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Conglomerates: Why Do Some Succeed While Others Don’t?

By Motley Fool Staff – Updated Apr 14, 2019 at 4:23PM

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Hint: It has nothing to do with insurance.

One of our Twitter followers asked why insurance-based conglomerates like Berkshire Hathaway (BRK.A 0.59%) (BRK.B 0.43%) and Markel (MKL 1.09%) are so successful, while others like General Electric (GE 0.19%) are struggling. Is it because of the insurance business? Great management?

In this Industry Focus: Financials clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss why General Electric has been struggling more than other conglomerates. (Hint: It has nothing to do with insurance.)

A full transcript follows the video.

This video was recorded on March 18, 2019.

Jason Moser: Let's jump in Twitter here really quick. We got a good question over on the Industry Focus Twitter feed yesterday, or maybe the day before. It was from Jerry @GSLOShake. Jerry asks, "Can you explain why conglomeration is viewed as a positive for companies like Berkshire Hathaway, Markel, and Boston Omaha but not General Electric? Is it all about the insurance angle? Or is it more about a track record of smart acquisitions? Thanks for the great podcast."

Jerry, thank you for the kind words. Thank you for listening. And thank you for the question. Matt and I agreed this was one we wanted to get on the show here today. It's a fun one to sit here and talk about a little bit. Matt, what's your first take here?

Matt Frankel: There's actually a couple of different questions contained in that tweet. Let me tackle them one at a time.

First of all, it's not that conglomeration is a bad thing in GE's case specifically, or because it's a noninsurance company. The problem with GE is leverage. As of the last quarter, about 75% of GE's capital structure is debt. That's not sustainable. It's how they conglomerated. In the early 2000s, GE Capital, the finance arm, started to get a little bigger and then started to take on products that it was never really intended to do. It was really just meant to supplement GE's other businesses, providing financing for things they already make. But they got into subprime mortgages and things like that. Any company that got into subprime mortgages in the 2000s was not doing well. It's not that they didn't work. I would point to a company like 3M as an example of a noninsurance conglomerate that really works. 3M has healthcare operations, chemicals, consumer goods, you name it. It's a question of leverage. That's point No. 1.

Point No. 2 is, the insurance angle, it's not necessary, but it definitely helps in terms of the leverage financing angle. Insurance companies are a provider of very low-cost or no-cost, actually, capital. Warren Buffett mentions the float from time to time, meaning that all the money that is brought in from his insurance businesses before it's paid out, in the meantime, can be invested for the company's benefit. They don't have to pay interest on this money or anything. Imagine if someone gave you $100 billion that wasn't yours, but you got to keep every cent that was made by investing that money. That's a lot of capital that's essentially free. That's why the insurance business is really the fuel that helps some of these conglomerates that you mentioned.

Moser: One point also to remember with insurance companies is, because they are beholden to certain guidelines, rules, and regulations in regard to how some of that money is invested, some of that money has to be placed in low- or virtually no-risk bonds or other fixed-income instruments. Now, not all of it. I'm not saying all of it. But they do have to mind that. There is a little bit of a risk tolerance there, you could say. You know that they're not going to completely go off the deep end and just make all of these bad investments with all of that float. There's some protection there, wouldn't you say?

Frankel: Yeah. That's a very important point. You have to be good at running an insurance business for this model to work. Obviously, Warren Buffett and his team are. Markel's another one that's really good at running insurance businesses. Boston Omaha is up and coming, it remains to be seen. I'm hoping that they eventually -- I mean, not just because I'm a shareholder -- I hope that they grow into an insurance operation like Markel or even Berkshire.

You have to be good at running an insurance business first. If you're not running an underwriting profit, all the float in the world isn't really going to help you that much over the long run.

Moser: Yeah, that's a good point. It's worth noting, Boston Omaha and Markel are businesses that, they're running their businesses in that Berkshire mold. They look to Berkshire Hathaway as the North Star. They're thinking, "These guys did something and did it really well. We'd like to do the same thing there." So, they're running their businesses with similar philosophies in mind. Certainly, Jerry picked out a couple of good examples there in Berkshire, Markel, and Boston Omaha, and looking on the flip side with GE. Clearly, GE was mismanaged from a number of perspectives. All great insight, as usual, Matt. Appreciate that. And appreciate the question, Jerry.

Check out the latest earnings call transcripts for Twitter, Markel, and General Electric.

Jason Moser owns shares of Markel. Matthew Frankel, CFP owns shares of Berkshire Hathaway (B shares) and Boston Omaha. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), Markel, and Twitter. The Motley Fool owns shares of General Electric. The Motley Fool recommends 3M and Boston Omaha. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$401,490.00 (0.59%) $2,362.25
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$265.47 (0.43%) $1.15
General Electric Company Stock Quote
General Electric Company
GE
$64.47 (0.19%) $0.12
Markel Corporation Stock Quote
Markel Corporation
MKL
$1,081.58 (1.09%) $11.69

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