The Folly of Corporate Diversification

I've written a handful of posts about diversification. Perhaps the two that I find most important in conveying my core philosophy about diversified companies are found here and here.

Not surprisingly, because it is probably the best known American diversified conglomerate, GE has been the primary subject of those two posts.

However, GE isn't the only American company that is probably overly-diversified. Consider yesterday's sacking of Wachovia's CEO, Ken Thompson. One of Thompson's mistakes, in his rush to make Wachovia larger and faster-growing, was the unwise purchase of Golden West Financial at the top of the real estate boom in 2006.

Now, it appears that Wachovia, like its Charlotte rival, BofA, would have done better simply remaining a large commercial bank without trying to become a major presence in the now-national business of mortgage lending.

Over the past decades, auto makers have bought, then sold: EDS, Hughes, and several financial service companies.

Who knows how much better-managed and -positioned for today's changing, challenging environment GM, Ford and Chrysler would have been, had they not frittered away precious capital and management attention on these diversifications?

Or consider TimeWarner's disastrous merger with AOL. Eventually it destroyed huge amounts of shareholder value. A needless diversification that never truly worked.

Microsoft has grown cumbersome and complicated to understand and manage, judging by their total return performance over the past decade.

When I consider both Microsoft and GE, it seems pretty obvious to me that too broad an assortment of businesses, especially when their commonality is eclipsed by their differences, leads to mediocre total return performances for shareholders.

Who really believes that Microsoft's applications businesses need to share a corporate structure with the games division?

Or that GE's aircraft engine business has a lot of interdependence with its Universal/NBC unit?

What are the odds that executives overseeing these unlikely combinations actually add value that exceeds the costs of their administration?

Look at the nearby price charts for five companies and the S&P500 Index for the past five years.

The monoline companies- Google and Apple- far outperform the diversified ones- GE and Microsoft.

I know there are many reasons to assail this comparison. What I want to show is the huge performance gap between operating models. The focused, largely single-business firms have created far more value for their shareholders in the last half decade than have the two diversified ones.

How can Gates, Ballmer and Immelt possibly excuse such lackluster performance for so long?

I contend that CEOs who collect and 'manage' businesses too many in number, with little inter dependencies, are ineffectively constructing mini-indices of their own. As Microsoft's and GE's performances so clearly demonstrate, at best, they might perform like an index..but with much higher risk.

That's why I have written for years that both GE and Microsoft would benefit their shareholders by splitting their companies into their logical constituent parts. In both cases, their business units are sufficiently large to operate as independent corporations, and would have much more transparency and focus if they did so.

With total return performances like GE's and Microsoft's, it's hard for anyone to argue I'm wrong.

Does any reader know of a legitimate exception to my position? That diversification of corporations is, in today's environment, with deep, broad equity pools, needless and counterproductive for shareholders and managements?