Are PE firms actually conglomerates? And is it actually a problem?

A recent article in the economist argues that PE firms are looking very much like conglomerates. However, according to a study by BCG, this does not seem to be a problem, as diversified firms, e.g. conglomerates, are increasingly able to achieve superior returns by doing exactly what PE firms are doing.

ARE private-equity firms the new conglomerates? The two look more and more alike. The dozen or so top private-equity firms have taken positions in an extraordinarily diverse range of operating companies, much as big conglomerates have done.

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But the comparison is one that the private-equity firms have discouraged. After a fashion for industrial conglomerates peaked in America in the early 1970s, the term became a pejorative one among students of business. It came to signify inefficient management; a failure to master the demands of wildly different businesses; an absence of focus.

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The private-equity firms might want to know, however, that just as they are shunning the label of “conglomerate”, the term may be on the way back into fashion. A well-run conglomerate may be admirable after all. That, at least, is the message of a new study by the Boston Consulting Group, “Managing for Value: How the World’s Top Diversified Companies Produce Superior Shareholder Returns”.

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The study looks at 300 of the world’s biggest firms, some 30 of which are classic diversified conglomerates. It finds that most of the diversified firms outperformed stockmarket averages in the past five years, many by a significant margin. An average focused company in the study did even better, but this result was distorted by a handful of exceptional performers. Most of the focused companies failed to perform as well as the diversified companies.

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How did the better conglomerates do so well? For the most part, by behaving rather like private-equity firms. A successful conglomerate had a lean organisational structure; it had a consistent strategy for its portfolio companies, viewing them as trading assets, or holding and managing them for the long-run. And it was extremely efficient at allocating capital. It invested most heavily in its profitable units. That might sound like common sense. But over-investing in underperforming subsidiaries was a common problem among weak conglomerates in the study.