Small Is Beautiful – The End of the General Electric Conglomerate Confirms the New Era on Wall Street
The time is now for pure players, specialists in their field.
The last great conglomerate will die. General Electric, GE, whose origins go back to Thomas Edison in 1878, is going to disappear by splitting into three: health, energy, and aviation will go their separate ways. For many investors on Wall Street, this is no longer the time for conglomerates that combine unrelated activities. The problem is that such a combination of heterogeneous activities is a handicap because of the cumbersomeness and costs involved.
However, General Electric has long been the symbol of America. A symbol of the conglomerate model. Gigantic companies had to be present in a multitude of totally different sectors with the sole objective of being the leader in all sectors.
In recent years, the horde of conglomerates has shrunk worldwide: ITT, United Technologies, DowDuPont, ABB, Siemens have had to refocus under financial pressure. Even Toshiba, founded in 1875, has just announced plans to split into three companies. Eternal Japan is not spared from the fire of finance either.
Jack Welch, the "manager of the century", makes GE the world's largest capitalization in 2000 with $600 billion
When one remembers that GE's multiple previous divestitures, sales, and acquisitions have netted Wall Street banks more than $7 billion in commissions over the past 20 years, one thinks that finance's death sentence on GE is self-serving. The judge is a stakeholder here.
The central question here is: Are conglomerates animals out of time?
GE's strategy of conquest was decided by one of the most famous executives of his time, a certain Jack Welch. He took over GE in 1981 and pursued a very aggressive acquisition policy. And this, in all fields. The result is exceptional with a valuation that soars for GE until 2000. GE then represents the highest valuation of the stock market, at 600 billion dollars. Jack Welch became the “manager of the century” in the media.
The century-old group that had invented the light bulb, the jet engine, nuclear power, and wind turbines may have missed out on computers, but it still held its own in all the electromechanical industries.
Jack Welch had the ingenious idea of creating a lucrative subsidiary to finance his customers who bought power plants or engines. At the time, finance represented 80% of the profits of the entire GE conglomerate. If nobody knew it at the time, it was the beginning of the end.
This was the beginning of the end for GE, with the financial world turning away from conglomerates
Wall Street then systematically discounted the conglomerates, on average by 30%. GE's share price began to slide. The financial crisis of 2008 put the financial subsidiary in a bad light, guilty of bad investments. GE's golden goose is no more. The other divisions appear naked, unprofitable. A cascade of sales followed, from NBC television, plastics, household appliances, and finance itself. Nothing stopped GE's downfall. The stock will lose 75% in twenty years:
As is often the case, financial constraints are merciless. GE has to cut its costs, including those of its research laboratories. The budget initially stagnated at 4.5 billion dollars per year before inevitably falling. Meanwhile, its bankers, JPMorgan, Citi, and Goldman Sachs, are bombarding it with proposals to buy up so-called “nuggets” to boost its results.
This serves above all the interests of these banks, which can earn juicy commissions in the process. As we have frequently seen in the last few years, many of these takeovers have turned out to be disappointing. CEOs come and go at the helm of the company, but they are offered nice packages with each departure, like the one of about $233 million for the current CEO, Larry Culp.
The conglomerates seem to be doomed, at least for the moment. The age has become Schumpeterian. Joseph Schumpeter's theories on economic fluctuations, creative destruction, and innovation are increasingly being put forward.
Disruptive innovations now come from pure players who are specialists in their fields
The disruptive innovations of start-ups are breaking with the classical procedures of research and development. Pharmaceutical companies are currently experiencing this at their peril: they must acquire promising "nuggets", even if it means making mistakes and increasing their debt. In this context, the adage of conglomerates, "don't put all your eggs in one basket", may seem mortifying. One cannot have one's eye on everything at the same time, in health, energy, and aviation.
It is better to separate these businesses, as Larry Culp says so that they have “a better focus, dedicated capital, and a flexible strategy”.
Another argument goes in the same direction: finance now prefers small to big. “Small is beautiful” has become the norm. The fashion is for pure players, specialists who are leaders in their sector. Private equity has learned, in California but now everywhere else, to bet hundreds of millions of dollars on very specialized start-ups, while the big banks no longer know how to, or do not want to, accompany large industrial clients, because they are forbidden by the Basel III agreements or by the ecological reputation, or because they simply do not have the technical skills.
Conglomerates are no longer relevant, but the future may one day smile on them again
Nevertheless, the conglomerates may not have said their last word. Don't investment funds themselves divide the savings they are entrusted with into several baskets? Jeff Bezos has been the darling of Wall Street for many years, even though he combines commerce and rockets, which are unrelated. Ditto for Elon Musk with Tesla's electric cars and SpaceX's rockets.
It's all about the ability to manage innovation. In this field, there is no reason to think that a financier is better than an engineer. On the contrary!
The conglomerate can be a place for future arbitrage. When Wall Street is going crazy, conglomerates can once again become havens for serious long-term investments. So we should not rule out a return to favor in the future.
Some reading
Rich Bitcoin HODLer vs Poor Bitcoin Trader. November 10, 2021, is here to remind you why HODL Bitcoin is much safer for most people.
Mastering the Five Steps of a Successful Change. Change is an iterative process, not a singular event.
4 Things Every Bitcoiner Must Give Up - #2: Trusting without Verifying