Disaggregation and shareholder value

16Aug06

The growing profile and power of private equity shops has unleashed a number of trends, not least of which is the re-conglomeratization of corporate America. Under the aegis of these private equity shops we are seeing the aggregation of disparate companies under a single “corporate” umbrella.

On occasion deals occur within an industry to increase the size and scope of the portfolio company’s reach. Most of the time however, deals are done with little concern as the potential for synergies. In any event, some have learned the hard way that those synergies don’t often pay off. Given the time horizon of most private equity shops there really is no good reason to focus on these passing gains.

In contrast, in the public markets conglomerates have become passe. This point was driven home in article by Claudia H. Deutsch in the New York Times. In it Deutsch reviews the message of General Electric (GE) management at an analyst meeting on the power its unique corporate structure. Apparently the security analysts who follow the company have bought into the company’s message, but the market is still skeptical.

GE management is not standing still in its attempt to dispel the notion that it is simply an loose aggregation of assets, in short a conglomerate.

It has certainly tried almost everything else to jump-start its stock. It has sold its insurance operations, excising a source of great unpredictability in its financial results. It has greatly increased sales in China, India and other emerging economies. It has pumped huge amounts of money into fast-growing businesses like fuel-efficient engines, security devices, water quality and consumer finance.

The market for now, still views the company as a conglomerate that should be valued at a discount to the sum-of-its-parts as opposed to an operating company.

“We need investors,” Mr. Sherin said, “to understand that we are an operating company, not a conglomerate that just holds on to businesses.”

The history of American capitalism can be traced by the waves of business aggregation and disaggregation. In the public markets, or late, the trend has been towards disaggregation. If GE is unable to persuade the market that its business structure is indeed unique (and profitable) it may be forced to seek additional ways to increase shareholder value.

Granted we are not, in any way, predicting any specific corporate actions on the part of GE. Recently GE has chosen to use the public markets, e.g. Genworth Financial (GNW), to dispose of unwanted businesses.

On the other hand a slew of private equity “conglomerates” willing to bid on the various pieces of the GE empire are just a phone call away. In a switch, large private equity firms are as one sage writer noted:

Mega-funds are the conglomerates of 2007…

Sounds like a match made in heaven.

*Thanks, as always, to Going Private for the majority of the blind links in this piece.

**No position in GE.

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