How to divide and conquer

Diversification is a word we are starting to hear every day. Thanks to San Miguel Corporation’s behemoth upgrade, it seems like everyone wants to do just that. A strategy is only as good as its execution, and a chain is only as strong as its weakest link. Diversification in finance means reducing risk by investing in a variety of assets in simple terms, according to Wikipedia.

A grander way of defining it would be from the Business Dictionary: “It is a strategy to increase the variety of business, service, or product types within an organization. Diversification can be a growth strategy, taking advantage of market opportunities, or it may be aimed at reducing risk by spreading interests over different areas.”

Diversification is an age-old concept; it’s safe to say as old as the Bible. Ecclesiastes wrote about diversification back in 935 BC: “But divide your investments among many places, for you do not know what risks might lie ahead.” You have to love the Bible, really. This phrase has made many men and women rich and happy. 

Today, diversification is the ultimate expression of flexing one’s corporate muscles. As I mentioned earlier, San Miguel (SMC) and PLDT’s spate of recent divestments and investments exemplify this. The play for Meralco reminded me of Barbarians at the Gate. There is nothing like a takeover to bring out the warrior in us corporate types. Tektite frat boys on steroids. For deal-junkies, nothing says I love you more than a hit of a well-played battle in the boardroom.

It’s easy to get ahead of yourself. I always have to remind myself of some good advice I received from my mentor, which is to never fall in love with a deal.

PLDT has traditionally always been a telecom company. PLDT’s continuous strong earnings from its mobile business (in excess of P20 billion per year) are more than sufficient to finance continued upgrades, and pose a good problem to management: that of where to invest all that cash. As a result of this, PLDT has aggressively invested in hospitals, toll roads, power (Meralco) and media (ABC 5, Business World). 

The same is true for SMC. It seems that the view of corporate visionary Ramon Ang is that growth in SMC’s traditional business (beer and food) is limited. SMC is a clear market leader in both beer and food, and growth is basically dependent on population growth (single-digit growth per year). SMC has since sold a significant 43.25-percent stake in its San Miguel Brewery business for P58.9 billion, and is in the process of selling 49 percent of its Pure Foods business, valuing the company at US$1.3 billion. SMC is investing its cash in the power and telecoms sector, which promises higher growth rates than food and beer.

I wonder who’ll win from this mano a mano of suits and sharks. One thing is for sure: it won’t be a draw.

Diversification is a blessed poison for Asian entrepreneurs and conglomerates. It only seems like yesterday, but it still does hurt today. Nothing says goodbye more than seeing the corporate jet go to the auction block because of the company shopping spree done by some digit-happy CEOs during the bear-market days. Many SE Asian companies borrowed heavily in US dollars to finance expansion and diversification into new industries. When the Asian currencies devalued by more than half, many of these companies (and a few conglomerates) were not able to service their dollar-denominated debt. Many went bankrupt or were forced into painful restructuring programs, which left the surviving entity painfully stripped of its family jewels. I mean, you know when things are tough when you have to sell your paintings. That’s the first sign of Chapter 11.

Diversification done right, however, is how empires are built. The Rockefellers started in oil (Standard Oil) and diversified successfully into banking and finance by investing in Chase Manhattan Bank and JP Morgan. Their investments in finance eventually led them into owning interests in a wide range of businesses around the globe. The Rothschilds surpassed the Rockefellers in the success of their diversification strategy, eventually owning major stakes and forging alliances with some of the largest financial institutions of the 19th century. Talk about built to last.

There are several ways to go about a corporate diversification. These are:

• Horizontal diversification is expansion or acquisition of similar companies or product lines. The merger of Daimler and Chrysler is a clear horizontal acquisition strategy. It allows the merged entity to expand its market share in the same line of business (i.e., car manufacturing). Porsche and Volkswagen is another clear example of this. Pancake House acquiring Dencio’s is also a horizontal type of expansion/diversification.

• Vertical diversification can happen either through forward integration or backward integration. Forward integration is when a company acquires components in the value chain that lead closer to the customer. An automobile manufacturer, for example, can acquire the distribution centers and dealerships where the cars are sold. Backward integration is acquiring components towards the suppliers. A clear example of this would be steel tycoon Andrew Carnegie, who owns Carnegie Steel. Carnegie Steel acquires the steel mills that manufactured the metal, the mines that extracted the iron ore, and the coalmines that supplied the coal.

Oil companies are perfect examples of fully vertically integrated companies. They own everything, from the exploration, drilling, extracting, transporting, refining, distributing, and retailing (via gas stations).

The Italian mafia and Cali cartel also employed this type of vertical monopoly to keep a tight control over its supply and distribution. By owning every step of the chain, your company can capture a greater share of the margins.

• Lateral diversification or expansion is when a company or business expands into a completely unrelated sector or industry. The recent investments of SMC and PLDT are lateral diversification. Tata Group entering the telecoms sector is also a lateral expansion.

For thriving entrepreneurs out there looking for an exit plan (selling your business), strategic buyers come in the form of either horizontal, vertical or lateral acquisitions.

Buy, sell, consolidate, break up, enter, exit, list or let go. It only gets better.

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Any questions? Please e-mail me at egtheplayer@gmail.com.