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The Power of Diversified Companies During Crises

January 25, 2012 by Philip Beckmann, Dieter Heuskel, Ulrich Pidun, Harald Rubner, Christin Rudolph, and Bernhard Schwetzler
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New research from The Boston Consulting Group and HHL – Leipzig Graduate School of Management demonstrates that diversified companies perform as well as focused companies but have a measurable financial advantage during economic crises. More critically, the top diversified companies turn this financial edge into a competitive advantage that enables them to outperform their peers and recover rapidly from crises.

These insights, which are based on an analysis of more than 1,100 diversified and focused companies, build on previous findings from BCG’s research into diversified companies. In a December 2006 report, Managing for Value: How the World’s Top Diversified Companies Produce Superior Shareholder Returns, BCG showed that applying the conglomerate discount diversified companies is often unwarranted. The latest research from BCG and HHL shows not only that this discount is shrinking, indicating that the market is viewing diversified companies more favorably, but also that diversity can provide significant benefits, particularly in times of crisis.

Given today’s uncertain economic climate, all companies should learn from the experience of the top diversified companies and prepare to turn future crises to their advantage.

Market sentiment has swung in favor of diversified companies, which is reflected in the steady decline of the conglomerate discount.

  • From 2005 through 2009, the conglomerate discount in Western Europe and North America shrank to –6.0 percent and –7.2 percent, respectively, while a very small discount in the Asia-Pacific region was transformed into a conglomerate premium.

  • Detailed regression analyses demonstrate that the decline of the conglomerate discount is strongly correlated with the financial crisis.

Diversified companies’ superior risk profile gave them a financial edge during the market turmoil.

  • Diversified companies had significantly less volatile—or less risky—total shareholder returns (TSRs) than their focused counterparts.

  • Solid global credit ratings and narrower credit-default-swap spreads reflected this risk advantage and enabled diversified companies to gain cheaper and easier access to capital, particularly at the height of the crisis.

The top diversified companies turned their financial advantage into a competitive edge.

  • The financial crisis magnified the differences between strong and weak diversified companies. The performance gap between crisis outperformers and underperformers widened from 16 percent in the period from January 2006 through December 2007 to 52 percent by the end of 2009, and it continued to grow to 73 percent as the recovery got under way in 2010.

  • By the end of 2010, the top 50 percent of diversified companies had recovered their crisis losses and achieved a median cumulated TSR of 11 percent since the end of 2007. By comparison, the diversified underperformers were still far from recovery, with a median cumulated TSR of –34 percent.

To excel in the next crisis, companies should follow four key lessons from the top diversified companies.

  • Use financial stability to avoid disproportionate crisis reactions such as mass layoffs and fire sales.

  • Invest in the future while peers are financially constrained in order to ensure a faster rebound from the crisis and an ongoing competitive edge in areas such as R&D.

  • Pursue M&A while prices are low and competitors are out of cash.

  • Leverage the diversity of the company’s portfolio to allocate capital more smartly.

The conglomerate discount refers to the undervaluation of diversified companies caused by the perception that corporate diversification destroys shareholder wealth. In the academic literature, the discount is commonly derived by comparing a diversified company’s actual corporate value with the value of a matched portfolio of focused companies.

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