The Conglomerate Discount Phenomenon: A Valua7on of Orkla ASA

Joakim W. Severinsen & Henrik G. Gundersen

Student thesis: Master thesis

Abstract

The stock of a company engaged in multiple unrelated business segments is typically traded at a price below the combined value of its separate entities. This phenomenon is commonly known as the ‘conglomerate discount’, pointing to a valuation disadvantage of the conglomerate structure. After being structured as a conglomerate for nearly three decades, Orkla ASA suddenly shifted its business focus, in September 2011, towards becoming a pure-play branded consumer goods (BCG) company. Although several subsidiaries in the company’s wide-spread portfolio have been divested at the time of writing, the restructuring process is not fully completed. The authors found this shift in strategic direction very interesting in relation to the historical discount associated with the company’s stock. Therefore, the overall objective of this thesis has been to combine a thorough analysis of corporate diversification with a ‘sum-of-the-parts’ valuation to assess whether the stock is still traded at a conglomerate discount. Before delving into the specifics, it was necessary to establish the relevance of considering a phenomenon such as the ‘conglomerate discount’. Through a comprehensive literature review, it was revealed that conglomerates first and foremost could be justified from an ‘economic perspective’. This view emphasizes that companies are able to benefit from an internal capital market through easier access to capital and through opportunities to seize profitable investments in different industries. However, both empirical evidence and our own regression-analysis pointed towards a negative effect of corporate diversification on relative firm value. The prevailing reason for this seems to be that investors are not willing to pay for the corporate diversification and rather prefer to assemble their own portfolio of assets. It was thus surprising to observe that there appears to be no common practice among financial analysts as to how a conglomerate discount should be incorporated into the valuation. Through interviews with leading analysts covering the Orkla stock, it was evident that their interpretation of the discount varied. Some argued that there is still a discount of about 10%, another argued it had dissolved, and yet another did not even consider a conglomerate discount. With such varying opinions among experienced practitioners, it could also be expected that market participants vary in their interpretation and approach. Therefore, in order to assess whether there still seemed to be a conglomerate discount associated with the Orkla stock, a valuation of the individual parts of Orkla was conducted. With BCG being the core-business going forward, this segment was valued using a fundamental analysis and discounted cash flow (DCF) approach. The non-core segments were valued using trading-multiples. The analysis yielded a theoretical share price of NOK 52.50, as of March 20th 2014. Compared to the market price of NOK 48.30, the valuation of the underlying assets indicates a discount of 8.7%. The discount is clearly below the historical average of about 25%, and it is reasonable to expect that the discount will continue to gradually disappear when Orkla transitions into a single-business firm. This implies a potential upside for investors, which is unrelated to the general performance of the company.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2014
Number of pages252