Conglomerate

A conglomerate is a corporation made up of a number of different, seemingly unrelated businesses. In a conglomerate, one company owns a controlling stake in a number of smaller companies which conduct business separately.

The largest conglomerates diversify business risk by participating in a number of different markets, although some conglomerates, such as those in mining, elect to participate in a single industry.

Conglomerates are large companies that are made up of independent entities that operate in multiple industries. Many conglomerates are multinationals and multi-industry corporations. Every one of a conglomerate's subsidiary businesses runs independently of the other business divisions, but the subsidiaries' management report to the senior management of the parent company.

Taking part in many different businesses help a conglomerate's parent company cut back the risks from being in a single market. Doing so also helps the parent lower costs and use fewer resources. But there are times when a company grows too big that it loses efficiency. In order to deal with this, the conglomerate may divest.

There are many different types of conglomerates in the world today, from manufacturing to media to food. A manufacturer may begin by making and selling its own products. It may decide to expand into the electronics market, then moving into another industry like financial services. A media conglomerate may start out owning several newspapers, then buy television and radio stations, and book publishing companies. A food conglomerate may start by selling potato chips. The company may decide to diversify, buying a soda pop company, then expand even more by purchasing other companies that make different food products.

Warren Buffet’s Berkshire Hathaway, a conglomerate that has successfully managed companies involved in everything from plane manufacturing to real estate, is widely respected and one of the most well-known companies in the world. Berkshire Hathaway has a majority stake in over 50 companies and minority holdings in companies ranging from Wal-Mart to car manufacturers. Yet, the company has an office with a small number of people.

Buffet’s approach is to manage capital allocation and allow companies near total discretion when it comes to managing the operations of their own business.

Another example is General Electric. Originally founded by Thomas Edison, the company has grown to own companies working in energy, real estate, finance, and healthcare, previously owning a majority stake in NBC.

The company is made up of specific arms that operate independently but are all interlinked. This makes it so research and development (R&D) on specific technologies can be applied to a broader range of products.

• A conglomerate is a corporation made up of different, independent businesses.
• In a conglomerate, one company owns a controlling stake in smaller companies which conduct business separately.
• The parent company can cut back the risks from being in a single market by becoming a conglomerate.
• Sometimes conglomerates can become too large to be efficient, at which time they have to divest some of their businesses.

For the management team of a conglomerate, having a wide array of companies in different industries can be a real boon for their bottom line. Poorly performing companies or industries can be offset by other sectors. By participating in a number of unrelated businesses, the parent corporation is able to reduce costs by using fewer resources, and by diversifying business interests, the risks inherent in operating in a single market are mitigated.

In addition, companies owned by conglomerates have access to internal capital markets, enabling more ability to grow as a company. A conglomerate can allocate capital for one of their companies if external capital markets aren’t offering as kind terms the company wants.

The size of conglomerates actually hurts the value of their stock, a phenomenon called conglomerate discount. The sum of the value of the companies held by a conglomerate tends to be more than the value of the conglomerates stock by anywhere between 13% to 15%. The combination of a handful of different issues relating to financial transparency and management makes conglomerate stock valued at a discount.

History has shown that conglomerates can become so diversified and complicated that they are too difficult to manage efficiently. Since the height of their popularity in the period between the 1960s and the 1980s, many conglomerates have reduced the number of businesses under their management to a few choice subsidiaries through divestiture and spinoffs.

Layers of management add to the overhead of their businesses and depending on how wide-ranging a conglomerate's interests are, management’s attention can be drawn thin.

The financial health of a conglomerate is difficult to discern by investors, analysts, and regulators because the numbers are usually announced in a group, making it hard to discern the performance of any individual company held by a conglomerate.

Conglomerates were popular in the 1960s and initially overvalued by the market. Low interest rates at the time made it so leveraged buyouts were easier for managers of big companies to justify because the money came relatively cheap. As long as company profits were more than the interest needing to be paid on loans, the conglomerate could be ensured a return on investment (ROI). 

Banks and capital markets were willing to lend companies money for these buyouts because they were generally seen as safe investments. All of this optimism kept stock prices high and allowed companies to guarantee loans. The glow wore off of big conglomerates as interest rates were adjusted as a response to steadily rising inflation that ended up peaking in 1980.

It became clear companies weren’t necessarily improving performance after they were purchased, which disproved the popularly held idea that companies would become more efficient after purchase. In response to falling profits, the majority of conglomerates began divesting from the companies they bought. Few companies continued on as anything more than a shell company.

Conglomerate companies take on slightly different forms in different countries. 

Japan’s form of conglomerate is called Keiretsu, where companies own small shares in one another and are centered around a core bank. This business structure is in some ways a defensive one, protecting companies from wild rises and falls in the stock market and hostile takeovers. Mitsubishi is a good example of a company that is engaged in a Keiretsu model.

Korea’s corollary when it comes to conglomerates is called Chaebol, a type of family-owned company where the position of president is inherited by family members, who ultimately have more control over the company than shareholders or members of the board. Well-known Chaebol companies include Samsung, Hyundai, and LG.

[Important: Many conglomerates in China are state-owned.]