Today will be a bit of a more unique article discussing a rather theoretical concept around the valuations of conglomerates such as ALPP. As always, hope you enjoy!
Conglomerate Discount
What is a Conglomerate?
First off, a conglomerate is a collection of companies under a holding structure which are diversified from each other in some way. The most classic example of this is Berkshire Hathaway, which is one the world’s largest insurers, owns a massive railroad, owns dairy queen, and Duracell batteries, among many others. They also have billions of dollars in direct equity investments.
When you buy a share in Berkshire, you’re really owning a small portion in a holding company which owns and operates all these businesses. From a portfolio management perspective, you’re not getting concentrated exposure to one industry, etc., you’re getting exposure to lots of industries through the various subsidiaries. In a way, your investment in one share of Berkshire is inherently diversified to an extent.
Now remember, a publicly listed company can have many different operating divisions, subsidiaries, products, etc. without being a conglomerate. Take a company like Pfizer. They produce and sell hundreds of pharmaceuticals and healthcare products, but we wouldn’t call them a traditional conglomerate per se because it’s all focused on one industry. The point of a conglomerate is that if one industry goes bust, the company doesn’t necessarily go under because it’s diversified.
Why is a Conglomerate Discounted?
Conglomerates tend to (but not always) trade at a discount to their intrinsic value had they all been separate companies. In other words, if the conglomerate magically separated the companies into perfectly separate standalone companies, the sum of their values separately would exceed the value of the conglomerate. Why is that? A few reasons…
First, conglomerates are inherently more troublesome for an investor looking for specific risk exposure to a certain industry. Say I’m an investor that wants to add an insurance company to my portfolio as my exposure is currently too low. Berkshire has huge insurance operations (everyone’s famous Australia Gecko for example). But if I invest in that, I’m also stuck with exposure to railroads, milkshakes, etc. Given that, I’ll naturally pass on Berkshire and go invest in Allstate.
Second, conglomerates can be incredibly difficult to value for an outside investor. All we get to see are SEC filings which do their best to break down performance by segments, but those segments can be massive and contain dozens of businesses. It’s harder for investors to understand the true drivers of a business, where the strong points are, where the weaknesses are, etc. As such, investors tend to place a higher required rate of return on a conglomerate which tends to lower the price. It tends to mask under-performing members of the portfolio and understate the high performers.
For example, when a company is spun off from a conglomerate, many times the reason is what’s called “unlocking value”. The shareholders the a conglomerate think that a portfolio company is being undervalued by the market because it’s buried amongst so many other companies. So, they spin off the company, have it go public, and give conglomerate shareholders the shares in the new company. Then (hopefully) the company takes off because people see “wow this company’s great!” when they see the company operating on its own.
A third reason is certain inefficiencies of operating as a conglomerate. This is the never-ending pendulum of business… “let’s consolidate we’ll gain so many efficiencies!” five years later… “This is so inefficient we have no synergies between these businesses, divest!” Many conglomerates are not actually driving any shareholder value by being one consolidated company, and the market can reflect that whether it’s truly inefficient or not. Again, not all, but some. I personally find this the weakest argument.
ALPP – Is it Being Discounted?
ALPP is a great example, in my opinion, of a company likely being discounted by it being a conglomerate of very different businesses. But I think it is mostly from the “hard to value” standpoint. When we think about the many businesses ALPP owns, you get an industrial and/or technology vibe, but the business can be quite different. You have everything from construction services, nutraceutical manufacturing, drones, HVAC, sheet metal, etc.
Furthermore, the mission of ALPP is that they acquire small businesses to grow them. We’re not talking about one or two big acquisitions in a year, we’re talking about eight in year. Almost every two months a company is being brought into the ALPP family, maybe more. The landscape is changing constantly for the company and so does how you value it.
This brings me to my last point… when you have a conglomerate like ALPP, even one that reports segments in a relatively detailed manner, it is very hard to choose an appropriate valuation technique. For the Stabilizers, a simple discounted cash flow analysis or an asset valuation would work well. For a Driver though, you now have to think about those high growth technology type valuation metrics like a price/sales valuation multiple, etc.
Therefore, savvy investors won’t just slap one or two ratios on the company and understand roughly where its valuation is. You need to individually value the segments (Defense, Aerospace, etc.), and you may even have to individually value certain businesses within each segment.
All in all, it makes it quite challenging to decipher the intrinsic value for a particular investor. Like I mentioned above, this means investors tend to have lower price expectations of the company via a higher required rate of return.
ALPP – is the Conglomerate Discount a Bad Thing?
In my opinion, it is NOT a bad thing for ALPP investors that ALPP may be getting its price deflated from its conglomerate nature. I purposely didn’t mention this above in my description of the conglomerate, but many times the discount placed on conglomerates is actually a benefit to investors. Why is that?
For the exact reasons I mentioned above…if you believe in a company, have done your homework, believe in management, and know the subsidiaries inside and out, investors will find that the conglomerate being discounted means that it’s, well, undervalued! Shares are trading at a discount, and the market is not properly valuing the conglomerate because it has unfounded concerns about it being a conglomerate. Sounds like a buying situation!
Think of it like this. The market thinks conglomerates are inherently riskier and/or more difficult to invest in, so ALPP’s price is somewhat deflated due to that. You know the business well and there’s no cause for concern, so that leads you to think the conglomerate discount is temporary and unfounded. Therefore, your intrinsic value will tend to be higher than the market and you will find many more buying opportunities. Over long periods of time and continued success of the company, ALPP could very well reward investors who were buying at somewhat of a discount.
It’s not like the value of the company disappears because of this discount, and the conglomerate discount is not permanent. The value is still there, it’s just trading at a discount due to the nature of the company i.e. it being a conglomerate. Over periods of prolonged success, this tends to reward investors in the same way that “value” investing tends to reward investors over a long period of time.
Closing Thoughts
The conglomerate discount is a very real thing that, in my opinion, is likely present in ALPP given the complex interplay/co-existence of its portfolio of companies. If you believe in the company and its subsidiaries, over long periods of time, this should tend to reward longer term investors. If you don’t believe in ALPP, well, then the conglomerate discount is probably not enough of a discount!
Hopefully you found this interesting and let me know your thoughts!
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DISCLAIMER – AT THE TIME OF WRITING THIS ARTICLE I DO NOT HAVE A FINANCIAL INTEREST, LONG OR SHORT, IN $ALPP. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES. AT THE TIME OF WRITING THIS ARTICLE, PERSONS AFFILIATED WITH THE COMPANY ANALYZED ABOVE MAY BE PROVIDING MONETARY COMPENSATION AS MONTHLY PATRONS THROUGH MY PATREON. THIS COMPENSATION IS NOT PROVIDED IN RETURN FOR ANY SERVICE, WRITING ABOUT A PARTICULAR TOPIC, AND/OR FAVORABLE OR UNFAVORABLE OPINIONS. MY PATREON SUPPORTERS HAVE NO INFLUENCE ON THE CONTENT OF MY ARTICLES.
