After years of turmoil and a valiant effort by its latest CEO Larry Culp, General Electric (GE) finally gave up in its efforts to salvage its broad-reaching business as a singular unit.
The company has consistently spun off numerous assets across the sprawling conglomerate in recent years to lessen its debt load. Perhaps most important was a $20 billion deal to ship its biopharmaceutical business to Danaher (DHR) in 2020. Yet, it appears the moves were not enough to satisfy Culp's ambitious recovery goals for the once-great industrial giant.
"The world demands-and deserves-we bring our best to solve the biggest challenges in flight, healthcare, and energy," Culp said in a statement on Tuesday. "By creating three industry-leading, global public companies, each can benefit from greater focus, tailored capital allocation, and strategic flexibility to drive long-term growth and value for customers, investors, and employees. We are putting our technology expertise, leadership, and global reach to work to better serve our customers."
Similarly, the lawsuit-besieged Johnson & Johnson (JNJ) announced it would spin off its consumer health division from its higher growth pharmaceutical and medical devices divisions in the coming two years.
Judging by the jump in GE stock after the announcement and the early jolt to Johnson & Johnson stock after its announcement Friday, the market certainly looks as though it was offering its initial approval for the streamlining of separate companies. Still, a few questions quickly come to mind.
First, is this indeed a deft move by management in both cases and therefore deserving of the share-price reaction? And if so, are there more companies that could benefit from following the example set by both of these storied companies?
Better After a Breakup?
The first line of questioning is one of whether or not two or three firms are truly better than one.
On paper, it would certainly appear to be so. As of Thursday's market open, GE touted a valuation of about $119 billion as a total entity. However, when broken into constituent parts, RBC Capital Markets analyst Deane Dray suggested up to a 20% upside for investors. Judging by company metrics and projections, it could well be even higher.
Also, each of the spun-off GE units will be less encumbered by the debt of their former counterparts within the broader company, especially as asset sales in recent years alleviate debt and pension issues. Further, future deals are more likely to reach approval based upon diminished antitrust risk, opening a much wider world of opportunity for investors in the streamlined companies.
The logic is very much the same for Johnson & Johnson as its pharmaceutical business breaks free from the burdensome troubles of lawsuits over talcum-powder products as well as low-margin medicines like Tylenol. Separation is seen as a key step toward unlocking innovation.
"For the new Johnson & Johnson, this planned separation underscores our focus on delivering industry-leading biopharmaceutical and medical device innovation and technology with the goal of bringing new solutions to market for patients and healthcare systems, while creating sustainable value for shareholders," CEO Alex Gorsky explained in a statement. "We believe that the New Consumer Health Company would be a global leader across attractive and growing consumer health categories, and a streamlined and targeted corporate structure would provide it with the agility and flexibility to grow its iconic portfolio of brands and innovate new products."
To be sure, these targets and optimistic angles assume a rosy trajectory for each of the newly formed firms. As the example of DowDupont (now Dupont (DD) , Dow Inc. (DOW) , and Corteva (CTVA) ) shows, splitting up historic firms with sprawling business is not always a process that progresses precisely to plan.
Since splitting, the two storied industrial companies, once combined into one mega-conglomerate, have not had much success.
"New Dow will be well positioned to drive best-in-class financial performance and shareholder returns," Dow CEO Jim Fitterling said ahead of the firm's 2019 spinoff to a standalone firm. "We have a focused playbook of cost and growth drivers, clear and disciplined capital allocation priorities and a strong balance sheet. Our path to shareholder value creation is straightforward and in our control."
These pronouncements are very much in line with what GE has said of each of its planned new standalone entities. Also, in a move very much reminiscent of GE's quarterly results in recent years, the pronouncement promised much more than what has actually been delivered.
Since it's spinoff was official in April 2019, DOW stock has marked a less than 10% gain. Meanwhile, the S&P has risen over 60% over the same period.
An Example to Follow?
Still, assuming things do go well post-breakup, these moves could serve as a benchmark for other bigger, older, and perhaps bloated companies. At the very least, this is the logic adopted not only by aging and perhaps overcomplicated American conglomerates like GE and Johnson & Johnson, but also the nearly 150-year-old Japanese giant Toshiba (TOSBF) . In short, it looks as though a trend is taking hold.
"Companies that have very diversified portfolios continue to dilute the value to the shareholders," David Braun, CEO of M&A advisory firm Capstone Strategic, told Real Money. "We are in an era where technology and access to capital are different things. A conglomerate is going to have trouble competing."
"They continue to stockpile excess cash they cannot deploy," Braun added, voicing the drawbacks of the behemoth business. "I'm not sure they benefit from that model any longer."
On the former, he is far from the first to suggest such a move. RBC's Deane Dray has actually been calling for such a breakup for a few years, alongside 3M (MMM) and Roper Technologies (ROP) , firms he also believes could benefit from being a bit less bulky.
"We believe the pendulum is still swinging towards the 'urge to demerge' trend," he wrote in a note on Tuesday. "GE's announcement today could embolden the boards of several other multi-industry companies to move ahead on more aggressive portfolio simplification moves, including Emerson, Roper Technologies and 3M."
As far back as 2019, Dray suggested a breakup of Emerson's automation and commercial divisions could be a boon for shareholders. While the stock has been on a roll since the pandemic began, such a breakup has already been intensely considered by management. In early February, Emerson announced it would not pursue a split "unless a major strategic acquisition catalyst is actioned."
At the least, if such a catalyst is to appear the company is clearly willing to consider such an option.
For Berkshire, it is eminently unlikely that any moves come while both Warren Buffett and Charlie Munger helm the conglomerate. But prospects for such a breakup could take many forms considering the business spans industries from insurance to construction to railroads. As such, attempting to size up a form that such a move might take is nearly impossible to forecast.
Finally, the prospects of a 3M breakup are certainly not out of the question.
Investors in the storied firm are understandably frustrated. Long-term shareholders have seen the stock stagnate over the past five years, marking a basically flat return even after shares were buoyed by demand for PPE and healthcare equipment that the firm manufactured during the pandemic. Looking back on the boost to the shares, many might have been happier with a pure-play option for healthcare and protective equipment rather than a company also weighed down by industrial, transportation, and consumer segments.
Toward this end, the company may have already telegraphed its intention to move toward breaking up. In March 2019, the company divided its business into four units. The units, entitled safety & industrial, transportation & electronics, healthcare, and consumer respectively, were created in order to focus the business.
"We are continuing to advance 3M into the future, and today's actions will strengthen our ability to meet the fast-moving needs of our customers," 3M CEO Mike Roman said at the time. "Our new alignment will leverage our business transformation progress, accelerate growth and deliver greater operational efficiencies."
As operational efficiencies have not materialized to the point of elevating the share price, it is not unreasonable to ask questions as to why separate businesses might further tap into the desired efficiency. In short, the healthcare business might be stronger if it was no longer adhered to a scotch tape and post-it manufacturer and vice versa.
In the end, if the pursuit of separate businesses proves successful in each of the current experiments under way, the lesson may be that bigger is not always better. For investors, it might also open a number of pure-play options that provide a better investment than their parent companies do at present.
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