The Time of the Conglomerates
THE URGE TO MERGE
HARVEY H. SEGAL / NEW YORK TIMES MAGAZINE 27oct68
An enchantment with innovation embraces all facets of contemporary society: the new writing, the new sound, the new politics. Micro-skirts and Nehru jackets, hirsute males and close-cropped females are conspicuous symbols of changing fashion. Computers and lasers, organ transplantation and space exploration foreshadow radical changes in the basis of physical life, while in business the revolution is heralded by the rise of the conglomerate, the corporation that grows rapidly by moving into unrelated markets through mergers.
To the geologist, a conglomerate is a rock composed of stone fragments held together by hardened clay or some other cement. Analogously, the conglomerate corporation is a group of companies which operate in separate markets and are held together by bonds of financial and administrative authority.
Last month, the world of finance was agog with the announcement of what could be one of the largest mergers on record, the offer by the Xerox Corporation to buy control of the CIT Financial Corporation. Xerox dominates the photocopying market and is moving into the field- of education, health and peripheral computer equipment. CIT, in addition to being the second largest commercial credit company, has moved into banking, X-ray equipment, insurance, office furniture and greeting cards. Clearly, a Xerox-CIT union would be of the conglomerate type. But despite the size of the merger-CIT has $3.4-billion in assets on its books, more than those of any company ever acquired by another-the merged corporation would not be nearly so diversified as some other conglomerates.
As an example of spectacular diversification consider the International Telephone and Telegraph Corporation. With $2.96-billion in assets at the end of 1967, I.T.T. ranked 17th among the nation's industrial companies. Originally an international communications company that still operates telephone systems and other enterprises in 123 countries, I.T.T. branched out first into the manufacture of telephonic equipment, a natural enough development. But in recent years, under highly efficient and aggressive management, it has come to rent cars (Avis), operate hotels and motor inns (Sheraton), build homes (Levitt & Sons), bake bread (Continental), produce glass and sand, make consumer loans, manage mutual funds, and process data.
But if diversity were the only criterion for distinguishing a conglomerate, General Motors, Ford and General Electric would each outrank I.T.T. G.M. makes locomotives, refrigerators and washing machines. Ford produces a line of radios and household durables. G.E. produces jet engines, computers and synthetic diamonds in addition to its traditional lines of electrical equipment. But none of these is a true conglomerate.
What distinguishes I.T.T. is the source of its recent growth. Its assets grew by more than $2billion in the period 196o-1967, and mergers accounted for more than a third of that total. In the same period, mergers made no contribution at all to the asset growth of G.M. or G.E. and accounted for a little more than 6 per cent of Ford's. Xerox's spectacular progress is the product of internal growth rather than expansion through merger.
In perusing the list of the 200 largest manufacturing corporations, conglomerates can almost invariably be distinguished by the high contribution of mergers to their asset growth. In 1966-1967, mergers accounted for nearly 46 per cent of Litton Industries' growth, and for others, the figures were as follows: FMC, 8o per cent; General Dynamics, 69 per cent; Gulf & Western, 47 per cent; Textron, 69 per cent; Martin Marietta, nearly loo per cent, and Glen Alden, 94 per cent.
Only eight conglomerates ranked among the 200 last year, but they accounted for all the exciting merger action. Ling-Temco-Vought, which ranked 92d, bought control of the 63dranking Jones & Laughlin Steel Corporation with assets of $i.1-billion. P. Lorillard, the tobacco company that ranked 184th was acquired by Loew's Theatres, a dazzling conglomerate that couldn't even qualify for the Zoo club in 1967.
What accounts for this corporate acquisitiveness, this frenzied urge to merge? Is the driving force biogenetic in origin, a vestigial survival of prowess from man's primitive past? The evidence points to dollars, rather than chromosomes.
If a group of applied physicists is joined with an electronic equipment manufacturer, it's reasonable to suppose that the merged company will be able to take on new business research and development contracts-which neither could have handled before the union. And with a greater capability for taking on larger contracts, it becomes easier for the company to borrow money that may be needed to finance work in progress.
But in the move from simple examples to corporate realities, synergism loses its force as an explanation of conglomerate mergers. In the case of Litton Industries and other conglomerates that reshape the managements of acquired companies and guide them through systems of centralized controls, some synergistic benefits might be realized. But the elements of the Ling-Temco-Vought complex function independently of one another and presumably the CIT's management would also remain intact after the proposed merger with Xerox. In such instances, therefore, especially when conglomerates are as widely diversified as I.T.T. or L.T.V., it's difficult to attach much weight to synergism.
