Breakups of GE, Johnson & Johnson don’t sway Chicago companies to drop diversification – Crain’s Chicago Business

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Planned breakups of storied conglomerates General Electric and Johnson & Johnson would seem to consign 1970s corporate fashion to the resale shop of history.

If so, some big Chicago companies still sport the strategic equivalent of leisure suits. Even after a wave of split-ups and spinoffs about 10 years ago, broadly diversified corporations tower over Chicago’s business landscape. In defiance of Wall Street’s oft-stated preference for highly focused portfolios, they still sell lots of unrelated products in different markets to a heterogeneous customer base.

These aren’t obscure little companies overlooked in the craze for de-conglomerate-ization. They include massive multinationals with market capitalizations in the tens of billions, like Abbott Laboratories, Caterpillar and Deere.

Local firms aren’t alone. A scan of the Fortune 500 confirms that diversification isn’t quite the dirty word that “conglomerate” has become. Behemoths such as Honeywell, 3M and Warren Buffett’s Berkshire Hathaway straddle multiple businesses. This despite evidence that single-business companies outperform diversified peers, in part because they can be nimbler in deploying capital and other resources.

Clearly, a diversified portfolio alone doesn’t mean a company is ripe for a breakup. Conglomeration can work when there’s a benefit to keeping unrelated businesses together, like a common technological base, or valuable economies of scale in key functions such as capital-raising.  For example, Boeing’s commercial airliner business and its defense unit both depend on aerospace technology.

With or without such a connection, breakups generally require a catalyst of some kind. Poor operating performance or a lagging share price can be the trigger, often after prodding from an activist investor.

“If you’re delivering decent results, you don’t have the activists showing up,” says professor Erik Gordon of the University of Michigan’s Ross School of Business.

A change in outlook at one or more divisions can also spur a breakup as execs look to untether faster-growing businesses from slower corporate siblings. That’s why Kraft Foods in 2012 separated its Kraft grocery lines from its snacks business, which was expected to grow faster.

Given those parameters, do any local companies look like breakup material?

We know of at least one. Energy giant Exelon plans to split regulated utility operations from a nuclear power plant business that has weighed down corporate earnings for years.

Lake Forest-based Tenneco is another candidate. The $15 billion-revenue auto-parts-maker planned to separate its powertrain business from units that make shock absorbers and other aftermarket products, but heavy debt put the deal on ice two years ago. With its stock down by two-thirds since 2018, Tenneco needs to make a move.

“Tenneco may be able to eventually separate its businesses as leverage comes down further if industry volumes recover over the next couple years,” Deutsche Bank analyst Emmanuel Rosner wrote Nov. 9.

In a recent SEC filing, Tenneco said, “We are continually evaluating our portfolio and a full range of strategic options to enhance shareholder value creation.”

A case could be made for breaking up other local conglomerates. Caterpillar, for example, makes everything from backhoes to mining equipment, power turbines and locomotives. Illinois Tool Works’ portfolio spans auto parts, construction tools, kitchen equipment, welding products, testing equipment, and industrial polymers and fluids.

If independent businesses really do outperform, the various units of these companies might do better alone. But no catalyst for such a move has yet arisen. Illinois Tool Works has delivered superior profit margins and above-average stock market performance. And while Caterpillar shares have underperformed recently and over the past decade, its outlook is improving.

In a statement, ITW says, “We earn the right to be diversified through our performance, and every ITW business must perform significantly better as part of ITW than they would outside of the company.”

Importantly, no activist investor is hectoring management at either company. That could change, depending on how the companies perform as the post-COVID-19 economy normalizes. ITW’s long-standing revenue growth struggles could attract attention, and Cat’s exposure to fossil fuel markets might force a reckoning.

Leaders of diversified companies shouldn’t wait for outside pressure to assess the value of keeping all their businesses under one roof. Gordon points out that a business portfolio is ultimately a capital allocation decision, the primary responsibility of management and directors: “This is a conversation the board should be having with the CEO on a regular basis.”