When Less is More: Reasons for Shrinking the Corporate Empire
Described by commentators as one of the biggest shake-ups in the company’s 125-year history, GE’s strategy is to focus on continued investment and growth in its world-class industrial business. The move is far from unique, as other corporates across all sectors return to their core business. Danny Davis, a London-based merger and acquisition (M&A) integration expert, says that conglomerates have been falling out of style for decades but transforming large businesses can take many years.
GE announced that it will “pursue disposition of most GE Capital assets over the next 24 months”. The language used by GE chairman and chief executive (CEO) Jeff Immelt echoed that of management consultant and founder of The Institute for Strategy and Competitiveness, Michael Porter. Immelt said: “This is a major step in our strategy to focus GE around its competitive advantages.”
A firm positions itself by leveraging its strengths. Porter has argued that a firm’s strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic – ergo not sector-specific – strategies result: cost leadership, differentiation, and focus.
Davis, a speaker at the London Business School on post-merger integration, says that shrinking the corporate empire is spurred by the philosophy of ‘sticking to your knitting’, or adhering to what you do best. This idea has regained urgency in recent years, driven by the global recession’s exposure of any assets that provided a poor return on capital (ROC). In addition, the banking crisis provoked a shortage of liquidity for some corporates, which prompted the sale of anything that could be labelled non-core to help overall company financing. Treasury has played a key role in identifying those corporate assets that could – and should – find a home elsewhere.
Helping to boost the balance sheet, even where it means a drop in turnover, seems a good reason for pruning. For instance, in February 2015 Mechel, one of Russia’s leading mining and metal companies employing 70,000 staff, closed a deal on the disposal of its North American coal producer, Mechel Bluestone, which it bought only six years earlier when coal prices were still high and demand from China for the commodity was strong. According to reports, the sale yielded the Russian company only US$5m although it paid US$$436m for the business in 2009.
However Mechel, Russia’s largest producer of metallurgical coal, has been in talks with its lenders, mostly state banks, to restructure its borrowings. Chief executive officer (CEO) Oleg Korzhov commented at the time of disposal: “As part of the revised development strategy we continue disposing of non-core and non-strategic assets. With the market situation being what it is, mining at Mechel Bluestone’s mines and open pits is not profitable.
“The company’s average annual net loss since 2012 was around US$60m. Selling Mechel Bluestone will not only enable us to avoid these losses, but also takes some US$140m of liabilities off the group’s balance sheet and allows us to avoid over US$160m worth of legal risks. The sale will allow us to focus the freed cash flows on servicing the company’s debt.”
What fits, what doesn’t
When corporates complete acquisitions they often acquire businesses that are not central to their core mission, says Davis. For instance, an oil entity acquiring a competitor may also pick up its chemicals business as part of the deal. If the strategy is to focus on oil, then the sensible move is to dispose of the business that does not fit in with the plan.
Acquisitions and disposals are the natural long term outcome to a strategic change of direction. That means that the group often appears to be involved in a roundabout of acquisitions and disposals, although there is a method discernible behind the activity. Unilever is one of those companies that has been reshaping the portfolio. In early March, the Anglo-Dutch consumer goods multinational announced that it had signed an agreement to acquire the niche personal care brand REN Skincare. In its 2014 strategic report (part of its annual reports and accounts) Unilever CEO Paul Polman had written:
“We took steps last year to sharpen the portfolio even further with a number of strategic acquisitions and disposal of non-core brands, although there is always scope to do more and I would like to see the level of activity accelerate in the year ahead. It is also clear that we still need to do more to get our foods category growing again, although we are winning market share.”(see below*)
In the REN Skincare announcement Unilever said that “the multi-award winning brand is today sold in 50 countries and has built a committed consumer base.” Fifty countries might not yet amount to global dominance, but it is certainly a strong international presence and that is another driver for corporates shrinking their corporate empire according to Davis.
With global marketing now possible in the internet age, the days when multinationals used various brand names for the same basic product in different territories are over. Much more efficient is to have a few global brands which dominate and concentrate on them by selling off second-tier brands to smaller or regional entities. “Companies have been talking about a global approach – one brand name, one marketing – for 10 to 15 years and now it is happening,” confirms Davis.
Shrinking the corporate empire is not always about long-term plans, sometimes it is a reaction to bad news. Companies often restructure and refocus after a difficult time. As part of the turnaround of the UK’s biggest supermarket group Tesco, a strategy which has already included exiting its Fresh & Easy business in the US, CEO Dave Lewis recently announced the sale of its film and music streaming business Blinkbox.
According to reports, the business was sold for a fraction of the acquisition price and investment as in 2014 alone losses were £42m and the Tesco broadband business also went. Part of the Blinkbox problem was that the businesses were just too small to gain any management time – this week saw Tesco post a £6.4bn annual loss (US$9.6bn/€9.0bn) – by far its worst-ever result. The supermarket operator might also feel happier selling Dunnhumby, the data analysis company that runs Tesco’s Clubcard loyalty scheme, which analysts have valued at £1bn to £2bn. That business is now close to the corporate check-out.
Size was also a determining factor in the disposal plan of UK security firm and outsourcer G4S. The company went into turnaround mode partly after it gathered poor publicity in the UK over its criminal tagging business and inability to supply enough security staff for the 2012 London Olympics.
G4S has identified 35 divisions which could close. Announcing its annual results last month, chief financial officer (CFO) Himanshu Raja described the result of divestments and rationalising its smaller portfolio business as “sharpening the strategic focus and significantly enhancing the quality of earnings of continuing operations”. That policy should, of course, eventually improve returns for shareholders.
Shrinking the corporate empire looks set to continue and where GE goes others are bound to follow. As Davis points out, many large corporates have still got a lot of items for which they would like to find a buyer. They can’t all go on the market at once as they wouldn’t fetch a good price. However, with the desire to focus the strategic shrinking aim remains.
*How Unilever is reshaping the corporate empire
Following up on Unilever CEO Paul Polman’s comments a spokesperson told gtnews that Unilever is sharpening the portfolio with M&A and driving opportunities for growth through:
The Unilever portfolio has evolved over the past six years. Personal care, as a percentage of total group turnover, increased from 28% in 2008 to 37% in 2014. Over the same period the percentage represented by food products reduced from 35% to 25%. This is due to a combination of organic growth and acquisitions such as Alberto Culver shampoos and conditioners, Sara Lee personal care products and Russian beauty company Kalina offset by disposals in foods such as Ragu pasta sauces and Skippy peanut butter.
Unilever says it is building its presence in premium segments: For example T2 has seen double-digit growth in its home market of Australia and New Zealand during the first year since acquisition and has added three stores in London and one in the US.
The group says it is continuing to shape the portfolio towards faster-growing, more value-creating categories and segments. Specifically that means increasing its presence in more premium segments, further acquisitions in personal care and some limited disposals of brands in other parts of the business if value creation opportunities are limited.