The conglomerate is dead, long live the conglomerate! (Column: Behind Infra Lines)



News headlines from across the world seem to suggest that conglomerates that dominated many industries for the past decades are seeing a seismic shift of business strategy.

News from Europe about Siemens looking to sell its power business and Nestle's decision to spinoff the skin care unit, to the gradual sizing down of General Electric that has happened over the last decade indicate a greater focus on higher margin core businesses by the conglomerates. 

In India, the recent announcement by the Tata Group to combine its consumer business under the umbrella of Tata Consumer Products is again a move by a large conglomerate to simplify the corporate structure for value realisation. An analysis of the sizing down of conglomerates and the nature of new market participants who are acquiring the assets being spun off in the corporate carveouts throws light upon some significant trends, especially with a view on India.

The general trend that the conglomerates have seen is spinning off what are low-margin businesses to focus on core businesses that have both high-margins and a significant contribution to the top line. As the corporate spin-offs pick up pace, one trend that stands out is the nature of the buyers. While strategic buyers are present, the ever-increasing participation by capital-rich private equity funds and sovereign wealth funds is one that merits attention. The primary aim of the buyers is to aggregate smaller pieces to create a large platform and more importantly, utilise a lower cost of funding to improve return on equity. Mainly, the larger private equity funds are emerging as the new-age conglomerates as it were with a focus on scale, efficiency and low-cost funding.

In India, in the years to come, we should see both the global trends of a streamlining of conglomerates as non-core businesses are spun off and increasing participation from capital providers to acquire corporate carveouts having a significant impact. As the capital markets in India evolve and companies move beyond bank funding, to truly create value and attract the appropriate funding a simplification of the conglomerates and increased participation from capital providers will be essential.

Amid all the changes taking place in the conglomerate space in India, there is still space for "capital-efficient" conglomerates. While efficient capital allocating conglomerate businesses do well all over the world, with the likes of Berkshire Hathaway being market leaders, India presents certain peculiar conditions that make efficient conglomerate structures even more relevant.

While capital markets in India have developed significantly with a large equity market and a fast-growing bond market, credit markets still lack the granularity and sophistication as compared to the ones in more developed economies, especially the United States. An efficient conglomerate in India can help smoothen the financing constraints that Indian businesses face. The ability of a conglomerate in India to structure annuity generating businesses that can help fund new growth, without an over dependency on bank loans is the single most significant factor as to why conglomerates in an Indian context will continue to hold great value.

A closer analysis of the issues that Indian conglomerates faced since 2009 will show an over-dependency on bank loans to fund growth, and an inability to service debt as rapid business expansion faltered. An alternative model to debt-fuelled expansion is the utilisation of stable cash flow generating businesses along with moderate amounts of debt for growth.

To elaborate further, conglomerates driven more by strategic needs that strengthen the balance sheet will still have a place in India. Strategic needs here could mean vertical integration that allows such integration to reduce exposure to the business cycle. Alternatively, the strategic need could be driven by the cash-flow structure of the business, whereby a low-growth business with stable cash-flows, due to low exposure to the business cycle such as essential consumer products, is combined in a conglomerate with an area of high growth that requires significant investment upfront. Essentially, a defensive business in a conglomerate can create an "economic moat" with which to grow and boost riskier high growth segments.

Going forward it will be essential for successful conglomerates in India to focus on the strategy mentioned above as opposed to an approach of chasing growth for the sake of pure revenue growth, a strategy fraught with risk as evident from the issues multiple conglomerates in India faced post-2009.

With rapidly evolving global dynamics, India will see significant activity in line with global trends of large conglomerates streamlining businesses and an emerging class of new capital providers. These trends imply substantial value creation and investment opportunities in India. That said given market dynamics, well-structured conglomerates will continue to be significant players in emerging markets such as India. IANS