arconic and its separated company,

Alcoa,

and GE have all underperformed the market since they wielded the scalpel. The one exception is Danaher, though the spinoff Fortive has struggled.

The reasons vary: Poor management was a problem at GE, while some macro trends have hit the DowDuPont successors. Plain bad timing might also play some role: Trade pressures have hit at Alcoa. What is clear is that separation is no panacea. To reward shareholders over the long term, activist investors need to do more than just break companies up.

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