Marginal benefits of highly diversified conglomerates

One of the all-time favorite blue-chip stocks, which had the reputation of being one of the most resilient corporations in the world, is now ringing an alarm bell which investors are paying attention to with amazement and worry.

Historically GE has been able to extensively outperform the market and return cash to its shareholders during both good and bad market conditions.

Since the 2000’s dot-com bubble GE behavior started to change and vulnerabilities within its business strategy started to emerge, hindering it prestigious position of an all-weather stock.

FIG.1 – GE and S&P500 stock price from 1990-2018

Over the last year and a half, GE stock price lost more than 60% of its value reaching levels that were previously touched during the 2008 GFC. (FIG.1)

The problem in this case, is that today we are not in the midst of a “2008-style” recession but instead we are experiencing one of the greatest bull markets in history.

Everything in the market has been consistently going one way…UP! Over the same year and a half period, the S&P500 skyrocketed by more than 25% reaching historical all-time highs.

So, to what is GE’s negative performance attributable, given the fact that over the last years the economy has seen one of the healthiest periods in history which pushed worldwide markets into a synchronized global growth?
We look inside GE’s technological portfolio to understand whether this can potentially be a fundamental innovation/technology challenge or a business model/management related issue or both.

FIG.2 – GE Technology Innovation map since 1974 to present & the associated nearby domains.

From the InnoSenze map we notice that GE’s overall technology portfolio is exceptionally diversified and only a few technology domains are left for the company to explore (FIG.2 Blue circles on the map).

Highly diversified technology portfolios are generally associated with a low coherence among the innovations that constitutes them, thus increasing the hurdles for a company to synthesize novel ideas, hence achieving synergetic innovation growth.

Furthermore, extreme levels of differentiation of products and services under a single cap will eventually create substantial management challenges which will ultimately drain resources from the core division of the business to re-direct them toward integration and scalability issues. 

As GE pioneered its industry globally, but faced fundamental issues in expanding its technology base, the Company shifted the weight of its operations toward the financial services side, becoming a de-facto Bank (FIG.3 – notice how GE returns are highly correlated with the XLF financial sector) which provides financial services such as loans and insurance while running complex financial arbitrage schemes globally, given its worldwide presence.

FIG.3 – GE (Red) vs Siemens (Blu) vs Finacnials (Green) vs US stock sectrors 2003-2018

This type of strategy substantially increased the exposure of the company towards exogenous factors. As such the 2008 GFC further highlighted the risk that the GE was bearing, given the high degree of financialization, to the point the that company needed a $140B bailout from the US government. 

We want to gain more insights form GE’s portfolio and understand which of its segments retain a higher degree of innovation capability by using the InnoDex metric generated by the InnoSenze technology positioning map:

We notice form the chart how the GE’s Healthcare division particularly stands out given the relative high level of Innovation capability. Last in line we find GE’s Capital division.

Given this result, we can assume that GE is not taking advantage of its highly valuable Healthcare division and the fact that GE has tried to keep everything under one corporation might be limiting the potential synergies of its individual segments taken as stand-alone entities.

To provide a reference, we take a look inside GE’s current bigger conglomerate competitor Siemens:

From the chart we notice how Siemens Healthcare division is also standing out from its other branches but at the same time Siemens has been able to maintain a higher level of technological value across the other segments.

Contrary to GE, Siemens has placed much less emphasis on its Financial division and this ultimately allowed the former to achieve higher returns and to be less prone to the volatility of the financial sector of the market, which is the one that historically has been exposed to broader risk factors and ultimately led GE in its current conditions. This can be noticed again in FIG.3 where Siemens has been able to achieve returns in line with the market. (FIG 3 – Blue line).

To sum it up, we ask ourselves weather GE will be the ultimate example that highlights the limits of a corporation scale and the law of diminishing returns for which the scope and complexity of a firm will ultimately hinder its ability to generate sustainable financial performance without increasing the risk of the business itself.

Eventually GE will have to scale back its business and try to achieve a “diversified & coherent” portfolio that focuses on its main historical capabilities (FIG.2 – red domains) and reduce its systemic risk exposure by achieving a balance between its manufacturing technology capabilities and the financial operations business by either reinventing its’s management models or spinning-off part of its business divisions.