Conglomerates Still Cast a Giant Shadow

The troubles at General Electric Co., Tyco International Ltd., Vivendi Universal and other diversified companies, coupled with Wall Street’s new distrust of corporations with intricate accounting, have prompted talk that the conglomerate is passe.

Not only are GE and the others suffering lackluster growth and sinking stock prices, they’re also being criticized for being what they are: complicated. In the aftermath of Enron Corp. and Arthur Andersen, investors are demanding simplicity and raising eyebrows at multifaceted, multinational behemoths.

They want businesses that are easy to understand and that carry transparent balance sheets devoid of financial chicanery. To their critics, GE, Tyco and Vivendi--with their unrelated operations--prove that the conglomerate no longer works, or at least doesn’t provide enough value to warrant its complexity.

Sound familiar? It should. Over the last three decades, the conglomerate has been chastised, ridiculed and declared dead. Many conglomerates have been broken apart or merged into other companies because their formulas for success stopped working and they suffered a crisis of confidence among investors. Huge companies such as ITT Corp. and Teledyne Inc., which once were stellar players on Wall Street and employed tens of thousands of workers, no longer exist.

Yet the conglomerate endures, and in good part because GE and some others keep proving that it usually works under good management. GE excelled at making its disparate pieces work together to deliver years of steady gains in sales and profit.

But without the help of the strong economy of the late 1990s, the company was forced to warn investors last month that it had stopped growing. First-quarter revenue fell at its aircraft-engines, plastics, lighting and GE Capital units. Its power-systems group enjoyed strong growth in the quarter, but GE and analysts agree that its sales are peaking, and there’s concern as to how quickly GE’s other divisions can offset the power group’s slowdown by bouncing back themselves.

Regardless of how soon GE and the others recover, or whether they will require radical changes to adapt to the skeptical mood among investors, “the conglomerate will survive,” said William Fiala, an analyst with brokerage firm Edward Jones & Co. who follows GE, Tyco and others. “The concept of a conglomerate is still very valid.”

Why? Because many executives believe in the business model and potential profit that conglomerates provide: namely that a hodgepodge of businesses smooth out economic cycles, eliminating the risk that a single-purpose company will get whipsawed if demand for its one product or service suddenly shifts.

GE, for example, knows that at various points in the economy’s cycle its aircraft engines and turbine-power systems will flourish, picking up any slack in its appliances and medical systems’ groups. When the economy shifts, the reverse happens.

Another “critical piece of the equation” depends on having pieces that work with each other even if they’re in different industries, said David Morrison, vice chairman of Mercer Management Consulting Inc. For instance, GE Capital helps customers finance equipment they buy from GE’s other divisions, which in turn helps those divisions lock in sales, he said.

Another factor that keeps some conglomerates in investors’ favor is the company’s chief executive, said James O’Toole, a USC business professor who has written extensively about conglomerates.

“One of the lessons learned about conglomerates ... is that a lot of their success is dependent on their leader,” O’Toole said. “Look at Berkshire Hathaway,” he said, referring to the holding company of famed investor Warren Buffett. “They [investors] have confidence in the guy running that company.”

And for all of Wall Street’s snarling about conglomerates these days, many investors can’t resist the notion that conglomerates’ diversity reduces risk; it’s the same reason investors buy mutual funds. So they keep acquiring stocks of conglomerates that they believe are soundly managed.

The shares of several other conglomerates are advancing nicely this year. Berkshire Hathaway, Fortune Brands Inc., Sara Lee Corp. and SPX Corp. have outperformed the 14% drop of the benchmark Standard & Poor’s 500 index over the last 12 months.

For outfits such as Tyco and Vivendi, the issue seems to be not that the companies are conglomerates but that they no longer are able to fulfill the conglomerate’s promise. It boils down to execution, and whether management can make the model work.

Many have failed that test over the years, even if they envisioned perfect synergy in which each division would send business and added profits to the others. Sears, Roebuck & Co. tried to peddle brokerage services and insurance through its stores in the 1980s, and ultimately gave up. That same decade, United Airlines--now a unit of UAL Corp.--bought hotels and rental cars to create travel conglomerate Allegis Corp., and it flopped as well.

Others went through wrenching restructurings to survive. One of the best-known conglomerate executives, Harold Geneen, used hundreds of acquisitions in the 1960s and ‘70s to build ITT into a powerhouse that did everything from selling international telephone service to baking Wonder bread.

With each acquisition ITT’s stock price would rise, giving Geneen a more valuable currency to buy more properties. The cycle repeated itself. But when Geneen retired in 1979 and was succeeded by Rand Araskog, ITT became a different firm in investors’ eyes. Suddenly they saw a patchwork company burdened with debt from Geneen’s reign, and Araskog went on a massive divestiture program--shedding more than 250 operations--to maintain the company’s value on Wall Street.

ITT eventually broke into three companies in 1995, and that’s just what Tyco’s aggressive chief executive, L. Dennis Kozlowski, planned to do with his company earlier this year. The idea: The combined stock prices of Tyco’s parts--which include electronics, medical products, security systems and financial services--would be worth more than the stock of Tyco as a whole.

But Tyco’s plan backfired. Its stock has slumped since the breakup was announced, and last month Kozlowski said the idea was a “mistake” and Tyco would stay mostly intact. That didn’t appease investors, and the stock continued to drop. However, “Tyco’s issues go much deeper than the fact that they’re a conglomerate,” said Fiala, pointing to investors’ skittishness about Tyco’s flip-flop strategy, heavy debt and lingering worries about its accounting methods.

