Indeed, bigness seems to be falling out of fashion, with an average of one spin-off a week being announced in the U.S. so far this year -- involving big names like ITT, Motorola and Marathon Oil seeking to be, well, not-so-big.
This Valentine's Day, for example, Marriott International Inc. announced plans to spin off its timeshare business. Then the next day, Australia's Foster's Group Ltd. said it would shed its wine operations -- showing that the trend is decidedly global.
Remarkably, the six U.S. spin-offs announced through Feb. 24 compare with just four in all of 2010, according to Mergermarket, a mergers-and-acquisitions information service.
The quoted dollar--value totals for these break-up transactions -- which in different forms are described as spin-offs, split-offs, carve-outs, or just plain "de-mergers" -- rarely are meaningful. In part, that's because many deals are viewed as realignments of business units. In ITT's case, for example, with its split into three parts, shareholders get three stock certificates for each one they have now.
In fact, in Mergermarket's tally, the total of $14.81 billion in spin-offs so far this year reflects the value for only one of them: closely-held agricultural giant Cargill Inc.'s spin-off of its stake in fertilizer maker Mosaic Co. Its total for the four spin-offs of 2010: $10.5 billion.
Still, early results clearly point to 2011 being headed for an astronomical increase in this type of downsizing.
A 50-Year Saga
Fifty years ago, when the conglomerate age began, the trend was the opposite. In that era giant corporations like ITT could achieve diversification beyond the reach of most investors, supercharge their earnings growth through acquisition, and generate capital internally far more cheaply than they could obtain it in small, parochial markets.
Today investor diversification is easily achieved, with even emerging markets open to individuals by way of exchange-traded funds. Capital markets are mature and global. And earnings, always Wall Street's top concern, are more easily analyzed in a lean organization than a bloated one. So conglomerates are being marked down.
"The average conglomerate discount -- and the evidence is very strong -- is between 10% and 20%," says Anant Sundaram, a visiting professor at Dartmouth's Tuck School of Business. To eliminate it, corporations are streamlining -- ITT included.
A Tax-Free Choice
ITT announced in January that it was breaking itself into three units: industrial products, defense and information solutions, and water technology products. The biggest of these, the defense segment -- which was expected to account for 2011 revenue of $5.8 billion, or half the corporate total -- was already dragging down the price of the company's stock, as defense outlays in coming years are expected to shrivel.
With that sea anchor cut adrift, the company's stock reacted exactly as ITT had hoped. The day of its break-up was announced -- ITT's takes the form of a tax-free spin-off to existing shareholders -- shares shot up 16.5%, to $61.50. Spin-offs, because they can be accomplished without losses to tax authorities, are a favorite tool of CFOs in corporate breakups.
It was in January, too, that Motorola Inc. split itself into Motorola Mobility Holdings Inc. and Motorola Solutions Inc. Marathon Oil Corp. announced plans to spin off its refining operations into the new Marathon Petroleum Corp. And Sara Lee Corp. said it would split into two public companies, one focused on its coffee business and the other on meats. In December, Fortune Brands had spun off two of its three business lines to focus on the liquor business.
A Long Way from Puerto Rico Telephone
ITT's break-up is the latest swing of the pendulum for the White Plains, N.Y.-based company. It began life in 1920 as Puerto Rico Telephone Co., and expanded rapidly in the following decade to Spain and other European countries. By the 1950s it was expanding into television and other communications lines.
But it really exploded under master conglomeratist Harold Geneen, who in the 1960s gobbled up more than 300 companies, often exploiting the latest financial innovations such as leveraged buyouts and hostile takeovers. It sprawled far beyond communications with units like Sheraton hotels, Hartford insurance and Avis rent-a-cars. Its reach was so broad it was implicated in the Chilean coup of 1973 that toppled Salvador Allende. By the 1990s, however, ITT had begun paring itself down. And in 1995, it splintered into three companies, severing its hotel and insurance businesses and focusing on the defense unit.
