The days of conglomerates are over. But many companies are still overly diversified.
Diversification – across companies, sectors, business models and currencies – makes sense for stock investors. However, owned companies should be targeted. Unlike conglomerates are often opaque structures and difficult to analyze, companies that have a clear direction perform better.
Many conglomerates emerged in 1960 in the United States, in a context of low interest rates and strict competition laws. Today, they are less and less “in vogue”. Yet there are still too many. Conglomerates persist for several reasons, including managerial hubris (bigger is better), false incentives (bonuses based on profit growth), passive investors, and managers who do not personally participate to their decisions or, as they say today, who don’t have skin in the game.
The trend towards simpler and more targeted business models is therefore likely to become even stronger. The 2020s could even become the decade of “deconglomerization”. Splits such as Carrier and Otis from United Technologies, General Electric’s spinoff, or Sandoz from Novartis should be just the beginning, but not the end, of this long-awaited trend.
The most effective protection against hostile takeovers and activist investors is a high stock price or valuation.
L’Oréal does better than Nestlé
A compelling example of the benefits of focus is provided by a comparison between two heavyweights in the consumer goods industry: Nestlé and L’Oréal. Nestlé, a convenience food giant with a turnover of more than 90 billion francs, and L’Oréal, the beauty market leader with a turnover of more than 40 billion euros . It is interesting to note that Nestlé is the main shareholder of L’Oréal with a 20 percent share.
In our view, Nestlé remains too diversified despite its size and scope. The company is active in various markets such as water, confectionery, pet products, prepared foods, dairy, coffee and health sciences, and synergies are limited. Nestlé’s history is marked by numerous acquisitions, including the recent acquisition of Starbucks’ consumer and restaurant products. Despite this, the results remain mixed, as evidenced by the recent billion-dollar write-down linked to the sale of the peanut-based energy food Palforzia. This is also reflected in modest organic revenue growth of just 5 percent over the past ten years and an average shareholder return of around 6 percent.
In contrast, L’Oréal focuses on one sector and is clearly a market leader within it, with a market share of around 15 percent. The company is broadly diversified, but not overdiversified, as it encompasses different regions, currencies, brands, distribution channels, price points and product categories. Acquisitions are also part of the company’s strategy, but always with a clear focus on the core business. L’Oréal’s balance sheet is strong, with the exception of the acquisition of The Body Shop business, which has since been sold. This clear focus is reflected in organic sales growth of more than 6 percent and an average shareholder return of more than 15 percent since 2013.
Cultivating your key skills makes the difference
As a stock investor, the call to businesses is: focus! The most effective protection against hostile takeovers and activist investors is a high stock price or valuation. How to achieve this? By focusing on core competencies and pursuing a clear and differentiated business model with strong market positions in target markets.
