Bloomberg/Bloomberg via Getty Images
Bloomberg/Bloomberg via Getty Images
In the first scene of the first episode of the classic sitcom 30 Rock, television showrunners Liz Lemon and Pete Hornberger nervously walk into an office under renovation to meet their boss, Gary. They can’t see him anywhere. “Where is Gary?” asks Lemon. Just then a man in a suit kicks down a wall and barges into the room. “Gary’s dead,” the man says. “I’m Jack Donaghy, new VP of development for NBC-GE-Universal-Kmart.”
Donaghy explains GE has promoted him because of “his greatest triumph”: the GE Trivection oven. It combines radiant heat, convection, and microwave technology, allowing you to “cook a turkey in 22 minutes.” His role in creating the oven is “why they sent me here to retool your show,” Donaghy explains. “I’m the new vice president of East Coast television and microwave oven programming.”
30 Rock perfectly encapsulated the absurdity of conglomerates, behemoth corporations operating in a mishmash of unrelated industries. Despite downsizing in the years since 30 Rock first aired (2006), GE remained the quintessential conglomerate. That is, until earlier this month, when GE announced it was splitting into three separate companies, independently focused on aviation, healthcare, and energy. Private equity firms are expected to further pick away at the dying conglomerate’s carcass.
You might call this the end of the conglomerate age. But, the truth is, that age ended decades ago in the United States. GE is just one of a few lumbering dinosaurs that survived the asteroid crash.
But while the old American conglomerates are going extinct, a new breed is evolving to take their place at the top of the food chain: Techglomerates. Companies like Google, Facebook, and Amazon have been acquiring companies and entering into industries they’ve traditionally had no involvement in.
Investors treat old-school conglomerates like they’re radioactive, but they’re treating Techglomerates like they’re Pete Davidson (who apparently everybody wants to hold these days). Call it the Conglomerate Paradox. But are Techglomerates really different? Or will the same forces lead to their demise?
When Conglomerates Were Groovy
Back in the late 1960s, conglomerates were all the rage. Take the ITT Corporation, which, through a frenzy of acquisitions, controlled companies like Sheraton Hotels, Avis car rentals, Hartford Insurance, and the maker of Wonder Bread. Or the LTV Corporation, which oversaw companies in aviation, consumer electronics, missile manufacturing, sporting goods, and meat packing. Or Litton Industries, which began as an electronics company and defense contractor, but gobbled up Stouffer’s frozen foods, a typewriter company, a manufacturer of household appliances, and various furniture makers. In 1968, The Saturday Evening Post magazine declared in a headline, “It Is Theoretically Possible for the Entire United States to Become One Vast Conglomerate.”
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Back when conglomerate mania was at its zenith, in the mid-to-late 1960s, Baruch Lev was a PhD student at the University of Chicago. “I remember that one of the first questions in the first finance exam that I took was: what is the business rationale for conglomerates?” says Lev, who recently retired after many years as a professor at NYU’s Stern School of Business.
To many companies, the answer was simple: it was a way for them to get bigger and more profitable. The federal government, while actively opposed to many kinds of mergers and acquisitions, was pretty lax when it came to companies expanding into unrelated industries. But, even more 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 ups-and-downs of markets. If one industry had a bad year, for example, conglomerates could cushion losses with profits from other industries.
“The idea was that by investing in several industries, you diversify the cash flow of the company,” Lev says. “People 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 be worth more than its individual parts. With a conglomerate, the thinking went, 2 + 2 = 5.
Conglomerate Becomes A Bad Word
Lev never bought into the conglomerate hype. “The whole thing was a sham,” he says. The core economic case for a conglomerate was diversification, the ability of a company to stabilize and boost its share price by branching out into a diverse array of industries. But, Lev says, investors can do diversification themselves. If you’re worried that the airline industry may have a bad year, for example, you can put some of your money in a healthcare company. You don’t need some CEO of an airline company to buy and manage the healthcare company.
“There is absolutely no business justification for conglomerates, because investors can achieve — on their own — everything that the conglomerate achieves,” Lev says. This was especially the case after the rise of mutual, exchange-traded, and index funds, which allow investors to diversify risk and buy shares of a diverse array of companies very cheaply.
Moreover, investors can do this without having to deal with all the problems that conglomerates create. Problems that arise when a bloated corporate bureaucracy struggles to oversee an unwieldy number of businesses: poor oversight, mismanagement, and sketchy decisions, like sending the man behind the GE Trivection oven to run a television show.
It’s why, Lev says, study after study finds conglomerates are inevitably hurt by something known as “the diversification discount.” It refers to evidence that a conglomerate’s stock price is around 10 percent lower than it would be if the conglomerate were instead broken apart and sold on the stock market as separate companies. It turns out the whole is actually worth less than the sum of its parts. With a conglomerate, 2 + 2 = 3.
In the 1980s, investors wised up to all this — and there was a bloodbath for conglomerates in the United States. Jerry Davis, a professor at the University of Michigan’s Ross School of Business, published a study about their dramatic decline. He says it was facilitated, in part, by a 1982 Supreme Court case that made it easier for financial firms to take over and restructure floundering businesses. By 1990, Davis says, “the typical corporation was way more lean and focused on its core competence.”
The Rise Of The Techglomerate
Baruch Lev has been working on a book about mergers and acquisitions, and as part of that, he recently analyzed 36,000 corporate acquisitions over the last couple decades. He found that, over the last 10 to 15 years, the percentage of acquisitions that can be categorized as conglomerate-style acquisitions spiked to about 47%. “It surprised me enormously,” Lev says.
This spike in conglomeration is driven by tech companies. Facebook, which recently rebranded itself as Meta, has bought companies like Ascenta, a solar-powered drone maker, 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 involved in everything from smartphones and glasses to self-driving cars and podcasting.
The stock market has historically punished conglomerates. Even the CEOs of conglomerates like 3M deny they’re a conglomerate because the term is a stinker. But the Techglomerates seem to be getting a pass.
Baruch Lev believes they shouldn’t. For the same reasons that old-school conglomerates blundered into 2 + 2 = 3, he says, these new-school conglomerates will do the same. Their attention will be spread too thin. They won’t find synergies in their acquisitions. They will mismanage their subsidiaries. The relentless logic of the diversification discount will come for their share prices too.
The reason they’ve been skating by in capital markets, Lev says, is that their core businesses are insanely profitable. It’s like they’ve had a halo, which allows them to get away with things traditional companies cannot. They can mess around with billions of dollars and get away with it, at least for now. “The day of reckoning is coming,” he says.
But it’s also possible that — unlike old-school conglomerates — tech companies really do possess ideas, talent, and know-how that translates well into a wide range of businesses outside of their core specialization. Jerry Davis suggests that maybe the Techglomerates really are drizzling a kind of special sauce on their acquisitions. The future is cloudy, he says, but the future will be tech. It may make sense to invest in companies that try to specialize in all things tech, even if they’re expanding into areas outside of their comfort zone. Sure, there will be many duds in their portfolio. But there could be some big winners.
Davis, somewhat ironically, pointed to GE’s centuries-long reign as a successful conglomerate. The child of Thomas Edison, GE came out of the gate as a conglomerate, operating in a diverse set of industries like power generation, lightbulbs, radios, and so on. GE, he says, was originally “in the business of all the stuff you can do with electricity,” and it really did possess the ideas, talent, and know-how that allowed it to succeed in a wide array of industries for a long time.
“Google is the General Electric of the 21st century,” Davis says. “GE was the stuff you can do with electricity. Google is stuff you can do with the internet.”
But when Google starts buying up cat food and microwave oven makers or something, beware.