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In the first scene of the first episode of the classic comedy series 30 rocks, TV presenters Liz Lemon and Pete Hornberger nervously walk into an office under renovation to meet their boss, Gary. They can’t see it anywhere. “Where’s my neighbor?” Lemon asks. Only then did a man in a suit kick the wall and sandals in the room. “My neighbor is dead,” said the man. “I’m Jack Donaghy, the new vice president of development for NBC-GE-Universal-Kmart.”
Donaghy explains that General Electric promoted him for his “greatest victory”: the GE Trivection furnace. It combines radiant heat, convection and microwave technology, allowing you to “cook a turkey in 22 minutes.” Donaghy explains his role in creating the oven “Why did they send me here to retool your show”. “I’m the new vice president of East Coast Television and Microwave Oven Programming.”
30 rocks Totally encapsulating the absurdity of conglomerates and giant corporations operating in a patchwork of unrelated industries. Although downsizing in the ensuing years 30 rocks First broadcast (2006), GE has remained the perfect conglomerate. That, until earlier this month, when GE announced it would split into three separate companies, focusing independently on aviation, healthcare and energy. Private equity firms are expected to pick out the corpse of the dying conglomerate.
You might call this the end of the agglomeration era. But the truth is that this era ended decades ago in the United States. GE is just one of the few faltering dinosaurs that survived the asteroid crash.
But while the old American agglomerates are dying out, a new breed is developing to replace them at the top of the food chain: Techglomerates. Companies such as Google, Facebook, and Amazon have acquired companies and entered industries they have not traditionally been involved in.
Investors treat old school conglomerates as if they were radioactive, but they treat tech conglomerates as if they were Pete Davidson (which everyone seems to want to keep these days). He called it the paradox of agglomeration. But are tactomeres really different? Or will the same forces lead to their demise?
When clusters were great
In the late 1960s, conglomerates were all the rage. Take ITT, for example, which, through the frenzy of acquisitions, controls companies such as Sheraton Hotels, Avis car rentals, Hartford Insurance, and maker of Wonder Bread. Or the LTV company that oversaw airlines, consumer electronics, missile manufacturing, sporting goods, and meat packaging. Or Litton Industries, which started as an electronics company and defense contractor, but devoured Stouffer’s frozen foods, a typewriter company, a home appliance manufacturer, and many more furniture makers. In 1968, Saturday Evening Post The magazine declared in a headline, “It is theoretically possible that the entire United States could become a large conglomerate.”
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Back when lumpy mania was at its height, in the mid-to-late 1960s, Baruch Lev was a doctoral student at the University of Chicago. “I remember one of the first questions on my first financial test was: What is the business rationale for conglomerates?” says Leif, who recently retired after many years as a professor at New York University’s Stern School of Business.
For many companies, the answer was simple: It was a way to get bigger and more profitable. Although the federal government is opposed to many types of mergers and acquisitions, it has been very lenient when it comes to expanding companies in unrelated industries. But most importantly, companies believed that by branching out into multiple lines of business, they could strategically improve each of those businesses and insulate themselves from the vagaries of the markets. If an industry has a bad year, for example, conglomerates can cut losses out of profits for other industries.
“The idea was that by investing in several industries, you could diversify the company’s cash flow,” Lev says. “People have talked about ‘internal capital markets,’ allowing you to allocate money from this company to that company.” The buzzword was “synergy,” and the idea was that the sum of a company could equal more than its individual parts. With agglomeration, the thinking is gone, 2 + 2 = 5.
lump becomes a bad word
Liv never bought into the lumpy hype. “It was all a hoax,” he says. The primary economic case for any conglomerate has been diversification, the company’s ability to stabilize and boost its share price by branching out into a variety of industries. But, says Leaf, investors can diversify themselves. If you’re worried that the airline industry will have a bad year, for example, you can put some of your money into a healthcare company. You don’t need some airline CEOs to buy and run a healthcare company.
