The term conglomerate discount refers to the tendency of markets to value a diversified group of businesses and assets at less than the sum of its part. A conglomerate, by definition, owns a controlling stake in a number of smaller companies that operate independently of other business divisions.
Many believe that this setup is more of a burden on financial performance than benefit. Sure, controlling an army of companies generating revenues and earning profits look appealing, but it also creates issues with management and transparency. Each subsidiary employs senior leaders with different values and visions that may differ from the larger conglomerate's interest. Investors tend to view this negatively, compared with companies with a narrow focus.
Breaking down Conglomerate Discount
A conglomerate discount occurs from the sum-of-parts valuation and drives the decision of many conglomerates to spin off or divest subsidiary holdings. It is calculated by adding an estimate of the intrinsic value of each subsidiary company in the conglomerate and then subtracting the conglomerate's market capitalization. This value tends to be greater than the value of the conglomerates stock by anywhere between 13% and 15%. History shows that conglomerates can grow so large and diversified that it becomes difficult to manage effectively. As a result, many conglomerates divest or spin-off assets to reduce the strain on upper management.
Management may still play a role in an investor's decision to discount the conglomerate stock. Adding layers of management to oversee different subsidiaries helps resolve efficiency issues, but creates a substantial burden on overhead expenses.
The discount can also vary between different regions. Large conglomerates in the US have traditionally experienced larger discounts than European and Asian countries. This can be due to their size and political influence. In Asia, conglomerates cover different industries and hold significant political connections that make it difficult for investors to discount.
Examples of a Conglomerate Discount
Conglomerates have always played a substantial role in the economy. Some larger ones throughout history include Alphabet (GOOGL), General Electric (GE) and Berkshire Hathaway (BRK.A). Before becoming an Alphabet, Google was criticized for not disclosing gains or losses from its moonshot investments. This point of contention did not necessarily punish shareholders but highlights the lack of transparency in conglomerates.
On the other hand, shares of General Electric have tumbled for the past five years from management's inability to focus the company and find meaningful value from each division. Berkshire Hathaway has managed to escape the market's inclination to discount over diversified companies.