[M&A Issues] What is a Conglomerate Discount?

Hello, this is MAFIAcapital! I bought a watch today! I'm looking forward to Monday. And I bought my child their favorite LEGO, and they managed to build a 7,800 yen set in just over an hour again. As a parent, since I bought something expensive, I kind of wish they had struggled with it a bit more... lol

This time, I will discuss conglomerate discount.
A conglomerate discount is a state where the value of a diversified company is evaluated as lower than the sum of the values of its individual businesses.
In short, it's when a company grows by acquiring many others through M&A, but its corporate value actually decreases! (How sad...)

For example, if there is a diversified company with four businesses and a total EBITDA of 300 and a business value of 2,000, the EBITDA multiple would be 6.7x, but sometimes the EBITDA multiple of the listed holding company for those four businesses is 5.5x, with a business value of 1,700.
It has gone down.

<<Why does a discount occur?>>

1. Lack of information, lack of IR

Although listed companies disclose financial conditions by segment for each business, that information is quite limited. Among that, investors' impressions are dragged down by businesses with large sales, and businesses that are actually generating profit get buried.

2. Agency costs

In a diversified company, there is a head office expense column after profit, and since the head office is a cost center, it becomes a negative number. The question is, are these costs necessary and sufficient?
This cost doesn't just mean that there are many people at headquarters and expenses are incurred; managers who are entrusted with funds from shareholders to increase corporate value are agents entrusted with management by owners called shareholders, and they are entities that should act for the benefit of shareholders. It is a cost problem where the manager prioritizes their own interests, makes decisions or takes actions that are not necessarily best for shareholder interests, and consequently reduces shareholder value.
Diversified companies are an organizational form where explaining the rationality of having business companies under one holding company is troublesome. They must not only properly disclose segment information but also conduct IR activities that convey in detail to investors the positive effects brought about by being a unified group, such as improved brand power and efficiency through the centralization of indirect department expenses.
Depending on the business, it is conceivable that becoming independent from the group, being freed from constraints, and having higher management freedom would lead to better performance than staying in the group, being subjected to budget tightening, and being treated like an orphan.
PE funds act as a bridge, finding businesses with potential value buried within diversified companies, taking risks to invest, and acting to aim for new value creation.

<<Is a hostile takeover evil?>>

In the past, Japan has seen integrations between peers such as megabank integrations, steel industry restructuring, and department stores, gas stations, and the retail industry.
This is called horizontal integration, and this pattern easily creates a composition where the strong force the weak into submission; for example, Oji Paper and Hokuetsu Paper, or Aeon and Parco. This time, I will discuss the hostile takeover of Hokuetsu Paper by Oji Paper.

(Hostile takeover of Hokuetsu Paper by Oji Paper)

In July 2006, Oji Paper proposed a management integration through a 100% acquisition of Hokuetsu Paper.
Hokuetsu Paper management opposed this. As an anti-takeover measure, they announced a capital alliance with Mitsubishi Corporation and a third-party allotment of 24.4% of issued shares to the company.
In response, Oji Paper announced a TOB at 800 yen per share without obtaining Hokuetsu Paper's approval. Furthermore, they stated that if Mitsubishi Corporation withdrew the capital increase, they would offer 860 yen.
Fearing that Oji Paper would consolidate its position as the industry leader by integrating with Hokuetsu Paper, the industry's second-largest, Nippon Paper Group, and third-largest, Daio Paper, also joined the defense.
As a result, judging that a majority acquisition would be difficult, they abandoned the hostile takeover.

(Why did they try to buy it?)

It can be assumed that Oji Paper judged Hokuetsu Paper's lowest stock price of 580 yen to be "cheap".
Since a TOB usually has a premium of about 20-30%, 800 yen is considered a sufficiently high premium.
From the 1st to 6th place in the industry, the PBR is low at 0.8 to 1.3x. In other words, it is considered an industry that cannot acquire excess earning power and is exhausting its strength through excessive competition. Oji Paper's acquisition intent of needing to compete globally rather than pulling each other's legs domestically can be seen.
The median TOB price of 831 yen is 1.2x in terms of PBR and 8.5x in EBITDA multiple, which falls within the range of Oji Paper's own multiple figures.
What can be understood from the above is that even if the stock price level cannot be said to be undervalued from the perspective of multiple indicators, an acquisition at a price with a premium can sufficiently occur. Therefore, if you look only at the numbers, I think this acquisition has a certain persuasiveness.

<<Finally>>

Hostile takeovers are often carried out from overseas against Japanese companies with low PBRs. While the term hostile takeover might sound bad at first glance, there is also a problem with Japanese management teams that neglect to improve corporate value, so it cannot necessarily be called evil.
You can obtain the yardstick for corporate value calculation from the Japan Company Handbook, and you can also decipher news about PE funds that makes the world buzz.

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