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Booms and Busts, Conglomerates and Platform Companies


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Here is an interesting article, whose argument is that we have had a boom in conglomerates (aka platform companies in some circles).  This was posted in the individual stock section, (don't remember who posted it or which stock it was, anyway), but it is deserving of greater discussion.

 

The easy (facile) premise is basically there are booms and busts with conglomerates and these companies are subject to these markets cycles.  Ok, fair enough.  But it also dumps Berkshire and Teledyne into this basket.  And had you bought either at their (various) peaks you would have made out ok.

 

http://www.valuewalk.com/wp-content/uploads/2016/01/Conglomerate-Boom-2.0-JHL-Capital-Group-10-20-15.pdf

Conglomerate-Boom-2.0-JHL-Capital-Group-10-20-15.pdf

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What Malone is doing is shielding profits earned by his cash-cows by combining them with growth companies with high capex needs. Prototypical are the QVC/LVNTA tracking stocks. This is fundamentally different from what pharma conglomerates do, blowing-up their EPS through shady acquisition accounting, which is almost exactly what the conglomerates did in the 1960s. The only thing those two models have in common is that they thrive on cheap debt through acquisitions.

 

I found it very interesting to see that in the recent sell-off LBTYA sold off in unison with the other "platform" cos. So consensus seems to be that they are one basket. But I agree with (board-member) Liberty that, at least in this case (Malone), you have to focus on the company level to get the difference. That said, I think the pharma "platform" cos are very comparable to the 1960s conglomerate and the REIT boom/bust sequences (both well documented and analyzed in Soros's Alchemy of Finance) but throwing in LBTYA doesn't add to the argument – it deducts from it.

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I found it very interesting to see that in the recent sell-off LBTYA sold off in unison with the other "platform" cos. So consensus seems to be that they are one basket. But I agree with (board-member) Liberty that, at least in this case (Malone), you have to focus on the company level to get the difference. That said, I think the pharma "platform" cos are very comparable to the 1960s conglomerate and the REIT boom/bust sequences (both well documented and analyzed in Soros's Alchemy of Finance) but throwing in LBTYA doesn't add to the argument – it deducts from it.

 

I think LBTYA sold off because it ticked a few boxes: 1) hedge fund hotel (all stocks popular with HFs sold more than market during that period) 2) leveraged 3) europe 4) complex (especially with unknowns about VOD deal at the time, CWC transaction that the market doesn't seem to like/understand, etc).

 

The good news is that none of this impacts the long-term fundamentals, and it has allowed the company to buy back a fair amount of stock at low prices.

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The term “platform” imo is a bit misleading: Google, Apple, Facebook, Amazon are all platform companies. A platform imo is any business that can scale very quickly, reaching a global footprint, and that can add new products or services to improve the experience of its customers.

 

Cheers,

 

Gio

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Conglomerates are diversified. Platform companies are not. They are mostly roll ups.

 

Yes. It's always slightly different. But the dynamics are the same. And you could make the argument that when even most broadly diversified conglomerates collapsed after their acquisition boom in the 1960s this must be even more true for roll-ups.

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Conglomerates are diversified. Platform companies are not. They are mostly roll ups.

 

Yes. It's always slightly different. But the dynamics are the same. And you could make the argument that when even most broadly diversified conglomerates collapsed after their acquisition boom in the 1960s this must be even more true for roll-ups.

 

In highly fragmented industries, I see roll ups as a great thing for shareholders.

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Yes. It's always slightly different. But the dynamics are the same.

 

These different terms are useful mental models, if you use them precisely. Unfortunately, most people don't.

 

1. Conglomerate - A diversified set of independent businesses. This is usually an agency problem. The management benefits from the size and stability, but shareholders do not benefit. Berkshire is a notable exception (central control of capital allocation adds value).

2. Roll-ups - Try to consolidate a fragmented industry. Goal is to achieve economies of scale, reduce competition, and lower cost of capital. Exxon, railroads, waste management, cable companies.

3. Platform - Set of existing assets or operational knowledge that allow you to quickly add value to acquisitions (or organic investments). For example, Coke's distribution network. Facebook's ad network. Philidor. Restaurant Brand's zero-based budgeting, ownership culture, and master franchise model.

 

The dynamics are very different for each of these.

 

But there are other important distinctions. Small bolt-ons are usually better than large transformational deals. Cash deals are usually better than debt or stock deals.

 

 

 

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Yes. It's always slightly different. But the dynamics are the same.

 

These different terms are useful mental models, if you use them precisely. Unfortunately, most people don't.

 

1. Conglomerate - A diversified set of independent businesses. This is usually an agency problem. The management benefits from the size and stability, but shareholders do not benefit. Berkshire is a notable exception (central control of capital allocation adds value).

2. Roll-ups - Try to consolidate a fragmented industry. Goal is to achieve economies of scale, reduce competition, and lower cost of capital. Exxon, railroads, waste management, cable companies.

3. Platform - Set of existing assets or operational knowledge that allow you to quickly add value to acquisitions (or organic investments). For example, Coke's distribution network. Facebook's ad network. Philidor. Restaurant Brand's zero-based budgeting, ownership culture, and master franchise model.

 

The dynamics are very different for each of these.

 

But there are other important distinctions. Small bolt-ons are usually better than large transformational deals. Cash deals are usually better than debt or stock deals.

 

Thank you, this is indeed a helpful way to differentiate between those mental models. However, what I meant by dynamics are the debt/equity dynamics – and they are very similar. The simple idea is that the ROI on your acquisition post synergies > interest on the additional debt. There are tremendous dangers for this model to get out of hand sooner or later, especially when the entity is not controlled by a single "owner"  (Buffett, Malone) but by independent agents that are, on top of that, rewarded with stock options (though even "owners" can overdo it like the Drahi/Altice example shows IMO).

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The term “platform” imo is a bit misleading: Google, Apple, Facebook, Amazon are all platform companies. A platform imo is any business that can scale very quickly, reaching a global footprint, and that can add new products or services to improve the experience of its customers.

 

Cheers,

 

Gio

 

Time to poke Gio :) For me the distinction is primarily empiric.  For every company I look at, I plot their revenue/ tangible book/ LT debt in Ycharts.  For platform companies you get a classic pattern: stepwise revenue growth, stepwise LT debt growth, and stepwise tbook cratering.  That tells me the company's growth is not organic and their earnings have at least the potential for manipulation through acquisition accounting.  By now, I also suspect an ascending-staircase debt maturity schedule as well.  GOOGL, AAPL, and FB don't exhibit this pattern.  This is because their existing businesses (rather than acquired assets) are the primary growth drivers.  This is good because (1) they may be able to finance acquisitions out of FCF (2) even if they can't, the amount of debt they need to raise should be small relative to shareholders equity.  For such businesses you get a nice smooth increase in both revs and tbook.  The debt if it is increasing should not be out of proportion to rev growth.  Such a business can be said to be growing "organically" in the empiric sense.  Buffett moat companies are a good example.  Berkshire is another.  The taxonomic aspect is less important to me as an investor than the growth sustainability aspect, since the market tends to reward growth indiscriminately during the loose-credit portion of the cycle then pummel the same companies when refis are not forthcoming.

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