Understanding the conglomerate discount
Conglomerates – firms comprised of multiple separate businesses with a high degree of unrelated diversification – are now relatively uncommon (at least within the US setting). Go back several decades though, and they were much more common.
Such unrelated diversification is in general not seen as bringing value to firms – in fact, it is associated with many negative outcomes, for example, that management have less insight into any one firm. As such, many conglomerates were seen as underperforming, with the combined entity worth less as a whole than it would be split into parts. The corporate layer of having these unrelated divisions combined together in one company meant that the sum was worth less than the parts.
Sources of the conglomerate discount
The sources of the conglomerate discount are similar to the disadvantages of unrelated diversification, including:
- Management spread too thin
- Politics between divisions
- Inefficiencies of divisions can be hidden – poorly performing divisions are buffered by better performing divisions
- Slower decision making
In addition, unlike related diversification, unrelated diversification as part of conglomerates have few to no opportunities to share resources between unrelated divisions.
Splitting up of conglomerates
Since conglomerates were trading at a discount – the sum worth more than the whole – then there was an opportunity for someone to come in, split the firm up, and make money selling off the parts of the company. This is exactly what happened with corporate raiders – coming in, selling off the divisions, and realizing the conglomerate discount.