The Massif Capital Review volume 1, No. 1 for the month of January-February 2017, titled, “Conglomerates Redux.”
Conglomerates are thought to be the troubled corporate structures of a bygone era. Investors often consider them as likely to destroy value as to create it. Wall Street Investment Analysts almost universally shun them; they never fit neatly into any industry or style box. It is probably safe to say that the conglomerate boom of the 1960s and 1970s was the heyday of the difficult to manage corporate structure. Nevertheless, conglomerates persist here and there and are well worth the diligent value-conscious investors’ attention.
At the most basic level, the conglomerate is a collection of different businesses within a single enterprise that have minimal interdependence. The claim that they create value for investors has always been, rightly, viewed with suspicion. The spectacular blow-ups of past conglomerates, LTV and Litton during the 1960s and more recently Valiant (a “Platform Company” or conglomerate by another name), surely justifies the skepticism. The blow-ups of these diverse corporate entities should come as no surprise; considerations other than value frequently drive conglomerate formation.
For example, the spread of conglomerates during the 1960s was driven as much by federal government antitrust policies during the 1950s (specifically the Celler—Kefauver Act of 1950 which made horizontal and vertical growth all but impossible) as it was any strategic logic. In some investors mind, the latest wave of conglomerate creation (specifically in pharmaceuticals and consumer goods) has again been, in part, caused by a government/central bank policy that has created a debt permissive environment.
Other market observers believe we are at the start of a new wave of technological conglomerates which spread into different industries in a search of the next big thing. Apple and Alphabet (Google), both have significant cash and need to do something with it, why not branch out? Some on Wall Street argue these new style conglomerates are of a very different nature than those of the 1960s. Tech giants may be product conglomerates (Apple – Computers, Watches, Phones, TVs, Software) but the companies maintain an internal strategic logic, different products connected by an ecosystem. A line of thought that is hard to argue with, but also not new. Conglomerates have a long come in two flavors: broad diversification (LTV, ITT) and narrow diversification (Textron and Teledyne).
Finally, there are the conglomerates at the heart of the spectacular growth of Asian Economies over the last thirty years. Mckinsey has calculated that over the past decade conglomerates made up 80% of the largest 50 companies by revenue in South Korea and revenue grew 11% a year. In India, conglomerates constitute 90% of the top 50 companies (excluding state firms) and have average revenue growth of 23% a year. Academics have weighed in and argued that the success of Asian Conglomerates is the result of an “institutional void” that will fill as the economies develop. Only time will tell, emerging firms may find it difficult to wrestle market share from politically connected companies with comparably bottomless budgets. Populism being what it is at the current time, the titans of Asian economies should be wary of spreading themselves too far.
In this issue of the Massif Capital Review, we take a deeper look at the now defunct conglomerate Beatrice Foods in search of clues as to what makes a successful and unsuccessful conglomerate. The end result, a short checklist to help the value conscious investor evaluate conglomerates. Three conglomerate investment ideas are also presented. Finally, a review of the performance of Asian Family Conglomerates over the past ten years.
A Brief History of Beatrice Foods
Over the course of the 100-year history of the now defunct conglomerate Beatrice, the company underwent many name changes and strategy pivots. When it was first founded in 1897 by George Haskell, the company was known as Beatrice Creamery Company, and it engaged in a narrow industry focused geographic expansion via acquisition. In 1945 the company changed its name to Beatrice Foods, in recognition of its shift from a narrowly focused dairy company to a narrowly focused food conglomerate.
The name changed again in 1983, this time to Beatrice Company, a name management felt better captured the company’s broad diversification into everything from bulk chemicals to Samsonite luggage. Finally, in 1986, following the leveraged buy-out of the company by KKR, the name was changed to BCI-Holdings, the name the company would have until all its many disparate parts had been sold off.
The strategic changes, and name changes, of Beatrice, are useful markers as they mirror phases of not only corporate America’s general strategic evolution but transitions from good practices to bad. Within each phase of the company’s growth and development, management established readily identifiable corporate practices that when taken together can serve as a checklist of things an investor should look for in a conglomerate investment and what to look out for.
Beatrice Creamery Company Era
In 1905 Beatrice Creamery Company CEO, George Haskell, engineered the acquisition of Continental Creamery Company of Topeka, Kansas. In doing so, not only did he achieve the largest consolidation in the history of the US dairy industry, but he also secured ownership of the strongest brand in the dairy business at that time, “Meadow Gold” (the Meadow Gold brand still exists and is owned by Dean Foods). The acquisition also made Beatrice the largest creamery in the world with operations throughout the United States.
Given the time sensitive nature of dairy products and the local nature of farms, Beatrice could only manage its coast to coast dairy operations via a decentralized corporate structure which put the onus of success on individual dairy plant managers. The creamery stage of Beatrice evolution thus highlights two important elements of a successful conglomerate: a minimal corporate office with specific functions (in this case legal, financial, marketing and quality control) and a heavy emphasis on a single set of performance standards and subsidiary accountability for performance.
As with all elements of business success, there are no hard and fast rules, and while a small corporate office is common throughout the history of successful conglomerates, it is not present in all successful conglomerates. Berkshire Hathaway has one of the smallest corporate offices of any publically traded company, but GE does not. What is common, and easier with a small corporate office, is decentralized management. From the outset, Beatrice pushed decision making own to the plant level, and in doing so placed responsibility for performance where sales and profits were generated.
When a division of a conglomerate is in trouble, there is little that corporate management can do about it. Beatrice HQ in Nebraska could do little to help when the milk spoiled at a West Coast distribution facility; plant management had to be empowered to act. The decentralized management system worked because Beatrice headquarters incentivized people correctly and clearly articulated performance expectations to plant management. The performance standard was plant specific and the incentive was based on the performance of the plant, not the company overall.
Accountability for achieving a clearly articulated performance standard is a practice repeated time and again at successful conglomerates. GE was once famous for its performance standard: if a business was not first or second in its industry, it should be sold or closed. The value