The more decentralized the conglomerate becomes, the more it resembles a mutual fund or a pension trust account in a bank. Neither play active roles in the management of companies in which they hold stock.
Synergism implies greater efficiency in the production of goods and services, but it is doubtful whether such considerations weigh heavily in merger decisions. Yet there is no doubting the fact that managements which pursue aggressive merger policies can persuade investors to pay more for their stock. Thus, it is to the stock market rather than the production line that one must look for an explanation of the conglomerate corporation.
Conglomerates vary widely in size and maturity. Textron, which achieved success a decade ago in moving from textiles into optical instruments, electronic equipment, paper machinery, aircraft and a host of other fields, doesn't make news so often with announcements of acquisitions as Gulf & Western. Some conglomerate rockets have burned out (Merritt-Chapman & Scott) and others (Olin Mathieson, for one) have failed to reach their earnings targets. But the underlying strategy of conglomeration is essentially the same in every case: It consists in making investors willing, if not eager, to pay higher prices for shares in the company's stock, more in relation to each dollar that the conglomerate earns.
Conglomerate entrepreneurs-or conglomerators-must raise the price-earnings ratios of their stock if they are to expand, for unless it's loaded with cash, the rising conglomerate must depend on loans to acquire new companies. The higher the price of its common stock, the more it can borrow by pledging stock as collateral or the more it can raise by selling bonds that are convertible into common stock at a prearranged price. Where the merger is consummated through the exchange of stock, the higher the market price of the conglomerate's stock, the fewer shares it must give up in exchange and the smaller the dilution in the earnings per share.
The need for maintaining a rising P/E never ceases so long as the conglomerate continues to make acquisitions. And in order to avoid a decline or a slowdown in its earnings per share, it should seek to merge with companies whose P/E's are lower than its own.
It's not necessary for conglornerators actually to demonstrate that they can diminish risks and raise earnings per share through diversification. The mere intention to embark on the path of conglomeration may be sufficient to raise expectations. Franc
Ricciardi, an alumnus of Litton Industries who helped to turn Walter Kidde & Co. into a successful conglomerate, explains that the "stock market was very generous" with the new management from the start. As soon as they "threw their hats in the door," Kidde stock "went up 6o or 70 per cent, in the expectation that something might happen."
There are many stars in the conglomerate firmament, but none shines so brightly as that of James Joseph Ling, a 45-year-old high-school dropout who was born in Hugo, Okla., (population 6,287). In 22 years he has parlayed an investment of $3,000 in an electrical contracting shop into a diversified empire with more than $2-billion of assets and $3-billion in sales. A financial Archimedes, he has demonstrated what can be done with the leverage of rising P/E's.
After scoring a success as an electrical contractor-his skills were acquired in the Navy-Ling was able to go public when a Dallas investment banker agreed to underwrite stocks and bonds in Ling Electronics. That venture prospered, and in 1960, Temco Electronics and Missiles was acquired along with Altec, a major producer of sound equipment, and other companies. Two years later, in ig6i, the Vought was added to Ling-Temco when Ling borrowed $10-million to gain control of Chance Vought, an aircraft, missile and electronics company with sales of $195-million. He was assisted by Troy Victor Post, a friend of Lyndon Johnson's. Post's own conglomerate, Greatamerica, which controlled insurance companies, a large bank and Braniff Airways, was merged into L.T.V in 1967.
Texas tycoons are not noted for modesty in their personal tastes, and Ling is no exception to the rule. The cost of his home-a Palace of Versailles in the style of a Holiday Inn-is variously placed at figures in excess of $i.5-million, inclusive of a guest house, now under construction. "People don't live like that in the Northeast," a New York banker remarked, "even when they can afford it."
Ling once proclaimed that his goal was a combined sales total of $10-million a year, and he took a giant step toward achieving it when he acquired control of Wilson & Co. in 1967. It was a performance that combined exquisite financial insight with perfect timing, one that made Ling the Lorenzo of the conglomerators.
Wilson was itself a conglomerate, producing sporting goods, meats and chemicals. Its sales were then nearly $i-billion, as against $468-million for L.T.V Yet the python swallowed the pig.
