The LA Times reports that:
VCA Inc. has spent the last three decades consolidating chunks of the pet health industry into a leading chain of animal hospitals and diagnostic labs.
Now the Los Angeles company has agreed to be bought for $7.7 billion by Mars Inc., which is best known for its candy but also owns a significant pet-care business. ...
Mars, which is based in McLean, Va., and has $35 billion in annual sales, is the privately held maker of brands such as M&M’s, Snickers, Milky Way, Skittles, Dove chocolate and Wrigley’s gum.
The century-old company also has a major pet-care unit whose pet food brands include Pedigree, Whiskas and Sheba. It owns Banfield Pet Hospitals, many of which are in PetSmart Inc. retail locations.
What's the logic of bringing pet food and animal hospitals under one roof, especially when that roof is owned by a candy maker?
The deeper push into the pet business by Mars comes as large packaged-food companies are struggling with flagging sales. Changing consumer tastes, particularly a desire for less processed foods, has made it difficult for the companies that have dominated grocery-store shelves. Efforts to reduce sugar intake have struck an additional blow to candy makers such as Mars. That’s added pressure to diversify their portfolios.
But if that's Mars' reasoning, it's a lousy business idea. We have been here before, after all.
Once upon a time, companies often made strategic acquisitions for the sake of diversification. But why would a company choose to diversify its business when shareholders can very cheaply diversify?
For example, back in the 1960s ITT made telephones and other communication equipment. They also ran some phone companies. Then they decided to become a conglomerate: a holding company that owned lots of different businesses. They bought: Hilton Hotels, Wonder Bread, a steamship line, and a host of other companies. None of which had anything to do with telephones or each other.
Why would they do this? The theory was that a recession-sensitive industrial company (like ITT) could buy a non-recession sensitive company (like Wonder Bread), making it stronger by enabling it to always have some division that was doing well.
But this made no sense as a business strategy. Diversification necessarily reduces the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well.
Moreover, the theory only worked if good telephone company managers also make good bakery managers. But it simply wasn’t true that management expertise could be transferred from one industry to the other.
True, the company lowered its exposure to unsystematic risk by diversifying. But so what?
Investors could diversify away unsystematic risk in their own portfolios. Indeed, they can do it more cheaply, because they need not pay a control premium. Shareholders thus are not better off because of diversification. Management may be better off, because their employer is subject to less risk, but making themselves better off is not management’s job.
Economists generally now agree that the conglomerate mergers were very bad for the economy. Most are negative NPV transactions. Indeed, many of the hostile takeovers were de-conglomerations in which somebody bought up conglomerates cheaply (due to their depressed prices) and sold off the pieces at a profit.
Granted, Mars is a private company. But it's owners are now in the fourth generation and the company now has non-family managers. To the extent its shareholders are now mostly passive investors their situation is not all that different from public shareholders of an exchange listed conglomerate.