Not true that conglomerates would produce higher shareholder returns by focusing on fewer businesses, BCG says
08-Dec-2006 :
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Study identifies ten levers diversified firms can use to generate above- average returns.
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Not true that conglomerates would produce higher shareholder returns by focusing on fewer businesses, BCG says
The popular belief that conglomerates would generate higher shareholder returns if they focused on fewer business is not only empirically unfounded, it is also potentially counterproductive, according to a new study by The Boston Consulting Group (BCG) published today. Many conglomerates already outperform the stock market average, generating higher returns than many of the top focused firms. Moreover, diversified companies that do focus do not necessarily create additional value.
Based on an analysis of 300 of the world's largest diversified, slightly diversified, and focused companies in the United States, Europe, and Asia, BCG found that 52 percent of conglomerates beat the stock market average, measured by relative total shareholder return (RTSR).
Of the eight European diversified companies that focused in the past five years, only three created significant additional value. This reinforces the findings of an earlier BCG study (1) that only 30 percent of breakups create value and 45 percent destroy it.
In its latest report, Managing for Value: How the World's Top Diversified Companies Produce Superior Shareholder Returns, BCG identifies ten key “levers” that the top conglomerates use to create superior long-term value creation. These range from efficient internal capital allocation to a clear and consistent portfolio strategy, from rotating management skills among business units to strict corporate governance (based on the model used by many private equity firms).
“It's not a company's degree of diversity that determines its shareholder returns, it's how the firm manages its diversity that matters,” says Dieter Heuskel, one of the report's authors. “Provided the right levers are pulled, all conglomerates can produce above-average returns. Consequently, all diversified companies should resist external pressure to focus from investment analysts and other commentators.”
The conglomerate discount is almost exclusively a European phenomenon – and the pressure to focus is largely confined to Europe. However, U.S. conglomerates could also come under fire if their comparatively stronger fundamentals deteriorate. So too could diversified firms in Asia: these companies already have relatively low profitability and are likely to come under pressure to focus as the region's capital markets mature and become more demanding.
This study is intended to give diversified companies the confidence to resist calls to focus, as well as the insights needed to produce superior returns. The study demonstrates that there are limited occasions when focusing can add value, notably when there is a clear strategic growth opportunity. It also shows that there are many more opportunities for conglomerates to add value by managing their diversity more effectively.
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