Dealbreaker's John Carney points us to an absolutely stunning missive published today by Professor Michael S. Rozeff on the history of conglomerates, just in time, I might add, to supplement my recent musings on the topic and its connection to private equity and buyouts in particular. Consider this passage:
How one company could create value for its shareholders by paying a big premium over market value to buy another company in an unrelated industry was a mystery, then and now. When the conglomerate sold at a price/earnings ratio of 20 and bought a company with a price/earnings ratio of 10, the combination seemed to fetch a price/earnings ratio of 20! This financial legerdemain (or was it ledger-demain?) created value, for a while. It was not permanent. By 1970 the days of reckoning arrived and the conglomerates crashed along with many other stocks.
The company heads were empire-building. They were being paid according to the revenues they managed, so they grew revenues by acquisition. If Wall Street made their paper (stock) worth a lot of money, it made good sense, they thought, to issue more of it and buy real assets. It made sense for the managers who made more money. It made less sense for the shareholders who saw companies overpay for acquisitions. For awhile the roller coaster rolled upwards before reaching the crest and speeding downwards.
The financial-historical goodness continues unabated for some time and is an absolute must-read for the erudite Going Private follower.
(Art: "Conglomerates Collide" Apple II business simulation game by Rockroy Inc., c. 1981. Being a nostalgist for all things 1980s business- mostly due to the bitterness I experience due to the trick of fate, i.e. the late timing of my birth, that failed to permit me to be in LBOs back then- I cannot help but be totally fascinated by this ancient game. Try your hand at it on-line, oh, would-be captain of industry. Laughs by the dozen for the careful study of business irony. Your managing director will surely see it as work-related study). Consider:
THIS IS A GAME OF CORPORATE CONQUEST IN THE WORLD OF CONGLOMERATES.
EACH PLAYER CREATES HIS OWN COMPANY (BY NAME), SELELCTS ITS
INTERNATIONAL HEADQUARTERS AND STARTS WITH $20 MILLOIN IN ASSETS.
INITIALLY, EACH COMPANY HAS $10 MILLION IN CASH AND $10 MILLION IN
CONTROLLED CAPITAL STOCK. THE CAPITAL STOCK VALUE OF 10 MILLION
REPRESENTS 1 MILLION SHARES AT $10 PAR VALUE. THE COMPANY ALSO HAS
BASE EARNINGS OF $2 MILLION PER YEAR (TURN) WHICH REMAIN CONSTANT FOR
THE ENTIRE GAME. GIVEN THESE RESOURCES, YOU MUST INCREASE THE EARNING
POWER OF YOUR MULTI-NATIONAL CORPORATION BY ACQUIRING OTHER COMPANIES
KNOWN AS SUBSIDIARIES. WHEN BUYING A SUBSIDIARY, LOANS TO A MAXIMUM
OF 50% OF THE PRICE ARE AVAILABLE TO FINANCE THE PURCHASE. ONCE A
SUBSIDIARY IS ACQUIRED, THE AMOUNT OF FIXED EARNINGS FROM THAT COMPANY
ARE ADDED EACH TURN TO THE BASE EARNINGS OF YOUR CONGLOMERATE. ANY
SUBSIDIARY THAT IS AQUIRED MAY NOT BE RESOLD-FORCING PLAYERS TO LIVE
WITH THEIR DECISIONS. EACH YEAR (TURN) THE PRIME RATE WHICH RANGES
FROM 7 TO 30% CHANGES RANDOMLY AND CAUSES THE BANK RUN BY THE COMPUTER
TO COLLECT THE AMOUNT OF INTEREST DUE FROM EACH PLAYER'S COMPANY. THE
BANK WILL ALSO PAY INTEREST ON DEPOSITS AT A VARIABLE RATE LESS THAN
THE PRIME RATE WHICH PROVIDES EXTRA INCOME