Why are Old Conglomerates Breaking Up?
Three global mega-corporations have recently announced breaking up their businesses. Could this be a strategic move?
They have a storied history of over 400 collective corporate years. The most ancient among them, the Japanese conglomerate Toshiba is 146 years old, US pharmaceutical giant Johnson & Johnson (J&J) is in its 135th year, and the other US and global icon GE is 129 years. Apart from surviving all the industrial revolutions and leading some of those, the other common thread running through these three global mega-corporations, is that in the last couple of weeks they have announced they are breaking up their businesses. This had left management pundits wondering whether these were strategic moves to stay competitive, and unlock new value, or it was a case of past sins catching up, and shareholder activism demanding greater accountability.
A reputational crisis
All three have been hit by major scandals in the recent past, ranging from overstating accounts, to class-action suits alleging adverse health effects from use of their products. GE nearly cratered during the financial crisis, when its GE Capital unit played a key role destabilizing the market. J&J is facing tens of thousands of lawsuits related to claims that its baby powder caused cancer. Toshiba is still trying to recover from a massive accounting scandal that rocked the company 2015.
On November 9, 2021, GE, with revenues of US$79 billion, announced it would divide into three public companies. The new companies will be focused on aviation, healthcare, and energy (renewable energy, power and digital) respectively. The first spinoff of the healthcare division is planned for 2023 and to be followed by the spinoff of the energy division in 2024. It is the latest to join the wave of divestitures.
Since 2017, there have been 178 US spinout deals worth nearly $800 billion, not counting GE, according to Dealogic statistics. In 2019, Siemens split off its healthcare and energy divisions. On November 4, 2021, IBM announced the separation of its managed infrastructure services business to a newly formed company Kyndryl. On November 12, 2021, J&J announced the splitting of its consumer products business from its pharmaceutical and medical device operations, creating two publicly traded companies.
Shareholder activism
Both GE and Toshiba (revenue US$28 billion) have been facing the intense heat of shareholder activism. Trian Fund Management, an activist firm led by Nelson Peltz, has been a long-time advocate of breaking up GE. A group of activists led by Effissimo Capital Management has also been pushing for changes at Toshiba, including calls to go private. Toshiba engaged in talks earlier this year to sell itself to CVC Capital Partners, but it now seems to be pursuing a different path.
Mega-Scandals
In 2020, the US Securities and Exchange Commission (SEC) announced that GE had agreed to pay a $200 million penalty to settle charges for disclosure failures in its power and insurance businesses. According to the SEC’s order, GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016, and nearly half in the first three quarters of 2017, stemmed from reductions in its prior cost estimates. The order also found that GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years, and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital. Despite the insignificance of the penalty amount, compared with the company’s turnover, the reputational injury to this mighty conglomerate was enormous.
Toshiba could never really recover from a huge accounting scandal that hit it in 2015 that led to the resignation of its CEO Hisao Tanaka. The company was accused of overstating operating profits by $1.2 billion. Details of the scandal emerged when an independent investigative panel released a report describing the accounting improprieties in detail. Improper accounting was found to have taken place over seven years, embroiling two former CEOs in the scandal alongside Tanaka.
Nevertheless J&J’s crisis of reputation is perhaps the worst of these three companies. In 2018, separate investigations by Reuters and The New York Times revealed documents alleging that small amounts of asbestos lurked in its baby powder. J&J has repeatedly denied the claim. There are about 38,000 lawsuits against the company that claim its baby powder was contaminated with asbestos that caused ovarian cancer and mesothelioma. J&J last month, created a company called LTL and moved all of its baby powder-related liability to it. That company then filed for bankruptcy. The bankruptcy manoeuvre limits efforts to recover damages for those who claim to have been harmed by the baby powder, according to consumer advocates.
The splitting of business could bring in some advantages as well, according to Charanpreet Singh (a.k.a CP), Founder and Director, Praxis Business School Foundation. “The benefit would be in terms of greater choice of collaborating partners – for example the company that will now run J&J’s consumer health business will be able to collaborate with an enterprise which is a competitor for them in the Pharmaceutical and Medical Devices business”, he argues.
Evolution of conglomerates
Scandals aside, western industrial conglomerates have been forced to evolve in the past 50 years. Heightened global competition reduced the ability of a single multinational to supply emerging markets with everything from train compartments to telecommunication towers. And GE’s initially successful but ultimately disastrous foray into finance put many groups off doing something similar.
The story is the same at GE and Toshiba: Healthcare is a different business from building jet engines. Renewable energy is different from memory chips. Businesses evolve, and businesses are cyclical. There was a time when the leaders of GE, J&J and Toshiba thought that pursuing scale was the best way to reward shareholders. Their track records of 20th century success prove they were probably right. Now, all three feels that slimming down is the solution. The greatest danger of our times is not turbulence, but dealing with today’s turbulence with yesterday’s logic. Are these companies correcting the old ways of doing things?
“All the companies mentioned are umbrella brands – their businesses are integrated under one brand name. Although this gives them great advantage in terms of global capitalization of a single name and instant goodwill, an umbrella brand also creates restrictions – it casts a ‘shadow’ on the way business can be conducted. Splitting the company is likely to give more freedom to the smaller entities to adopt the practices of their respective domains and compete as sharply focused, agile players,” points out CP.
End of conglomerates?
Does this mean the end of conglomerates? Far from it. Global analysts might find it seductive to come up with a theory that these conglomerates are finding that the changes outside is faster, than the changes within their organizations, hence leading to demergers to create a nimbler structure. Let’s remember that these analysts had once been ardent supporters of diversification, as a corporate strategy to foray into emerging areas of growth. and de-risk the overall business by having businesses with contra-cycles. Then came the famous core-competency theorists who favoured companies focusing on what they did best and achieving leadership in those specific areas.
Strategy guru, Michael Porter in a 1987 article in Harvard Business Review, wrote that he did not find that diversification had resulted in some great business outcome. He wrote, “corporate strategy is what makes the corporate whole add up to more than the sum of its business unit parts. The track record of corporate strategies has been dismal. I studied the diversification records of 33 large, prestigious U.S. companies over the 1950–1986 period and found that most of them had divested many more acquisitions than they had kept. The corporate strategies of most companies have dissipated instead of created shareholder value.”
New conglomerates emerge
Let us throw in another element of confusion into this muddle of diversification vs. core competency. Webscale and Big Tech giants like Google, Facebook, Amazon, Apple, Microsoft are well-diversified organizations. The tech giants are also essentially conglomerates, although they trade mostly, but not entirely, in digital goods. Amazon, Apple, and Google argue that their businesses have synergies because everything fits under the “tech” rubric. And their rapid growth so far has more than compensated investors for any inefficiencies that stem from their size. “As a result of digitalization, consumers have the choice of very sharply focused brands (example, D2C brands like Mamaearth and Sleepyowl) – which means that large conglomerates will find it difficult to create that kind of brand intimacy across markets and industry verticals,” points out CP.
The jury will be out for some time on the future growth models. Nevertheless, it might be too early to write of the centurions who have battled, survived, and thrived through industrial revolutions. Even Big Tech is facing intense regulatory pressure, as governments across the world from China to the US feel that they have grown too big and maybe a bit too influential to be allowed to operate the way they are doing currently. That’s another story…watch this space.
Why are Old Conglomerates Breaking Up?
