Running a company is tough work. Take that work and multiply it dozens of times, all under one name, and the result is a conglomerate -- a combination of many different businesses. As you can imagine, conglomerating makes a difficult job that much harder. In fact, of all such combination-type businesses that have come and gone, only two come to mind as particularly successful.
One is General Electric (NYSE: GE ) , the giant behind such things as the NBC television network, aircraft engines, power generators, and light bulbs. The other is Berkshire Hathaway (NYSE: BRKa ) (NYSE: BRKb ) , the insurance firm that also happens to own a furniture chain, an executive jet business, a chocolate company, and even an underwear company.
More often than not, when companies stray too far from their roots, they end up "di-worse-ifying." In essence, they take concepts that might work well on their own but combine them in a way so that none of them functions at its peak potential. It's kind of like trying to drive your car without releasing the parking brake. Sure, you might be able to get where you're going, but it won't be a smooth trip, and things can certainly get ugly.
Release the parking brake
Fortunately, once you start driving your car with the parking brake engaged, you can usually simply release it to resume driving with little or no permanent damage. Likewise, just because a company strayed too far from its roots with a poor acquisition or expansion, that doesn't mean it's stuck that way. If a business combination is unwieldy, a firm can simply break itself apart to unlock its component parts and let them each perform to their full potential.
Motley Fool Inside Value selection Cendant (NYSE: CD ) is a conglomerate going through just such a breakup. In the first stage, PHH (NYSE: PHH ) was spun off and now operates as a separate mortgage management company. Later this year, the rest of Cendant will be split into four pieces, completing its breakup. One part will focus on real estate operations, another on travel distribution, the third on hospitality, and the fourth on vehicle rental services.
Likewise, fellow Inside Value selection Tyco (NYSE: TYC ) is another conglomerate on the path toward breakup. A veteran of the spinoff business, Tyco had previously set capital financier CIT (NYSE: CIT ) free. Now the whole company is coming undone. It's splitting into a health-care business; an electronics firm; and a fire, security, and engineered products corporation.
Why breaking up makes sense
The conglomerate structure is extremely expensive to maintain. On top of the ordinary business management, there's an additional level of executives focused on keeping the whole ball of wax together. Often, the structure gets mired down in company policies, practices, and bureaucracies in the name of consistency. While the initial combination may have promised efficiencies of scale, in many cases, the extra costs end up far outweighing whatever benefits do emerge.
With these splits, each separate company will be better able to focus on its core operations without the overhead associated with being part of the larger firm. As such, they can ruthlessly cut costs by streamlining operations, expand into more sensibly related businesses, and run without former parents' overhead.
Your chance to profit
Ultimately, the smaller firms, free to be lean and competitive, may very well shine. Until that happens, though, the original companies often get shunned by Wall Street. After all, the original investors who bought in to the conglomerate have been told that the structure is failing. At the same time, the folks who may be interested in the separate parts usually don't want to mess with the rest of the company. With nobody particularly wanting to buy shares, prices in the original firms often get depressed to below their true worth.
Remember, too, that these are shares in companies of which the breakup value is expected to be larger than the conglomerate worth of the entire firm. Take that to its logical conclusion, and it's as if you're using a coupon to get an additional discount off a company that's already on the clearance rack. As bargain-minded investors know, the bigger your purchase discount, the more your potential investing profit.
Do you want to profit from buying distressed companies at rock-bottom prices? Are you willing to pick up the businesses that Wall Street has discarded? Click here to start your 30-day free trial of Inside Value, and begin your discount-hunting journey. Subscribe today, and you'll receive Stocks 2006, the Fool's guide to the investing year ahead, free.