Some conglomerate holding companies are certainly worth considering as investments in my opinion.
You have likely heard of Berkshire Hathaway, LVMH, Brookfield, LG, Disney, Samsung, General Electric, and Sony. But what about Exor, Ayala, Bidvest, Sonae, or New World Development? Have you heard of them? Or Koç Holding, Larsen & Toubro, John Keells, or Groupe Bruxelles Lambert? Chances are, you have not heard of them either.
In North America, conglomerates were very popular in the 1960’s [An analyst I like in Hong Kong often refers to them as “Conglo's”]. Then in the 1970's, many performed poorly and were mismanaged. Slowly, investors became enamoured instead with “pure plays”, or companies with a single (or much narrower) focus. So conglomerates slimmed down and now, after the implosion of GE during the global financial crisis, there are not that many conglomerates left in North America. In fact, for the last 20 years, "conglomerate" was seen by many professional investors as a bad word, and owning them is often taboo. So long as they perform well, companies like Berkshire, Danaher, and ITT are loved, but as soon as conglomerates stumble, many hedge funds, activists, and private equity firms get their knives out!
Outside North America, there are still plenty of publicly traded conglomerates and holding companies. Many are still controlled by founding families, in some cases second, third, our fourth generations. Occasionally, activist investors do go after international conglomerates (examples include Sony, Hyundai, and Samsung). However, it is not as common as in North America, likely because it is not as successful or rewarding.
Why do many investors dislike conglomerates?
There have been many articles and studies discussing the conglomerate or holding company discount. There are a lot of reasons why investors stay away from conglomerates and holding companies.
I think one of the biggest reasons is they are often boring. Also, they can be complex and often it’s not easy to explain them. Investors (like any humans) like excitement. They like simple stories they can use to impress their bosses, clients, and friends.
Power Corporation of Canada is a great example. The stock is roughly the same price today as it was in 2007. Yet it has grown its book value per share from roughly $17 to $33 during that time, and paid shareholders $18 in cumulative dividends per share to boot. To me, that’s exciting! But try telling your clients a story about Power Corp, or your friends at a BBQ. People immediately start yawning and their eyes start rolling back into their heads! People want to hear about microchips, gaming stocks, electronic vehicles, riding sharing, etc.
There are many other reasons investors do not like conglomerates and holding companies. And many of the reasons are valid. For instance, conglomerate holding companies are often run for the benefit of founding families, not minority shareholders. Whether it be through lack of investor relations, related party transactions, or nepotism, there are many examples of minority shareholders being mistreated.
Also, if conglomerate holding companies were dismantled, and sold off in pieces, capital gains taxes would be owed upon the sale of each piece. Therefore, people argue these stocks should never trade at 100% of their net asset value. That is probably true, but in some cases these companies are never likely to be broken up, so their stocks should not be valued on their net asset values in the first place. Instead, they should be valued on projections of future income, dividends, or cash flows (just like you would value DuPont, Alphabet, KraftHeinz, etc.).
Conglomerates by their nature are diversified. They usually have parts that are more popular with investors and parts that are less popular. You might covet some of their business segments, but they might also own subsidiaries that are capital-intensive, earn low returns, lack a competitive advantage, or are just trophy assets for the founder (remember 20+ years ago when Magna owned horse racing tracks?). When you buy a conglomerate’s stock, you must take the bad with the good.
Because some conglomerate holding companies can be complex, it can be hard to understand their financial statements. Some of their investments might be consolidated while others are not consolidated. When subsidiaries are only partially-controlled, holding companies can have large amounts of minority interest on their balance sheets. Some investees might be public, while others are private. They can have different classes of shares. All this can make financial analysis difficult and some investors will just prefer to stay away. And some investors make it mentally easy by just avoiding the whole lot.
Some entrepreneurs got rich building their empires with debt. As a result, the conglomerate holding companies they created can still have too much financial leverage. This is a very valid concern, but it’s not always the case, and certainly not a reason to exclude all these companies from consideration.
Some conglomerates (or their subsidiaries) are in regions of the world that are less than ideal. Rule of law might not be as well-established or respected. Currencies or inflation might be bigger risks in these areas. Recent events in China prove political interests can supersede corporate/private shareholder interests. This issue warrants a discount that might only narrow over long periods of time.
After considering all these issues, a "chicken and egg" problem arises. Because investors tend not to like the stocks of holding companies, there are many examples where their stock prices perform poorly for extended periods, even when management is growing value per share. Trading volume and liquidity go down as a result. The stocks then get cheaper. Eventually everyone starts to agree the price will never go up. “It’s always been cheap…What’s the catalyst?” Even if value per share is rising and you are receiving a nice dividend while you wait, clients see the poor price performance as failure. So, to keep their clients happy, portfolio managers stay away.
So, are there conglomerates worth considering?
Some are certainly worth considering in my opinion. As with the example of Power Corp above, you can find some conglomerate holding companies with very good records of growing value per share over long periods. You can often get them at cheap prices. This means their dividend yields can be attractive (even when their payout rates are low) and share buybacks can be highly advantageous. Low valuations are ideal if you plan to buy more regularly over time. Some "conglo's" can be well-managed even a couple generations after founders and controlling shareholders have passed on management to professionals. In some cases, the management teams are more stable than those at many traditional public companies.
You can get decades of capital allocation experience in management teams operating in markets or industries they understand very well. Being opportunistic (buying investments when prices are low and selling when they are high) can be ingrained in their culture. Managers can have lifetimes of experience dealing with local markets, laws, and regulations.
Some of these companies are in areas that are more difficult for us to understand and follow and therefore provide us with diversification that we might not otherwise have access to. Some conglomerate holding companies can be very diversified such that their business results experience fewer shocks and surprises. When founding families are already very rich, their focus can be on sustainable growth and risk management, rather than taking gambles and swinging for the fences. Therefore you can find some conglomerate holding companies with very safe balance sheets. Some families have learned low leverage is not only ideal for surviving crises, but also for having capacity to take advantage of opportunities that inevitably arise when markets are depressed during downturns. Finally, in some cases, when you become a shareholder of a holding company alongside a founding family, you are aligning yourself with proven businesspeople whose whole future (and the future of their heirs) hinges on ensuring your investment is successful over the long term.
Over the last twenty years, I have accumulated a long watchlist of global holding companies. No doubt, some are better than others. We own a few of them now. One I like is Jardine Matheson. It is a company I first became aware of living in Bermuda twenty years ago. Of the potential attributes I listed above, it has many. “Jardines” is the large-cap stock most people have never heard of. Together with its subsidiaries, it has over 400,000 employees! (That's more than Toyota, Berkshire Hathaway, Starbucks, and IBM). Jardines is extremely diversified. Most of its businesses are in Greater China and Southeast Asia. The recent history of its stock price is similar to my example of Power Corp. Its stock is roughly the same price today as it was in 2011. Many investors would describe it as boring. But over the last 17 years, management has slowly grown its book value per share from $11 to $84, and paid shareholders $20 per share in cumulative dividends during that same timeframe. That’s another exciting conglo in my opinion!
What are some of my other favourite holding companies? Maybe I will save those for future blogs.
Please contact us if you would like to learn more about our investments in holding companies. We would be happy to discuss with you how we decide which companies make it into our portfolios. We are always eager to discuss our investment philosophy and how we feel it can help build wealth over time.
Until next time!
Erin
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