Decades ago, it was en vogue to create big conglomerates. Size was associated with being a sign of strength, bringing robustness in times of economic distress. However, as “holding discounts” nowadays are holding these companies back from achieving higher valuations, the opposite direction is pursued to lift these “hidden values”. Many German concerns are currently in this process. There is also one particular under the radar opportunity that is too cheap to be ignored.
Summary and key takeaways from today’s Weekly
– Several decades ago, it was en vogue to create conglomerates of great sizes, because they symbolized strength and robustness, especially during more difficult times.
– However, this led also to “diworsification” – and then companies started to become lean again, separating from non-fitting business units.
– Today, we look at some German blue chips that already kicked-off this transformational process. My latest research report covers another German company that is in the midst of lifting hidden values.
Two opposing philosophies with different goals and justifications of how to create shareholder value best are clashing here.
On one side, you have the “old school” proponents of “the bigger, the better”.
Conglomerates shall help to diversify a business and make it stand on several legs. This way, potential crises – whether from an economic recession or just affecting a particular unit – could be handled better. This safety aspect should theoretically deserve a higher valuation multiple.
On the other hand, you have the “modern filetizers” – breaking down intransparent businesses without cross-synergies into single pieces and ideally separate them into individual, stand-alone companies.
It is not important here whether via a separate listing or through a private sale.
Spin-offs and separations, enable to focus on the individual core businesses and unrestricted self-development. It is also what is now pursued more often, as big conglomerates suffer from so called “holding discounts” – their stocks are valued less by the markets than their individual pieces would be, if they were individuals.
Although I am writing today particularly about German companies, generally this Weekly also applies to other regions and markets.
One prominent example from the US certainly is General Electric (ISIN: US3696043013, Ticker: GE) whose stock currently sits at a five-year high, while its divorce into three separate businesses is underway.
The market seems to believe in the success of this story.
Today, we’ll be discussing the history as well as the present of some German companies. At the end, I am going to introduce you to a nearly-forgotten company that is currently also in the midst of a transformation, offering an interesting special-situation investment opportunity.
This company is also the topic of my next research report. My Premium Members receive an email alert with the report in parallel to the release of this Weekly (because I reveal the name of the company at the end) right into their inbox.
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First becoming overweight was attractive…
In the intro section, I wrote that the creation of conglomerates was justified with the diversification and safety aspect.
While this is not false per se, this inorganic growth option via acquisitions in some cases was undeniably used to also buy size and growth or even hide problems at the core operations, shifting the focus away to something seemingly more interesting.
As long as the growth party was running – more revenues, more profits – why comply?
Also, bigger companies mean more responsibility – and it comes with higher salaries and bonuses! Seemingly a win-win for all.
As often in life in general and in investing in particular, there is seldom just one reason for a specific development.
However, the general motto – the bigger the better – was a strategy pursued rather by an older generation of managers, as the study from Jung and Shin describes (see here: “Learning Not to Diversify: The Transformation of Graduate Business Education and the Decline of Diversifying Acquisitions”).
The authors argue that the choice between growing bigger organically or via takeovers correlates to a significant degree with the time and thus the philosophy of the education of the managers.
Depending on from which generation they stem, it was either taught to create conglomerates or to focus on the core, even if it meant getting rid of disturbing, non-performing business units, sacrificing the total size.
There are still roll-up businesses – companies “specialized” to grow mainly or even solely via takeovers, but the trend of fat conglomerates has reversed.
So you can say that depending on the beliefs, but also the corresponding zeitgeist, first mega-companies were grown by serial acquisitions. Due to several of them either reaching their limits sooner or later or even being obviously counterproductive, companies like GE or Daimler-Benz (today: Mercedes-Benz Group: ISIN: DE0007100000, Ticker: MBG) started to shrink again.
Those who in all cases clap their hands are unsurprisingly consultants and investment bankers who always are able to come up with useful arguments why to pursue one or the other direction – should it even be a roll backwards, as fees can be earned twice.
It is not difficult to find arguments that favor separations.
You just need to be excited enough to show your enthusiasm towards lifting hidden values that otherwise would stay forever under a dusty holding structure with non-complementary operations.
And then there’s the thing with the holding discount…
Factually, most investors even dislike these mega-holdings – I am one of them – as valuations are depressed. They are intransparent, harder to understand, more difficult to value – especially in times of bigger transformative restructurings that bring in even more confusion and uncertainty.
After a strict separation, the underlying investment cases become clearer. Stories that are easier to comprehend have a higher likelihood to lead to a higher share price.
But also from an operational perspective, freed up businesses suddenly get wind under their wings. They are able to make not only own decisions, but they can become more agile and pursue their individual goals, instead of having to forcefully fit into a big structure, they actually don’t fit into properly.