“There is absolutely no commercial rationale for conglomerates, because investors can — on their own — achieve everything that a conglomerate does,” Lev says. This was especially the case after the advent of mutual funds, exchange-traded funds and indexes, which allow investors to diversify risks and buy shares of a variety of companies at a very cheap price.
Moreover, investors can do this without having to deal with all the problems that conglomerates create. The problems that arise when a bloated corporate bureaucracy struggles to oversee an unwieldy number of businesses: poor oversight, poor management, and unclear decisions, like sending the man behind a GE Trivection oven to run a TV show.
That’s why, says Leaf, study after study has found that conglomerates are inevitably damaged by something known as a “diversification antagonist.” It points to evidence that the conglomerate’s share price is about 10 percent lower than it would be if the conglomerate were instead broken up and sold on the stock market as separate companies. It turns out that the whole is in fact equal to less than the sum of its parts. With agglomeration, 2 + 2 = 3.
In the 1980s, investors were aware of all this – and there was a bloodbath of conglomerates in the United States. Jerry Davis, a professor at the University of Michigan’s Ross School of Business, has published a study on the dramatic decline. He says this was facilitated, in part, by a 1982 Supreme Court case that made it easier for financial firms to take over and restructure troubled businesses. By 1990, says Davis, “the typical company was more focused and focused on its core competency.”
The rise of Techglomerate
Baruch Lev has been working on a book on mergers and acquisitions, and as part of that, he recently analyzed 36,000 corporate acquisitions over the past two decades. It found that over the past 10 to 15 years, the percentage of acquisitions that could be categorized as conglomerate-style acquisitions increased to about 47%. “It really surprised me,” says Liv.
This rise in conglomeration is being driven by technology companies. Facebook, which recently rebranded itself as Meta, has bought companies like Ascenta, a maker of solar-powered drones, and Oculus, a virtual reality company. Amazon has bought companies like Metro-Goldwyn-Mayer, a media company, and Whole Foods. Google has been venturing into businesses doing everything from smartphones and eyeglasses to self-driving cars and podcasts.
Historically, the stock market has punished conglomerates. Even the CEOs of conglomerates like 3M deny they are a conglomerate because the term stinks. But it looks like Techglomerates are getting a pass.
Baruch Lev thinks they shouldn’t. For the same reasons that old school conglomerates flopped to 2 + 2 = 3, he says, new school conglomerates would do the same. Their attention will spread very little. They will not find synergies in their acquisitions. They will mismanage their subsidiaries. The logic of a relentless diversification discount will come for their stock prices, too.
Leif says the reason they have slipped through the capital markets is because their core businesses are insanely profitable. It’s almost as if they have an aura, which allows them to get away with things that traditional companies can’t do. They can mess with billions of dollars with impunity, at least for now. He says, “The day of reckoning is coming.”
But it’s also possible – unlike old-school conglomerates – that tech companies already have ideas, talent, and knowledge that translate well into a wide range of business outside of their core specialty. Jerry Davis suggests that maybe the Techglomerates are really pouring some kind of special sauce into their acquisitions. He says the future is cloudy, but the future will be technical. It may make sense to invest in companies that are trying to specialize in all things tech, even if they are expanding into areas outside their comfort zone. Surely, there will be many losers in their portfolio. But there may be some big winners.
Somewhat ironically, Davis referred to General Electric’s centuries-old rule as a successful conglomerate. Thomas Edison’s son, General Electric came out of the gate as a conglomerate, working in a variety of industries such as power generation, lamps, radios, etc. He says that GE was originally “in the business of all things you can do with electricity” and really had the ideas, talents and knowledge that allowed it to succeed in a wide variety of industries for a long time.
“Google is GE for the 21st century,” says Davis. “GE was the thing that you can do with electricity. Google is the thing that you can do online.”
But when Google starts buying cat food, microwave oven makers, or something like that, beware.