Conglomerates: a nine-point plan

BUSINESS VIEWPOINT J. D. SLATER

Mr I. D. Slater is chairman of Slater. Walker Securities Limited.

The outstanding success of some of the so- called conglomerates in America is in stark contrast to the poor rating and past per- formance of many British industrial holding companies. In essence, they are two names for much the same- animal: a grouping of different kinds of business. But companies such as Litton and Textron, for example, sell on price-earnings ratios of forty-one and twenty- one respectively against the market average in America of sixteen. Conversely, in this country industrial holding companies in general sell on price-earnings ratios considerably lower than the market average.

When industrial holding .companies were the fashion in this country about ten years ago, they were selling on very high price-earnings ratios well above the market average. Since then their status has fallen, because their earnings per share have grown poorly, and there have been a few failures.

The main cause of failure was weak central management taking over a mass of diverse, small private companies in the belief that it could run them better than previous proprietor- management. In many cases, businesses were bought mainly for earnings with little attention to assets and liquidity, and little investigation into the sometimes suspect earnings in the year before acquisition which formed the basis for calculating the purchase consideration. Using shares quoted on a high price-earnings ratio together with loan stock and buying businesses with warranted earnings for the first year, there was no immediate problem. During subsequent years, however, profits often slumped. Key managers who had previously been active proprietors found that they pre- ferred life in the Bahamas, and the weak central management was unable to cope with the large variety of problems suddenly arising from diverse interests. In parallel with this, their rating in the stock market suffered, and with poor liquidity in many cases they could not buy their way out of trouble.

I believe that the American conglomerate has been successful when compared with the British industrial holding companies for the following reasons: (a) The financial policy has been sounder and the management more stock market orien- tated.

(b) Acquisitions have been considerably larger in size.

(c) Central management has been stronger.

I believe that there is very considerable potential in this country for the development of new and far stronger conglomerates. I think that the essential requirements for success can be summarised in a few critical points which I have listed without endeavouring to put them in order of importance:

1. It is essential for there to be very strong central financial control: In this context, accurate monthly profit and loss figures are essential, together with budgets and a detailed analysis of all variances from those budgets. Similarly, there should be very close central control of group liquidity.

2. There should be a strong central team, free of day-to-day routine, who can deal as a task force with trouble spots as and when they arise.

I. Bach new acquisition should fit reason- ably well into an existing division of the com- pany or be of sufficient size to be the nucleus of a new division.

4. After deciding that a proposed acquisition makes general commercial sense and provides scope for substantial organic growth, the approach to it should be financially orientated. In particular, the main criteria should be whether or not it will improve the assets and earnings per share of the main company. The other critical question is whether or not it will impair liquidity. Each acquisition should be looked at with these three criteria in mind— the effect on earnings, assets and liquidity.

5. It is essential to be market orientated. In this context, the main aim should be to achieve a 'smoothed out groWth rate.' By this, I do, of course, mean a smooth and regular growth in earnings per share. This is essential to maintain a reasonably good price-earnings ratio which is again essential to make acquisitions relatively less expensive.

6. Industrial companies should be managed in the same way as an investment portfolio. The key to this is to cut out or improve loss makers rapidly and back winners. Money should be channelled where management is succeeding in good, long-term growth areas as opposed to where it is pushing uphill–in the wrong field.

7. Acquisitions should in general have a good asset backing, which will provide an essential buffer and reserve for bad times. It is a very dangerous policy to be purely earnings orientated and this is one of the main reasons for past failures.

8. Acquisitioni should in general be sub- stantial in size. This is one of the most vital points of all, as otherwise management becomes an almost insuperable problem. Rela- tively large companies usually have manage- ment in depth and are not wholly dependent on one or two men. It is then possible to con- centrate on improving the financial and com- mercial side of the business without having to interfere to any extent with the technical and more general aspects of the business.

9. In addition to the central management being free to tackle trouble spots, they should also be free to assist in selling off loss makers where the task of putting them right is not worth the effort involved in doing so. With- out this firm policy of selling off real trouble spots, one can easily develop the-habit- of chasing good money after bad and spending a disproportionate amount of time on endeavour- ing to recoup losses as opposed to developing profits.

I believe that the basic theme should be to build up earnings per share and then reverse into assets. From these assets, cash shOuld be generated by selling off loss makers and re- investing the proceeds in further earnings. As further earnings are generated, the cycle is again repeated. By doing this, assets per share are kept moving up in line with' earnings per share and it is these increasing assets which provide a firm base for future development.

'Whether companies are called conglomerates or holding companies matters little. In the long term, their rating in the stock market- will depend upon the amount by which they in- crease their earnings per share each year and the degree of reliance that can be placed upon their doing so in future years.

During the next decade it will be interesting to see the degree of success that is achieved by holding countries in this country - and whether or not any of them compare favour- ably with the outstanding growth achieved by some of their American counterparts.