One of my beacons of investing wisdom – successful fund manager Peter Lynch – was warning about the effect of (no typo) “diworsification”.
What he meant with this artificially created word, is that acquisitions often can be destructive for shareholders, when they are pursued just to achieve growth (think of higher revenues and net profits for the headlines of the next earnings releases).
The new company, however, becomes worse and inefficient through a failed, ill-timed or not fitting diversification. A good way to measure this is by looking at earnings, or better free cash flow, per share, instead of the absolute headline numbers. Even worse are adjusted numbers.
By neglecting aspects like paid prices, checking the compatibility as well as cross-synergies with existing operations, often precious shareholder value has been destroyed, historically.
Again, we can have a look here at General Electric.
The iconic company that Thomas Edison once founded, was puffed up into an unsustainable conglomerate with businesses that had nothing to do with each other. Besides the traditional, but lower margin and more cyclical industrial activities, the famous CEO Jack Welch (but also his successor) slashed and bought frequently new businesses units.
Temporarily, this approach seemed to work, for as long as GE grew. Until the burst of the dotcom bubble, for a brief period, GE was even the company with the highest market capitalization.
Nearly self-explanatory, today it is far away from the former “glory” and size.
Today’s Mercedes-Benz also has its dark period.
First, former CEO Edzard Reuter dreamed about creating a true technology company of the car maker Daimler-Benz with its core brand Mercedes-Benz in the late 1980s / early 1990s. So he went on a shopping spree. By gobbling up several electronics and even aerospace companies, Reuter diworsified the company.
But the true shot in the foot came with his successor, Jürgen Schrempp, who arranged the “marriage in heaven” with Chrysler – it became a disaster, until its final divorce. You can see below that the all-time high of the Daimler / Mercedes stock was in 1998 – at the height of the disastrous merger with Chrysler.
By the way, having an acquisition-rich history, today CEO Källenius even separated the truck from the car business – once a no-go – with a separate listing via Daimler Truck (ISIN: DE000DTR0CK8, Ticker: DTG).
There are many such examples.
When it comes to Germany, the region we are focussing on today, the winds have changed towards separations, spin-offs and shrinking into healthier sizes. This is insofar remarkable, as strong unions historically have been opposing such drastic transformations, because they often came with job cuts.
In the next section, we are going to have a look at some prominent examples.
…now it’s about getting lean again
Two German blue chip companies were at the forefront of this new trend:
- Bayer (ISIN: DE000BAY0017, Ticker: BAYN)
- Siemens (ISIN: DE0007236101, Ticker: SIE)
Both already have spun-off even several business units over the last two decades.
However, they have rather been extreme outliers until recently. Spin-offs have become a new phenomenon. Once rarely practiced, suddenly they have become common practice over the last years. More and more companies are at least thinking out loudly about such a move.
Bayer, currently having a market cap of around 60 bn. EUR, in 2004 spun-off its special chemical business, called Lanxess (ISIN: DE0005470405, Ticker: LXS; market cap today: 3.2 bn. EUR) and in 2015 its synthetic materials operations, called Covestro (ISIN: DE0006062144, Ticker: 1COV ; ca. 7 bn. EUR).
Both are very cyclical operations. Without them, Bayer became less volatile.
Lanxess generated only a 4.6% return annually (without dividends). But you can see the massive up and down swings. The stock started at 15.50 EUR, with a high around 70 EUR. Currently, shares change hands for half of that.
An even bigger rollercoaster ride has been the stock of Covestro.
The first price starts slightly above 25 EUR. The all-time high in 2018 was even close to 100 EUR, only to gradually fall back under 40 EUR. Since the IPO in 2015, the annual return without dividends is 5%.
Currently, the 170-year old Bayer is under stress from activist investors to split again. Bayer has three business units, consumer healthcare, agro chemicals (called life science) and pharma. Demanded is a separation of the latter two, but the first could also be sold.
Siemens, founded in 1847, on the other hand, had already more spin-offs. Among them were:
- 1999: Infineon (ISIN: DE0006231004, Ticker: IFX); semiconductors
- 2013: Osram (ISIN: AT0000A18XM4, Ticker: AMS; now part of Austrian AMS-Osram); lightning
- 2017 / 2020: Siemens Gamesa / Siemens Energy (ISIN: DE000ENER6Y0, Ticker: ENR); wind, but also gas energy turbines
- 2018: Siemens Healthineers (ISIN: DE000SHL1006, Ticker: SHL); offering diagnostic and therapeutic products and services
Infineon so far has been a respectable success story. Not necessarily, if you bought it at the IPO at around 10 EUR. But during the financial crisis 2008–2009, the stock even dropped below 0.50 EUR, only to become a multi-bagger until today:
The chart above is not on an intraday basis, that’s why the low is “only” at 0.62 EUR. But the stock was even below that, temporarily.
