Pandemic hastening conglomerate break-up: Bain & Co

Singapore

COVID-19 is hastening the break-up of conglomerates in South-east Asia, as these hefty multi-industry corporations look to "slim down" their organisational structures to overcome conglomerate discounts and underperformance relative to pure-play companies.

South-east Asian conglomerates averaged 24 per cent in annualised total shareholder return (TSR) from 2010 to 2013, according to a study by Bain & Company, beating pure-plays by six percentage points.

From 2014 to 2018, however, they underperformed pure-plays by a substantial six percentage points - with average annualised TSR of just 2 per cent.

Jean-Pierre Felenbok, managing partner of Bain & Company Southeast Asia, is not surprised that what used to be advantages of size, diversification and close government connections, which fuelled decades of success for conglomerates in the region, have now turned against them.

First, the relevance of scale has diminished as developing economies mature. There is improved access to capital all around, and governments are more willing to work with a wide range of partners - including disruptive and innovative start-ups that are the very anti-thesis of conglomerates.

Second, heft has become problematic. Till Vestring, advisory partner at Bain & Company Southeast Asia, said that additional layers in the organisation add to costs and make it easier for poor-performing divisions to hide behind the success of better-performing parts of the portfolio.

"Sometimes conglomerates may even underinvest in their best positions just by spending too much time, capital and management attention on their weak positions. That is the dilemma with a proliferated portfolio," he said.

Covid-19 thus marks a crucial juncture for the reinvention of conglomerates. "The Covid-19 crisis is going to be another strong catalyst for either the disappearance or the strong transformation of conglomerates in the years to come," Mr Felenbok said.

Nimbleness will be required for them to reshape their portfolios. "But nimbleness hasn't been a strength for conglomerates in the past. Many have been accumulating positions but have not been very good in reshaping them and moving out of positions, so this is going to be a test," he added.

He expects a reshuffle of portfolios, as conglomerates with strong balance sheets get "on the offensive", taking advantage of declining asset prices in some sectors to reinforce their leadership position in the coming few years. Conversely, those without balance sheet strength may need to shed positions to survive and refocus on where they have stronger market share.

"I think there would be premium for more focus," Mr Felenbok said. "It will be very difficult for groups to achieve a very wide set of positions and we can see some of these trends playing in some of the more mature markets such as Singapore and Japan, movements that indicate more reshaping and slimming down."

The recent demerger between conglomerate Sembcorp Industries and shipbuilder Sembcorp Marine is an example of that.

To survive and lead, conglomerates need to cut costs, reengineer supply chains, invest in digitalisation, work in leaner ways, and reshape their portfolio for a post-Covid world, Bain & Co said.

Mr Felenbok said that leadership positions will matter even more for conglomerates post-Covid. But the pandemic also "reshuffles the deck" because some industries are going to be disrupted, perhaps permanently, by changes in consumption patterns. It is up to these companies to reshape their portfolios to ensure their competitiveness.

This might mean divestments. For instance, Philippine conglomerate JG Summit will probably have to consider what to do with its aviation business given that air travel is likely to be depressed for a long time.

There are conglomerates that have survived well over the years. The top quartile of conglomerates achieved a 26 per cent annualised TSR from 2010 to 2018, compared with negative 6 per cent TSR for the bottom quartile.

Such "all-weather stars" tend to be family-controlled businesses that are able to take a long-term perspective while being disciplined about where and how they participate, Bain & Co said. They have also clearly defined how the conglomerate can add value to each element of its portfolio - what Bain & Co refers to as "parenting".

For example, in Indonesia, Sinar Mas's business units operate largely autonomously yet have access to capital and short-term borrowing, with the conglomerate effectively playing the role of a banker. This parenting model helped Sinar Mas achieve a 24 per cent annualised average TSR from 2010 to 2018.

In Vietnam, one of Masan Group's parenting advantages is its consistently strong balance sheet and merger and acquisition capabilities. Its access to long-term capital in the form of equity and local debt also allows the conglomerate to strike major deals when its competitors are overstretched.

A decade from now, the authors of the study expect the number of conglomerates doing well in South-east Asia to dwindle further - starting with Singapore as a developed economy.

Examples of conglomerates include companies such as Hong Leong Investment, Keppel Corporation, Olam International, Sembcorp Industries, Singapore Press Holdings and Singapore Technologies Engineering, all of which have substantial holdings in at least two sectors.

Examples of local pure-plays are the three local banks, telcos Singtel and StarHub, property developers, as well as commodity, consumer and semiconductor players.

Mr Felenbok said: "My sense is that the potential breakdown in conglomerates in Singapore is just starting, and if we look again at the list five years from now, quite a few will have moved from being very proliferated across different industries to way more focused and pure-play-like."

The factors that make a conglomerate model work just don't anymore, replicating what has happened in the US or Europe, he said.

It also seems that shareholder preference these days tends towards asset allocation by sector, partly to overcome the problem of conglomerate discounts. Conglomerates are increasingly spinning off units to realise value.

The last decade has seen General Electric's wind-down of GE Capital and the sale of NBCUniversal, with potential for other parts of its conglomerate business - aviation, health and power - to be spun off too.

Two years ago, United Technologies (renamed Raytheon Technologies) was broken up into three separate aerospace, elevators and building divisions. Its spin-off of Otis Worldwide, an elevator manufacturer; and Carrier Global, a heating, air-conditioning, and refrigeration solutions provider, were completed this year.