What it means
Mergers are usually sorted into three types. Horizontal deals combine direct competitors, vertical deals combine a business and its supplier or customer, and conglomerate deals combine businesses with no commercial link at all.
Pure conglomerate mergers involve genuinely unrelated activities, while mixed conglomerate mergers stretch a company into a new product line or a new geography where some capability carries across. The distinction matters because the second type can produce real savings and the first rarely does.
The classic argument for conglomerates is that combining unrelated earnings streams smooths group profits, since a weak year in one division is offset by a strong year in another. The classic counter-argument is that shareholders can diversify far more cheaply themselves simply by owning both shares.
A more mechanical attraction is the effect on earnings per share. When a company on a high price to earnings multiple buys one on a low multiple using its own shares, group earnings per share rises immediately even though nothing has improved operationally.
That arithmetic works only while the acquirer keeps its premium rating, and markets tend to withdraw it once they spot the pattern. This is why many conglomerates eventually trade at a discount to the sum of their parts and end up breaking themselves back up.
In practice
Real-world examples.
Example
A regional building materials group with strong cash generation and few reinvestment options buys a facilities management contractor. The businesses share nothing operationally, but the acquisition gives the cash somewhere to go and adds a recurring revenue stream to a cyclical one.
Example
A family-controlled food manufacturer acquires a hotel group to reduce its dependence on grocery buyers. Two years in, the board discovers that no one on it understands hotel occupancy management, and an external chief executive is hired to run the division at arm's length.
Example
A media group buys an educational publisher, arguing that both sell content. The shared capability turns out to be thin, and the market treats the deal as a conglomerate merger rather than a related one, marking the group's multiple down accordingly.
Formula
Calculation
Combined earnings per share = combined net income / combined share count
Company A is an engineering group: net income $40,000,000, 20,000,000 shares, so earnings per share of $2.00. It trades on a price to earnings multiple of 20, giving a share price of $40.00. Company B is an unrelated specialist insurer: net income $10,000,000, 5,000,000 shares, also $2.00 of earnings per share, but on a multiple of 10, so a share price of $20.00 and a market value of $100,000,000.
A offers $24.00 a share for B, a 20% premium, valuing B at 5,000,000 x $24.00 = $120,000,000. Paying in its own shares at $40.00 each, A issues $120,000,000 / $40.00 = 3,000,000 new shares, taking its count to 20,000,000 + 3,000,000 = 23,000,000.
Combined net income is $40,000,000 + $10,000,000 = $50,000,000, so combined earnings per share is $50,000,000 / 23,000,000 = about $2.17. Earnings per share has risen 8.7% from $2.00 without a single cost saving, purely because A bought cheaper earnings with more expensive paper. If the market then rerates the combined group down from 20 to 17 times because the insurance earnings deserve a lower multiple, the share price becomes 17 x $2.17 = about $36.90 and A's own shareholders are worse off.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Marlow Halden Group, an invented industrial holding company, spent four years assembling an unrelated set of businesses: a valve manufacturer, a payroll bureau, a chain of veterinary clinics and a plastics recycler. Each acquisition was paid for in Marlow Halden shares, and each target was bought on a lower multiple than the parent's own rating of 18 times earnings.
For three years the arithmetic flattered the group. Earnings per share rose every year, the board described the diversification as deliberate risk management, and no one asked hard questions about the fact that no division had grown faster after being acquired than before.
In year four the invented group's rating fell to 11 times as analysts began valuing the parts separately. Group earnings had not fallen, but the share price had dropped by about 39%, and the same board that had built the fictional conglomerate announced a review that ended in the sale of the veterinary and payroll businesses.
Watch out
Common mistakes.
- Presenting an earnings per share increase from a conglomerate merger as evidence of value creation, when it can be pure multiple arithmetic.
- Assuming diversification benefits shareholders, when most shareholders can diversify more cheaply by holding both companies directly.
- Underestimating management bandwidth, since running unrelated businesses well demands different skills, different metrics and different reporting.
Questions
People also ask.
What is the difference between a conglomerate merger and a horizontal one?
A horizontal merger combines direct competitors and usually produces real cost savings, while a conglomerate merger combines unrelated businesses where those savings do not exist.
Do conglomerate mergers face competition scrutiny?
Usually much less, because there is no overlap in the market being served, though regulators still look at deals that could bundle unrelated products to squeeze rivals.
Why do conglomerates often trade at a discount?
Investors find diversified groups harder to analyse and suspect cross-subsidy between divisions, so they apply a discount to the combined value of the separate parts.
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