Feb 19 2014, 6:28pm CST | by Forbes
Companies ranging from chemical giants to restaurant chains have come under fire from shareholders wanting to break them apart, arguing that businesses perform better when they aren’t part of a sprawling conglomerate.
But activism is only part of the story. More fundamentally is the push from Wall Street.
Personal disclosure: Portfolio holdings include Caterpillar, Chevron and General Electric, given as examples below.
The Wall Street acquisition-divestiture cycle’s basis and results
Wall Street’s investment bankers are smart, hard working individuals who play an integral role in meshing businesses’ desire for success with the opportunities afforded through financial dealings. However, beneath the activity, there is a self-perpetuating cycle of acquisition and divestiture.
Previously, the cycle was in acquisition mode, with many companies buying for synergistic benefits – i.e., gaining an added payoff from the combination. Nowadays, with many corporations holding what is clearly a non-synergistic portfolio of businesses, the cycle has shifted once again to divestiture. Those hard-working investment bankers now focus on divestiture and growth-through-attrition.
Note: In the “go-go” market of 1967-1968, “synergy” (basically, 1 + 1 = 3) was the key belief that drove the creation of conglomerates whose stock prices rose and rose. Helped by financial reporting strategies (since banned), lower-valued acquisition targets would, in essence, be revalued by a higher-valued acquirer. Hence, the view was borne that synergy was a real creation, unleashed by the wise leadership at the leading conglomerates. Later, the stocks fell, the truth emerged and the view of conglomerates turned negative. The word, “synergy,” became associated with financial trickery more than skilled management. Since then, with time passing, the synergy argument returns during an acquisition phase, only to be tossed out anew during the divestiture phase.
Synergy isn’t false, just overhyped
Before the late 1960’s synergy-fad, acquisitions and mergers were often based on business strategies designed for growth and expansion through “integration.” Vertical integration seeks to gain better control over the process, from raw materials to final sale (think Exxon-Mobil, with its reserves, operating fields, refineries, service stations and integral transportation systems). Horizontal integration seeks to gain broader reach through the assimilation of businesses along the same line (think Caterpillar’s 2011 acquisition of Bucyrus-Erie). Managed well, these integrations can be synergistic, producing added benefits/gains and reduced risks/costs.
Divestiture: Corporate strategy vs. financial engineering
Now that we’re into the divestiture phase of the cycle, there is silence about synergy. That’s because the undoing of a company is typically viewed as being a positive step forward, not the removal of a synergistic element. In evaluating divestitures from a long-term investment standpoint, it’s best to think about corporate strategy. Is the move a step forward strategically, or is it something else? That “something else” is typically financial engineering or “growth through attrition.”
Two examples of strategic divestitures are:
(1) Chevron’s 2011 announced sale of its coal assets The purpose was to remove coal from their mix and to focus on the more promising energy areas.
(2) General Electric’s “shrinkage” of its finance arm, a long-time success component of GE. This action meshes with GE’s growth strategy that includes leadership in the new 3D printing industry along with other, chosen industrial fields (those recent ads highlight GE’s strategic focus and strengths well).
An example of financial engineering is Coca-Cola, as described in a recent Barron’s article, “Why Coke Could Regain Its Fizz.”
… Coke increased its exposure in 2010 with the purchase of the North American operations of bottler Coca-Cola Enterprises.
… Earlier this month, Coke announced that it will fold its North American bottling operations into its international bottling group. That gives it the opportunity to ultimately spin off the whole group, which would raise profit margins and unlock a higher valuation for the stock.
The 2010 acquisition appeared to be strengthening of vertical integration and, perhaps, a way to gain added benefits. Now, however, it looks like financial engineering meant to “unlock a higher valuation for the stock.” This purpose is exactly what the activists are attempting to do: Produce higher stock returns, not from long-term corporate strategies, but from getting a stock price bump and/or a shareholder payment, often from the divestiture of corporate assets. Hence, growth (of shareholder benefits) through attrition (of corporate assets).
The bottom line
Wall Street’s investment banking cycle has shifted to divestiture, helped by the pressure from activists. Are they good for the businesses? Yes, if they align with long-term strategic goals. Otherwise, the answer is usually no – serving a more narrow focus on shareholder benefits, particularly in the short run.
Source: Forbes Business
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