The same applies to Vivendi. Its chief executive, Jean-Marie Messier, took his French water and sewage-treatment company on a $50-billion takeover binge, gobbling up Universal Studios and Europe’s largest pay-television operator along the way. But now Vivendi is being criticized as a multi-headed monster with big losses, a huge debt load, unclear strategy and plunging stock price.

“Vivendi is too complicated, too diversified and too much of a conglomerate,” said Marco Blasi, a money manager at HSBC Republic in Paris.

Conversely, GE remains the bellwether for a conglomerate that works, though perhaps not as well as it once did. Under former CEO John F. “Jack” Welch Jr., the Fairfield, Conn.-based giant delivered remarkably steady growth during the 1980s and ‘90s by massively buying and selling assets and demanding that its divisions be No. 1 or 2 in their industries.

GE also exploited new technology and fervent cost-cutting to make itself more efficient, and built up GE Capital to the point where the subsidiary--itself a financial services conglomerate--now accounts for more than 40% of GE’s revenue and profit.

“Welch did a wonderful job of creating a management discipline and culture that was shared across all of its business units,” said Morrison of Mercer Management.

But even GE ran headlong into the investor skepticism that was spawned by the collapse of Enron and Andersen this year. Questions arose about GE’s uncanny ability to keep reporting double-digit earnings growth, and whether GE relied too much on acquisitions to fuel that growth.

Then GE dropped its own bomb last month, saying overall revenue isn’t growing because of the sluggish economy. And although GE vows that both revenue and profit will pick up as the economy rebounds during the rest of 2002, many investors and Wall Street analysts aren’t so sure. GE’s stock has tumbled as a result, although the company’s total stock market value of $308 billion still is the highest in the nation.

That’s putting pressure on Jeffrey Immelt, who succeeded Welch as CEO eight months ago. Immelt said, “I hate where our stock is,” and he acknowledged at GE’s annual meeting last month that “we live in a new age. Performance is not enough.”

But even in this new age, few are suggesting that the GE conglomerate is broken. “GE continues to execute very well in a difficult economy,” and the drop in its stock was “unwarranted,” analyst Jeffrey Sprague of Salomon Smith Barney said in a recent report.

GE remains a top player in most of its markets but faces stiff competition. In aircraft engines, for instance, it’s still the world’s top seller over Rolls-Royce and United Technologies Corp.’ Pratt & Whitney unit, but in locomotives it’s in a tight race for highest market share with GE’s Electro-Motive division.

In power systems, GE claims to be No. 1 but it’s constantly battling the likes of Siemens’ Westinghouse unit for new sales. And in major household appliances, GE is trailing in worldwide market share behind Whirlpool Corp. and Maytag Corp., according to research firm Freedonia Group Inc. Its NBC unit, meanwhile, leads in the prime-time ratings that advertisers care most about, and is the most profitable network.

GE rakes in an overall profit of $37.5 million every day, and not just because it’s a huge company. Last year it earned a respectable 11 cents per dollar of revenue--during a recession--and GE now earns 50% more than it did three years ago. (GE’s profit last year was $13.7 billion on revenue of $126 billion.)

But to keep GE on a growth track, Immelt could be forced to shuffle its assets. There’s speculation that GE might shed its appliances group, which earned only 6 cents per dollar of sales in this year’s first quarter, compared with double-digit profit margins at most of GE’s other lines.

NBC also is rumored to be a potential divestiture. Though still on top, the network is being pinched by the downturn in advertising revenue as its expenses are rising to keep hit shows such as “Friends” and “Frasier” on the air.

Then again, GE always has been about shedding languishing assets and acquiring new businesses with stronger growth prospects. History shows that the turmoil facing GE is nothing new. Welch had to deal with a string of setbacks during his 20-year tenure.

GE’s sales fell in 1992 when the economy tanked. And again in 1993. The company twice pleaded guilty to felonies concerning defense matters in the 1980s. And brokerage firm Kidder Peabody became a debacle for Welch; he finally unloaded it in 1994.

Now it’s Immelt’s turn, and he’ll have to overcome this set of obstacles and once again prove GE to Wall Street and the rest of the world, analysts said.

Immelt and his team “need a certain amount of time to get their bearings, and for the outside world to feel comfortable” with GE’s progress, said Roger Kenny, co-founder of Boardroom Consultants in New York. “I remember some really rocky times with GE’s stock in the past under Jack [Welch]. So you have to take the long-term view.”

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The Conglomerate Endures

Although General Electric Corp., Vivendi Universal and other complex firms face heightened investor scrutiny, some companies are sticking with the conglomerate structure.

Here’s a few of them:

* Berkshire Hathaway: Insurance, carpeting, paint, executive jets, candy, ice cream, newspapers. A holding company for famed investor Warren Buffett.

* Honeywell: Thermostats and other building controls, avionics, aerospace propulsion, polymers and other materials.

* SPX: Valves, pumps and other industrial gear, data-networking equipment, automotive products, power transformers.

* Sara Lee: Baked goods, meats, beverages, hosiery, intimate apparel, shoe care, air fresheners.

* TRW: Satellites and other aerospace equipment, air bags, other automotive products.

* United Technologies: Aircraft engines, elevators, helicopters, heating and air-conditioning systems.

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Source: Times research

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Times staff writer Sallie Hofmeister contributed to this report, and Bloomberg News was used in compiling it.