Siemens Energy is more or less where it started in 2020 (though also highly volatile), while Siemens Healthineers shows a more robust development, having nearly doubled since its IPO in 2018. Osram was rather a problem Siemes got rid off…
With the exception of Osram, all other four – Infineon, Siemens, Siemens Energy and Siemens Healthineers, are all constituents of the German blue chip index DAX 40 (formerly 30).
Over the last around five years, more and more such restructurings, splits and spin-offs via separate stock market listings occurred, just to name a few:
We have one of the world’s biggest automotive suppliers, Continental (ISIN: DE0005439004, Ticker: CON). In 2021, with a delay of several years, it finally spun-off its “dirty daughter” Vitesco Technologies (ISIN: DE000VTSC017, Ticker: VTSC).
Dirty, because its products were mainly used in combustion engines.
However, this company is also evolving and making more and more business with electric cars. After sliding by 50% from the IPO until the bottom, the stock now sits at new all-time highs, while Continental is 75% below its all-time high.
You can see on the following chart how Viteso (orange) outperformed its former parent (blue) since its own listing.
Then we have Volkswagen (ISIN: DE0007664005, Ticker: VOW) which first cut off and IPOed its truck business under the name Traton (ISIN: DE000TRAT0N7, Ticker: 8TRA) in 2019 and in 2022 part-floated Porsche (ISIN: DE000PAG9113, Ticker: P911) – one of the biggest IPOs ever in Europe by market cap.
So far, the Porsche IPO has been a great success.
Its stock rose by around 40% since the listing last year. However, I am somewhat defensive here, as the attention is too high. So is the valuation. This is a company to watch, but not an investment one has to make currently.
Currently under review is a possible and longer speculated about separation between Lufthansa (ISIN: DE0008232125, Ticker: LHA) airline and the aircraft repair and maintenance business, called Lufthansa Technik. The mother, Lufthansa is not completely against it. We will have to wait and see what happens.
However, both units don’t necessarily fit together. Lufthansa Technik is a more internationally oriented company, offering its services also to competitors of Lufthansa. And while the focus for Lufthansa Technik is on reliable, long-term service contracts, the mother Lufthansa has a way more short-term business.
These were just some of the most prominent examples. There are also smaller companies that either already have completed or are thinking about pursuing this step.
However, there is one particular company, where I was surprised that it does barely get any attention. It was also a coincidence that I stumbled upon it.
It was once one of the most important German industrial conglomerates. Its name is widely known and it has its roots going deep into the 19th century. Unfortunately, due to weak operating developments, a near bankruptcy, the drop-out out of the DAX and a forced sell of its crown jewel, this company shrank to only a small market capitalization – at least measured by its former size.
In the next section, I am going to introduce you to this famous company – it has such an interesting special situation that I am featuring it in my next research report, exclusively for my Premium Members.
A still under-looked opportunity
Today, this company is a shadow of its former self.
Once a proud member of the German DAX index and certainly one of the most respected industrial businesses over here, it fell into a decade-long decay.
However, we’ve now reached a valuation where things are getting absurd.
My investment thesis is built on lifting hidden values that are camouflaged and discounted by a heavily cyclical business inside of a holding structure.
It took some time to stop denying reality and to face the truth. After a change in the management and the forced sale of its crown jewel, only to escape a looming bankruptcy, the new management started a massive transformation.
In addition to cost savings, management reviewed all business units with the aim of separating from problematic divisions. Even the largest unit, its soul and tradition, is no longer a taboo.
Should management now proceed like publicly unveiled, the stock of this particular company is valued so ridiculously low that a sale of only one of its two units under stricter review could lead to a negative enterprise value – a free lunch?
Have you guessed which company I am talking about?
Scroll down to see it.
Would thyssenkrupp still be in the Dax, I am sure there wouldn’t be such a massive discount.
Have a look into my brand new report and decide for yourself.
For me, this is an unbelievable under-the-radar opportunity, should management proceed as planed. The good thing is, management is not under pressure anymore, because thyssenkrupp is flush with cash – it doesn’t have the liquidity problems anymore, it had a few years ago.
This is even a big understatement, as I show in my report.
Several decades ago, it was en vogue to create conglomerates of great sizes, because they symbolized strength and robustness, especially during more difficult times.
However, this led also to “diworsification” – and then companies started to become lean again, separating from non-fitting business units.
Today, we look at some German blue chips that already kicked-off this transformational process. My latest research report covers another German company that is in the midst of lifting hidden values.
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