Thursday, October 23, 2014

Breaking Up Isn't Always the Optimal Solution: The Curious Case of Dan Loeb and Amgen

Corporate breakups seem to happening every other day.   I blogged last week about some of the reasons for the recent surge in breakup activity.   In general, I think many of these breakups make sense, as firms tend to prosper when they are more focused.  Moreover, many of these firms are experiencing significant diseconomies of scale and scope.   However, I think we may be taking it too far in some cases.

Let's take the case of hedge fund investor Dan Loeb pushing Amgen to break into two independent firms.   Loeb proposes that Amgen split into one business focused on its mature products and another focused on its high growth products.   Typically, when investors propose such splits, they want the mature business to generate lots of cash and return much of it to shareholders.  They want the growth business to reinvest profits to stimulate even more growth.   

Here's the problem with proposals such as the Amgen deal though.   In the old BCG model of corporate strategy, firms were supposed to milk the cash cow and use those proceeds to fund promising growth businesses.   That model has since been completely debunked.  Cross-subsidization amongst unrelated business units makes no sense if external markets are reasonably efficient.  Chas cows should return excess cash to shareholders, and growth businesses should find their own sources of funds from private equity, venture capital, or public equity and bond markets.  Note the word "unrelated" though.  The BCG model is faulty if we are talking about using it to justify an unrelated diversification strategy.  However, a firm such as Amgen is clearly not an unrelated diversifier.  It has a set of highly related businesses.  Strong synergies exist among its lines of business.  In fact, some would say that it's a focused firm, not even a related diversifier.  Thus, Amgen is not in any way inappropriately using funds from a cash cow to fund a growth business. They are managing multiple products that each have stronger competitive advantage because they co-exist together in the same firm.  I don't see how you create real value by splitting a firm such as Amgen in two.  In fact, you may destroy value by doing so, because synergies are lost.  You create real value if you split an unrelated diversifier in two. 

No comments: