New Report by BCG and HHL on Diversified Companies Diversified Companies Can Shrink the Conglomerate Discount—or Even Turn It into a Premium—Through Better Capital Management and Portfolio Streamlining, Says Report by BCG and HHL Leipzig Graduate School of Management.
By combining better capital management and a strategic approach to portfolio streamlining, diversified companies can actively address the “conglomerate discount,” which reduces their valuations compared with pure-play companies, according to a new report by The Boston Consulting Group (BCG) and HHL Leipzig Graduate School of Management (HHL). The report, entitled Invest Wisely, Divest Strategically: Tapping the Power of Diversity to Raise Valuations, is being released today.
After shrinking during the financial crisis, the conglomerate discount rebounded to its typical range during the global economy’s tenuous recovery. Among companies publicly listed in the United States, the discount has increased to its precrisis range of 10 to 15 percent after shrinking to approximately 7 percent during the crisis. These findings are based on an extensive analysis of diversified and focused companies conducted jointly by BCG and HHL.
“While the conglomerate discount shrinks during recessionary periods and typically increase during economic recoveries, it does not disappear by itself over time,” says Jens Kengelbach, a Munich-based partner at BCG and coauthor of the report. “To improve their relative valuations, diversified companies need to actively employ means to overcome or reduce the discount. This effort begins with understanding what drives their undervaluation, which was a key focus of our research.”
Capital Allocation Efficiency Strongly Influences Lower Relative Valuations
“Our research points to inefficiency in allocating capital among their businesses as the major driver of diversified companies’ chronic undervaluation,” says Hady Farag, a Hamburg-based principal at BCG and another coauthor of the report. “All else being equal, companies that are better at matching capital investments to businesses’ attractiveness in terms of returns and growth prospects have higher valuations, whereas lower efficiency in allocating capital reduces relative valuation.”
Establishing capital allocation inefficiency as the link between diversification and the conglomerate discount has major implications for diversified companies seeking to improve their valuations. “Diversified companies suffer from lower relative valuations not because of diversification per se, but because their portfolio complexity makes it challenging to allocate capital efficiently,” explains Kengelbach. “This insight points to greater efficiency in capital allocation as the primary objective for diversified companies’ efforts to shrink the conglomerate discount or even turn it into a premium.”
Diversified Companies Can Drive Greater Efficiency in Capital Allocation
Excellence in capital management—steering capital flows among businesses to maximize returns—provides a powerful means for diversified companies to achieve higher relative valuations. In fact, many of the diversified companies studied have attained high relative valuations by maintaining highly efficient capital allocation.
This lever should be considered in combination with portfolio streamlining. The research found that reducing the number of businesses in a portfolio significantly increases diversified companies’ capital-allocation efficiency, while increasing the number of businesses significantly reduces their efficiency. This indicates that diversified companies may be able to reduce their capital-allocation disadvantages and drive substantially higher valuations by making strategic divestments.
“Diversified companies should also be particularly careful to consider how expansion into new business segments will affect their capital-allocation efficiency,” cautions Farag. “Expansion that initially can be accomplished at a reasonable cost could carry the unintended consequence of rendering capital allocation more difficult.”
Applying the Levers Requires a Plan Tailored to the Company’s Situation
A stringent, value-focused approach to portfolio management can be implemented through a role-based method of managing businesses and the capital flows among them. To apply such a method, the company determines specific roles for the individual businesses with respect to the outlook for cash generation and growth and sets investment guidelines for each role.
“If a diversified company finds that it has both attractive and unattractive businesses, the role-based approach will lead to a rebalancing of capital allocation in favor of higher-value businesses and to strategic divestments,” explains Kengelbach. “If its businesses permanently require larger investments than they generate in cash, the company should seek to raise additional capital or pursue joint ventures in order to fully capture the value from its priority segments.” Conversely, a company that lacks high-value investment opportunities for all the cash generated by its businesses should consider distributing excess cash to shareholders through dividends or buybacks.
“Our latest research supports BCG’s perspective that diversification in itself is not detrimental to value creation,” says Kengelbach. “Rather, it is how a company manages its diversified business that determines its performance. Although the management challenges are indeed significant, leading diversified companies have demonstrated that efficient capital allocation and a clear and consistent portfolio strategy can drive superior value.”
A copy of the report can be downloaded at http://www.bcgperspectives.com.
About HHL Leipzig Graduate School of Management
Founded in 1898, HHL Leipzig Graduate School of Management was the first business school in Germany. Currently, HHL is one of the country’s leading graduate schools, offering a variety of academic programs for different graduate degrees, including MSc, MBA, PhD, as well as Executive Education. The Center for Corporate Transactions, headed by Prof. Dr. Bernhard Schwetzler, is HHL’s major research unit in the field of mergers and acquisitions. It is designed to bring together scientists of HHL and its research partners working in the areas of corporate finance, accounting, law, and game theory to analyze and discuss problems in corporate transactions. For more information, please visit http://www.hhl.de/finance.
About The Boston Consulting Group
The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 81 offices in 45 countries. For more information, please visit http://www.bcg.com.
Bcgperspectives.com features the latest thinking from BCG experts as well as from CEOs, academics, and other leaders. It covers issues at the top of senior management’s agenda. It also provides unprecedented access to BCG’s extensive archive of thought leadership stretching back 50 years to the days of Bruce Henderson, the firm’s founder and one of the architects of modern management consulting. All of our content—including videos, podcasts, commentaries, and reports—can be accessed by PC, mobile, iPad, Facebook, Twitter and LinkedIn.
Volker Stößel | idw - Informationsdienst Wissenschaft
Is there a bubble in the art market?
07.01.2016 | Universität Luxemburg - Université du Luxembourg
Finance: Belief in higher returns from private equity may be misplaced
13.10.2015 | Universität Luxemburg - Université du Luxembourg
Today, plants and microorganisms are heavily used for the production of medicinal products. The production of biopharmaceuticals in plants, also referred to as “Molecular Pharming”, represents a continuously growing field of plant biotechnology. Preferred host organisms include yeast and crop plants, such as maize and potato – plants with high demands. With the help of a special algal strain, the research team of Prof. Ralph Bock at the Max Planck Institute of Molecular Plant Physiology in Potsdam strives to develop a more efficient and resource-saving system for the production of medicines and vaccines. They tested its practicality by synthesizing a component of a potential AIDS vaccine.
The use of plants and microorganisms to produce pharmaceuticals is nothing new. In 1982, bacteria were genetically modified to produce human insulin, a drug...
Atomic clock experts from the Physikalisch-Technische Bundesanstalt (PTB) are the first research group in the world to have built an optical single-ion clock which attains an accuracy which had only been predicted theoretically so far. Their optical ytterbium clock achieved a relative systematic measurement uncertainty of 3 E-18. The results have been published in the current issue of the scientific journal "Physical Review Letters".
Atomic clock experts from the Physikalisch-Technische Bundesanstalt (PTB) are the first research group in the world to have built an optical single-ion clock...
The University of Würzburg has two new space projects in the pipeline which are concerned with the observation of planets and autonomous fault correction aboard satellites. The German Federal Ministry of Economic Affairs and Energy funds the projects with around 1.6 million euros.
Detecting tornadoes that sweep across Mars. Discovering meteors that fall to Earth. Investigating strange lightning that flashes from Earth's atmosphere into...
Physicists from Saarland University and the ESPCI in Paris have shown how liquids on solid surfaces can be made to slide over the surface a bit like a bobsleigh on ice. The key is to apply a coating at the boundary between the liquid and the surface that induces the liquid to slip. This results in an increase in the average flow velocity of the liquid and its throughput. This was demonstrated by studying the behaviour of droplets on surfaces with different coatings as they evolved into the equilibrium state. The results could prove useful in optimizing industrial processes, such as the extrusion of plastics.
The study has been published in the respected academic journal PNAS (Proceedings of the National Academy of Sciences of the United States of America).
Exceeding critical temperature limits in the Southern Ocean may cause the collapse of ice sheets and a sharp rise in sea levels
A future warming of the Southern Ocean caused by rising greenhouse gas concentrations in the atmosphere may severely disrupt the stability of the West...
12.02.2016 | Event News
09.02.2016 | Event News
02.02.2016 | Event News
12.02.2016 | Physics and Astronomy
12.02.2016 | Life Sciences
12.02.2016 | Medical Engineering