Why It Is Practically Impossible To Compare Between Conglomerates

Conglomerates: love them or hate them

Published on:
January 26, 2018
Written on:

About The Author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Noam worked as a Vice President in Capital Markets at Silvergate (publicly traded on NYSE under SI since Nov-2019.) At SI, which he joined in 2010, Noam was responsible for advisory services to family offices,  private companies, and financial advisors.

Ask the person next to you at an investment conference for his or her thoughts about companies that own many operating divisions (known as conglomerates in business jargon) and you will get a love-it-or-hate-it type of answer.

Those who love conglomerates will most likely point you in the direction of the synergy and the cost cutting benefits. Their argument will likely include words such as “scale” and “moat” and they will probably say that the larger and more complex the firm is, the harder it is to copy its business model.

 They may also use the term “diversification risk” with the idea that companies that operate in many, diversified operating segments have an operating advantage compared to companies that focus on just one line of business. The basic argument is that business conglomerates are the answer to the epigram that you should never have all your eggs in one basket.

Those who hate conglomerates will likely argue that when you spread your eggs among many baskets, you often forget which basket has which egg and in which basket the egg might be spoiled.

Those who hate conglomerates will argue that all the points made by the love-conglomerate camp are myths. That synergy, the cooperation of two agents to produce a combined effect greater than the sum of their separate effects, is a novel idea borrowed from the world of chemistry, but is hardly seen in the business world where politics and ego tend to dominate rationality. 

They will tell you when companies operate in many different segments, they tend to exhibit a lack of focus, which often results in a subpar performance over many operating segments instead of a stellar performance in just one segment (they may ask you: who was the Olympic medal athlete that had won both the swimming division and the figure skating division? no one would be the right answer).

The hate-conglomerate camp may also point out to you that in the 80s conglomerates were as awed by financial markets as Fintech companies are today. And that the conglomerate business model did not do exceptionally well thirty years ago - mainly due to reasons mentioned in the above paragraph - and that conglmorates will not demonstrate out of the oridnary business perfomrance in the future.

Berkshire Hathaway compared to PICO holdings

Berkshire Hathaway is a popular success story of the conglomerate business model. Its revered boss, Warren Buffett, showed that a firm can be successful while owning many companies with little apparent connection among the operating segments. 

Berkshire’s business focus is vast. From insurance companies such as GEICO to building product companies such as Acme Building Brand; from real estate and brokerage operations such as Clayton Homes to clothing brand companies such as Fruit of the Loom).

But can any company become a Berkshire Hathaway? Last week, I came across PICO Holdings (PICO), a company that saw its stock decline from $20 to $13 over the past year (and it just so happens that its corporate office is across the street from where I practice Yoga.)

PICO Holdings had four materially different operating segments over the past few years. The company is in the water rights business through Vidler Water Company, the real estate business through UCP (where it develops land and builds homes - the company owns over 6,000 lots),

PICO Holdings is also in the venture capital business. It owns common and preferred stock of, and has a made a loan to Mindjet, a San Francisco-based software company. And in July 2015, management sold all of the assets used in the agribusiness segment.

Management’s scope of business has yet to prove to be a viable business model (this last sentence is my attempt to be politically correct. I should have written more bluntly: PICO is losing shareholder’s money and its future looks ominous at best). The company showed operating losses over the past decade. And management was not shy about taking additional debt obligations to sustain operations. Five years ago outstanding debt obligations were $46 million and now have morphed to $161 million. Or, in percentage: total liabilities grew by 246% over the past five years while assets only grew by 33%. Unsurprisingly, book value per share declined from $20.92 to $14.22 over the same time period. 

Not a heroic financial record.

The challenge (and lure) of a conglomerate

Valuing, analyzing and attempting to understand companies is a challenging task. And when I try to understand the value of a conglomerate, the task is harder and more complex. It is almost impossible to specualte who may purchase the company in the future; it is practically a guessing game to find comparable companies or competitors to estimate operating margins and value based on comparable valuations; and forget about having a reasonable estimate of which operating segment the company will be in the future. 

Add to that the regulatory risk. Since the 60s, there has been a growing sentiment that big businesses are evil and small businesses are good. And whether the prior statement is valid, what can easily be observed is that the bigger the business, the greater the regulatory pressure to dissemble the business into different parts. This “macro” risk complicates the valuation even further.

Yet I understand where the conglomerate lure comes from. I believe we all aspire - for some of us consciously, and for others, subconsciously - to have the broad intellectual scope of the Renaissance Man, where one’s interests included painting, sculpting, science, music, mathematics, engineering, literature, anatomy, geology, astronomy, botany, writing and cartography (visit Leonardo Da Vinci’s Wikipedia page if you don’t believe me). And perhaps we all dream of becoming owners of a Renaissance company.

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