Is the Asean conglomerate model losing its shine?
Like vinyl records and sideburns, conglomerates in America are a 1970s phenomenon now fast becoming obsolete. In their heyday, conglomerates like International Telephone and Telegraph Corp (ITT) commanded a massive stock market premium.
Investors in Asian conglomerates would be well-placed to heed the lessons of the hero of the golden age of American conglomerates. Harold “Hal” Geneen was not just the CEO of ITT from 1959 to 1977 but a symbol for the conglomerate asset class.
Geneen grew ITT from a telegraph equipment producer with US$765 million in sales to a conglomerate with US$17 billion in revenue in 1970. At its peak, ITT’s interests included insurance, hotels, and real estate. It controlled one of the largest private landowners in the US as well as the hotel giant Sheraton.
Under Geneen, ITT also became a serial acquirer of businesses. He completed 350 acquisitions and mergers in 80 countries. This was long before such acquisitive scale was easy due to cheap money.
Geneen’s mantra was that large, multi-industry companies provide unmatchable efficiencies. These disparate businesses had nothing in common except their parentage.
By building scale, the conglomerates could command a lower cost of capital. Also, it could cut costs and apply a uniform culture. Others that followed ITT’s formula in 1960s included Litton Industries Inc and General Electric.
Geneen was a tireless worker who ruled by fear and numbers. He worked the hours of a convenience store – from 7am to 11pm. His
New York Times obituary said that “he was a man who always needed to know everything”.
The ITT senior executives had to send him weekly reports on their targets. They were exceptionally detailed even in the pre-excel era. In a typical month, he read 146 reports with a total of 2,537 pages. All the reports from farflung managers were sent to him directly, removing the prospect of tampering from middle managers.
But Geneen was not just an outstanding manager. He timed his exit to perfection. By 1977, conglomerates could no longer monopolise efficiencies. Their relative returns started to falter and siloed corporations were more in vogue.
By the mid-1990s – following a series of splits and disposals – the scale of ITT was reduced. It became a mid-size producer of industrial and aerospace parts. Other conglomerates suffered a similar fate. Litton Industries, for example, was acquired by Northrop Grumman in 2001 while General Electric suffered the ignominy of being booted off the Dow Jones Index in 2018 after more than a decade as a component stock there.
Asean conglomerates, such as Jardine Matheson, Salim Group and San Miguel, have long enjoyed a relative premium valuation. In 2000-2019, the leading conglomerates in Singapore, Malaysia, Indonesia and the Philippines have traded at an average premium of 21% over the market.
Investors were enamoured by the scale and efficiency that a conglomerate like San Miguel could generate. It operates in a vast swathe of businesses from beer to petroleum refining. Its cost of capital, corporate governance and operating efficiency was believed to be superior to its focused rivals. For much of this period, the enthusiasm was warranted, as they have outperformed the market in total shareholder return terms.
The reverence with which the market viewed Asean conglomerates may be about to wane. The Salim Group’s constellation of business interests range from mining in the Philippines to noodles in Indonesia. Its CEO Anthony Salim is known to have a similar work ethic to Geneen, as well as faith in numeracy.
The Hong Kong-listed First Pacific is at the pinnacle of the Salim Group’s organisational chart with a gross asset value of US$5.7 billion. First Pacific’s discount to its sum of the parts (SOTP) valuation has widened from 23% five years ago to 57% today. This indicates a steepening conglomerate discount. In that period, its TSR has plummeted to 9%, well below the TSR for Asean pure plays.
From 2014 to 2019, Asean conglomerates have delivered a TSR of 10% compared to 13% for pure plays. A study by Bain Consulting Group has also shown that Asean conglomerates have underperformed in terms of revenue growth and margins.
The conglomerate premium diminishes as an economy prospers. This is especially apparent in the cost of capital. Thailand has tripled its GDP per capita since the Asian Financial Crisis.
Thai pure plays such as the Thai Beverage raised US$ 2.1 billion in a domestic bond issue in 2018 at just 3%, which is close to an American cost of capital. It is similar to the rate that a Thai conglomerate like Charoen Pokphand group, which has interests ranging from agriculture to retail to telecommunications, could command.
The 2020s may be the decade that Asean conglomerates are eroded. Shorting them would be a winning strategy.