In the spring of 1967, Ling was able to borrow $8o-million from New York brokers, London merchant bankers, insurance companies and university trust funds in order to buy a controlling interest in Wilson stock. He paid a premium of 25 per cent over the market price to get it. The remaining Wilson stock was acquired by offering the owners a special L.T.V convertible preferred stock.
Then he embarked on "Operation Redeployment," a tactic pursued in 1965 to reduce L.T.V.'s debts. He broke Wilson up into three independent companies, listed them on the exchange and sold blocks of stock to the public which in no case amounted to more than 25 per cent of L.T.V.'s holdings. Intrigued brokers referred to the new issues as "golf balls;" "meat balls," and "goof balls."
The sale of Wilson stock brought in $44.4-million, enough to retire more than half of L.T.V.'s debt. But the real pay-off came a short time later when the market had an opportunity to appraise the prospects of the new Wilson companies and boost their P/E's. The happy result was that L.T.V's remaining holdings of Wilson stock were valued at a cool $250-million. With his highly appreciated bag of assets, Ling was in a position to offer collateral for bigger loans for bigger acquisitions. The opportunity came in May this year when he raised $425-million in cash to gain control of the Jones & Laughlin Steel Corporation. L.T.V put in about $200-million from its own kitty and borrowed the rest, principally by tapping the Eurodollar market-U.S. dollars held on deposit in European banks.
Other conglomerators play variations on the same pecuniary theme. Meshulam Riklis, the scholarly chief of Glen Alden, accomplished less spectacular feats by selling convertible debentures, bond-like instruments that can be swapped for common stock. He once referred to them as "Castro (convertibles) pesos," and again, the ease with which they can be sold hinges on the crucial P/E of his common stock.
But none of the problems raised by the emergence of the conglomerate corporation are so complex-or politically explosive-as those relating to their impact on competition. Mergers once posed relatively simple antitrust problems. For the most part they were horizontal (one retail food store taking over another in the same market) or vertical (the acquisition of a slaughter-house by a retail food chain). Legality hinged on whether the mergers would lessen competition in the affected markets-not an easy judgment to make, but conceptually manageable. But conglomerates, which account for about 9o per cent of the assets acquired by merger-or for about $10-billion in 1968, according to preliminary estimates by the Federal Trade Commission-can't be fitted into a neat analytical scheme.
Conglomerates raise the issue of political power in a new and disquieting fashion. Litton, L.T.V., General Dynamics-to name only a few owe their rise to defense contracts and a continuing relationship with the Federal Government. The "military-industrial complex," of which President Eisenhower warned before leaving the White House, is very much a reality.
Little light has yet been cast, however, on most of the antitrust issues. Veteran antitrust economists, whose survival in Washington's lobby jungle is a tribute to their courage, argue that conglomerates pose several clear threats to competition, and their contentions are mirrored in recent F.T.C. and Supreme Court decisions.
The first threat is from price subsidization-the use of profits, earned in a market where the position of the conglomerate is strong, to drive out the competition in another market by cutting prices below costs and subsequently raising them. If entry into the market is easy, the conglomerate's higher profits will soon attract competition. But if there are substantial barriers to entry, the gambit could pay off.
Second, if the conglomerate is very large and commands great financial resources, its move into a highly competitive market of small sellers could discourage potential entrants.
Third, there is reciprocity-the fear that the conglomerate will use its power to effect tie-in sales. Conglomerate X buys ball bearings from Company Y which in turn gets its steel from Company Z. If X acquires Z, it may then put pressure on Y to buy X-Z steel at an unfavorable price by threatening to patronize another manufacturer of ball bearings.
There are sharp disagreements among economists and lawyers as to whether these threats to competition are palpable. Nonetheless, the F.T.C., at the behest of Senator Philip Hart of Michigan, the chairman of the Antitrust and Monopoly Subcommittee, agreed to undertake a broad fact-finding investigation of conglomerates.
That decision elicited a loud blast from James J. Ling. He warned insurance company executives in Chicago of "the bureaucrats who would democratize and socialize all business and thus pave the way for the ultimate demise of the enterprise system . . . ."
The one certainty that emerges from the web of controversy is that the conglomerate issue isn't going to be resolved by Ling's rhetoric, the F.T.C: s fact findings or the interpretations of the courts. A new, or at least novel, style of entrepreneurship is evolving, one based on raising expectations of rapid growth. It might disappear when the conglomerators, like Alexander, weep because there are no more worlds to conquer-but that isn't likely to happen for a very long time.
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