The philosophers might generally agree that the whole is greater than the sum of its parts.
There are many reasons for this (and certainly too many to discuss here) but one such example is when a number of simple things or processes join forces and become more complex, the result can be greater than they would be simply added together. Imagine, for example, a number of computers working independently of each other in isolation. Join them together on a network and you have a version of the internet – and of course the impact the internet has had on the global way of life is far more profound than anything the individual users could have foreseen.
With regard to the business world, in difficult times, perhaps in the lead up or even in mid-recession, the accepted business wisdom is that costs need to be concentrated on, since the general recessionary background makes it much more difficult to concentrate on growing sales, or revenues.
At that point in the economic cycle, mergers tend to become prominent since there are often synergies to be enjoyed by merging two companies who work in a similar industry. Indeed, the dictionary definition of synergy recognises that the whole is greater than the sum of the parts – applied to business this could be due to complementary skills, economies of scale or removal of duplication.
Perhaps it is then a little surprising that we find ourselves in a totally different environment to this today, although of course this could change in due course.
The current preferred model seems to be quite the opposite. There are an increasing number of cases which actually aim to break up the company being acquired, in the hope of selling off the individual components at a profit, with the buyer usually using the excuse that there is more value to be had if the (newly) individual companies concentrate on their own niche area.
Nor is this confined to Merger and Acquisition activity. Or should that be Demerger and Acquisition activity?
Over recent months, outside of M&A, a number of companies have chosen to split their businesses into their constituent parts, with the usual rationale being the focus we have already mentioned, along with the ability of the local management to concentrate their efforts on a specialised field. WH Smith split into two (WH Smith and Smiths News), and Severn Trent demerged its Biffa (waste disposal) unit to go back to its core water business. GUS, the former “Great Universal Stores” decided that its US credit checking arm, Experian, and its UK retail operation (now called the Home Retail Group, comprising Argos and Homebase) would be better served as two separate companies.
Before its recent approach, Alliance Boots had of course comprised Alliance Unichem and Boots.
So, does this represent the new world or is it simply part of an ongoing cycle?
Companies can only grow either organically or by acquisition. As a general rule, an acquisition will be made in order to provide something which can enhance the current business. A UK bank for example might decide to acquire an overseas bank to buy access to a market which it would otherwise be hugely expensive to grow from scratch, whilst probably retaining some local knowledge to help the integration along.
Thus, acquisition activity will always be part of the overall picture.
But what of those companies who have pretty much exhausted their market and the only way for them to expand is into areas which they had not previously had experience? This is how conglomerates are formed, and whilst history can provide a long list of successes, there have been a notable number of failures where the proposed synergy simply did not happen.
Equally, if the integration can be made successfully, the “new” company could reach a size when it is of sufficient power to stand alone. The parent company may then choose to divest itself of the subsidiary as we are seeing at the current time in many cases.
Investors may like to give some thought to identifying companies with successful and strongly branded subsidiaries at the present time since, with an estimated $300 billion of private equity sitting on the sidelines waiting to be invested, there may well be some significant break ups to come yet.
In business, proof perhaps that the sum of the parts can be greater than the whole.
If you’d like to read more free research, comment and analysis from me and the rest of my colleagues at Hargreaves Lansdown please visit our website at www.H-L.co.uk
Richard J Hunter
Head of UK Equities
Hargreaves Lansdown
www.hargreaveslansdown.co.uk