Good to be Private, Conglomerates and Growth without Growing

How Good it it to be Private… and illiquid (The Diff)

  • “Slippage” is the difference between the overall corporate profits and the profits of public companies (hint: the former is larger than the latter).

  • It’s one of the reasons why smaller public companies are taken private.

  • 1900-2009 (US): GDP growth: 3% YoY; real dividend per share growth: 1% YoY. This means that (3%-1% = 2%) is the price the investors put on liquidity.

  • Current large public companies (thing FAANG) are doing this in reverse: they consistently redistribute value from their suppliers to the customers while pocketing the higher commissions.

  • SAAS companies get get a stable or growing share of the economic growth in their customers they enable (increasing the net dollar retention number).

  • Recapturing the difference between corporate profits and per share growth is the reason why large companies cost as much as they do, and why there’s no future for small businesses.

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Engineering a Conglomerate (The Diff)

Some theory

  • A conglomerate has one or all of these features: 1) good at raising money [i.e. cheap capital]; 2) bad at returning money to shareholders [i.e. sits on capital with no productive use]; and 3) good in M&A + running acquired companies, no matter what they do.

  • In fact, it’s silly to think that even an experienced exec can run ANY sort of company, as it’s close to impossible to offset the lack of domain expertise.

  • If anything, conglomerates should have discounts, not premiums. Diversification is better managed on the investor level (i.e. one can make a portfolio themselves), not on a conglomerate level.

  • There are lots of reasons why conglomerates arose in 1960s and then started falling over since 1970s. The successful ones (Berkshire Hathaway) have an incredible mix of luck and some spare cash – and having too much cash is a huge red flag for shareholders.

  • Being able to buy cheap is less sexy than people think. Example: you can buy a firm at 80% of their fair value. Merger premium (30% on top or so) aside (let’s pretend there’s none), if it takes 10 years to recognize the value, this is ~2.3% YoY excess return. Is it really worth the trouble and the risk?

  • Also, how many firms are there, which are dramatically mispriced? <$10m? Quite a few. <$100m? Some, perhaps. <$1B – even less. <$10B – hardly any, unless there’s an incompetent management [MK: something’s telling me it’s irony].

What about now?

  • Current big tech companies look a lot like conglomerates (some are trying to play the ecosystem game, but ecosystems are not conglomerates). And there’s a huge benefit in looking like a conglomerate without looking like an ecosystem (hint: antitrust regulation, which is all too relevant as of October 2020).

  • … but the current way is not acquiring other firms, but rather building the new businesses from scratch and acquiring companies to supplement the core business. Part of the explanation is that large companies have to overhire the talent [MK: hence all these stories about smart people twisting thumbs instead of creating value] in order to be able to deploy resources should the burning need arise, but these people have to be busy with something outside the core business not to raise suspicions.

  • Maybe it’s the US thing, maybe not, but it does look like successful conglomerates can only survive with a front person/brain present (so much for the transferrable management talent, see above); people are mortal and companies are not, unless they continuously grow faster than the GDP and risk eventually consuming the entire economy like the black hole.

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Now, speaking about infinite growth…

Growth– the Elephant in the Boardroom (INSEAD blog)

  • World Resource Institute: We need new business models that are not predicated on selling more stuff to more people. [MK: see what I mean?]

  • Most CEOs of direct-to-consumer firms can’t consider such models, and so can’t the Boards that hire them.

  • And these new business models mean any of the: environmentally friendly goods and services, ethics, responsibility, diversity. Are these really models?

  • A business model is based on sales growth (as simple as selling X% more items next year) or cost savings / efficiency (the gizmo sold now requires Y% less materials than a year ago).

  • The author advocates abandoning the firm’s economic growth to (for a while) capture the maximum margin and reduce the resource consumption, as well as thinking about business success in terms of the impact on people, planet, government and communities.

  • The new paradigm for businesses (that shouldn’t be really called “businesses” after accepting it) is that shareholder value growth is less important than: a) reducing the impact on the plant; b) the interests of all non-shareholder stakeholders.

  • Indeed, with this new paradigm the “new businesses” will grow, although in the non-revenue directions and it’s not clear how the shareholders are going to appoint Directors not directly acting in the currently acceptable best interests of the firm.

  • [MK: This is not to say this idea is a pipe dream, quite the opposite: whatever looks uncomfortable now tends to catch us off-guard relatively soon.]

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