Diversified embarrassment risk

After rah-rah enthusiasm during the 1960s and early 1970s, the strategy of unrelated diversification has fallen out of favor with strategists and financial markets. GE nothwithstanding, it’s been shown that firms waste a lot of managerial time trying to manage disparate businesses that have no synergies, and that stockholders can better diversify risk by buying their own shares in the underlying businesses. Such unrelated diversification still remains a pattern in countries where the aggregate market power overrules the underlying inefficiences, such as Korea’s chaebol and (until recently) Japan’s kigyō shūdan.

Today, the Wall Street Journal published a list of companies doing business with Iran to help finance its oil and gas development. American frustration with Iran is building since it seized 15 British sailors and Marines on March 23, and some in the Senate are proposing a boycott of firms that do any business with Iran.

Most of the companies on the WSJ list are energy companies, but one jumped out — Korean conglomerate LG. The LG Group doesn’t have much (any?) petrochemicals presence in the US, but instead it sells a lot of LCD screens via its joint venture with Philips. More visibily, its LG Electronics subsidiary is the world’s fifth largest maker of cell phones (at about 6% in 2006) and the largest maker of CDMA handsets.

LG has a potential exposure here, but it’s not clear how big. Right now, the US pressure on firms doing business with Iran is fairly weak: it’s not clear whether the ultimate pressure will begin to resemble the (successful) anti-apartheid divestment efforts of the 1980s, or whether it will just fizzle out.

In some cases, the risk of scandal in a diversified company is severe. The broad portfolio of clients (not technically diversification) held by Arthur Andersen & Co. proved to be its undoing, as the choice of one particular Houston-based company proved fatal. However, as a “Big Five” accounting firm, Andersen was in the business of renting its previously stellar reputation to validate the financial statements of public firms, so once it lost its reputation it had nothing. Obviously thousands of former Andersen employees wish that the Houston office had not taken that client (or had done a better job of protecting Andersen's storied 90-year-old reputation). And the damage to the Andersen brand accelerated the decision of its Andersen Consulting spinoff to rebrand itself as Accenture.

LG won’t face such a consequence, if for no other reason than the Korean government won’t allow it to happen. If the pressure increases, the RoK government will probably try to protect LG rather than a more pro-active strategy such as separating the electronics and petroleum companies into separately traded firms.

Also this week, the diversified company ITT was fined this week for transferring military technology to China. Given that Loral survived (despite bankruptcy) after transferring ballistic missile technology to China, ITT is likely to skate after paying its $100 million fine for the night-vision goggle technology.

Technorati Tags: LG, mobile phones, diversification