Popular in the Classroom, Too
The urge to de-merge is popular with finance professors as well as portfolio managers.
Many of the claimed benefits of conglomeratization are simply "financial engineering," in the words of New York University economics professor Richard Sylla.
"A company run by a clever entrepreneur might command a high value in the stock market," says the member of the faculty of NYU's Stern School of Business. "It then buys a doggy company, folds its earnings into its own and maybe they'll be capitalized at a higher value, regardless of business efficiencies."
Sylla says this kind of financial shuffling was a hallmark of once-high flying conglomerates like Gulf + Western, which disappeared in the 1990s, having proved to be as unsteady as its Columbus Circle headquarters in Manhattan, which swayed so much in the wind that some employees became seasick.
As to diversification--shareholders can achieve this on their own, without the added expense of corporate intermediaries. Indeed, a sophisticated investor who seeks to diversify by industry can be frustrated by conglomerates, which often have major operations in more than one.
Aggregating disparate businesses into a whole has other disadvantages, from adding extra management costs to reducing clarity by bundling financial results in a way that confuses or defies investor analysis.
"What is deeply troubling to me," says Sundaram, "is that CFOs at many conglomerates often tend to use corporate performance, or hurdle, rates to measure divisional rates." The corporate average of 12% annual growth could, for example, be achieved by matching an old-line unit with a 6% rate and a go-go division that's growing 18%. "CFOs have this habit of saying, 'Everybody deliver 12%.' This leads to the likelihood that the 18% division feels happy underperforming, while the 6% division cannot deliver."
The Lure of Smooth Earnings
But while many conglomerates are succumbing to Wall Street's siren call to improve shareholder value, plenty of others are saying no thanks.
Smoothing earnings by offsetting cyclical vulnerabilities, a cornerstone goal of conglomerates, is exactly what Dynamic Materials Corp. (Nasdaq: BOOM), set out to achieve.
"We sought to diversify back in 2007, to counter the cyclical nature of our business, and that has proven to be the case," says Richard Santa, CFO of the Boulder, Colo.-based company. As its ticker symbol suggests, the company's original focus was on using explosives to shape and bond metals in industrial processes. The acquisition of a German-based company allowed it to expand its reach into explosives used in the oil and gas industry.
Another justification for conglomerates is that they can create opportunities for sophisticated tax management among competing regimes. "U.S. taxes are the highest of any country we have business in," notes Santa, whose firm also has operations in France and Sweden.
An Old Argument Lives
The argument that internally generated capital is the cheapest kind has not gone away. Warren Buffett literally built his fortune on this premise at Berkshire Hathaway, which draws on immense cash flows from its old-line insurance businesses to fund faster-growing units like Geico Insurance, as well as frequent acquisitions.
The best-run conglomerates, such as Berkshire, General Electric Co. and United Technologies Corp. , do trade or have traded at premiums to the value of their individual holdings.
So plenty of firms, even amid press speculation that they are ripe for breakup, are resisting shrinking.
Bank of America Corp., the nation's largest bank holding company, says it has no plans to shed any of its disparate business lines. "We have a leading position in every business in which we compete," says a spokesman. "The franchise and the power of Bank of America and Merrill Lynch is exactly why we put these companies together."
Illinois Tool Works Inc., a sprawling combine of nearly 800 business units in numerous industries from food services to auto parts, routinely acquires dozens of small companies each year. It did not respond to a request for comment for this story, but has told the Wall Street Journal it has no plans to divest any major businesses.
In short, the lesson from the current trend towards de-conglomerating is that it may just be a wrinkle in the fabric of business judgments CFOs, investors and others are constantly making, says Steven M. Davidoff, a law professor at the University of Connecticut who is the "Deal Professor" at the New York Times's DealBook weblog.
"Just spinning off a business does not create value," says Davidoff. For example, "spin-offs are a very easy way for management to get rid of businesses they may not like as much. Bad spin-offs are subsumed within the good ones."