Have shown a 47% outperformance, equivalent to an excess return of 4.5% CAGR versus MSCI All Countries World Index since 2006. Report superior cash returns and economic value creation, underpinning premium valuations and share price outperformance, says a Credit Suisse Research Institute report “The Family Business Model”
A report based on Credit Suisse's proprietary database of over 920 publicly listed companies in 35 countries that have a market capitalization of at least USD 1 billion and where there is a family-owned shareholding of at least 20% of shares outstanding, reveals that family businesses shows superior cash returns and economic value creation, underpinning premium valuations and share price outperformance.
The newly released Credit Suisse Research Institute report “The Family Business Model” based on CS Global Family 900, shows that 76% of the CS Global Family 900 are businesses in Asia. More than 50% of the top 50 family-owned businesses in this universe by market capitalization are in Asia. In terms of total market capitalization by country, India has the third highest representation in the CS Global Family 900 universe, following USA and China.
Using the Credit Suisse HOLT valuation framework, the report findings show that the CS Global Family 900 has shown a 47% outperformance, equivalent to an excess return of 4.5% CAGR versus MSCI All Countries World Index since 2006.
Stefano Natella, Global Head of Equity Research, Investment Banking said: “For the first time, we look to establish if and how family-owned businesses create wealth at a global level. We compare the cycle of growth and returns at family-owned companies worldwide versus the MSCI ACWI as well as the differences in business strategies to understand why family-owned businesses outperform.”
Giles Keating, Deputy Global Chief Investment Officer, Private Banking & Wealth Management added:“Entrepreneurship is borne of opportunity and necessity. As the macroeconomic backdrop has moved towards increased deregulation and decreased involvement of the state, we have seen that family-owned businesses are not just key drivers of economic growth but are also key employers. It is therefore imperative to understand how and why these companies perform and how they will impact macroeconomic policies and stock market performance. With the lessening of the role of the state in the economy across the globe, entrepreneurs will be the innovators and drivers of future growth and development.”
Naturally, it pays to invest alongside the founder. The analysis finds that investing alongside the founder in the early years of a company’s existence when period of high growth generates the best share price returns, while the outperformance decreases over subsequent generations. The CAGR of first-generation companies has been 9.0% since 2006, while interestingly third-generation ownership marginally outperforms the second generation.
Incidentally, family-owned companies have traded at a small premium versus MSCI ACWI of 12% on Enterprise Value (EV)/EBITDA and 5% on the Price to Book ratio since 2006. This reflects ROEs that have on average been 4.3% higher than the benchmark and cash flow return on investment (CFROI) over 9% higher.
Over the longer term, family companies in the CS Global Family 900 have generated twice the economic profit (EP), defined as earnings in excess of the opportunity cost of using the assets or capital, compared to benchmarks. This can be one of the key reasons that markets pay a higher valuation for family-owned businesses relative to the multiple their lower ROE would suggest they merit. Investors are prepared to pay this slight premium for a more stable sales-and-return cycle relative to benchmarks as well as the sustained longer term value creation reflected in superior CFROI and economic profit metrics.
Among the top 50 family-owned businesses by market capitalization covered in the study conducted by Credit Suisse include Tata Consultancy Services, Reliance Industries, Sun Pharmaceuticals Industries Limited, Tata Motors Ltd., HCL Technologies, Wipro Ltd.
Superior and more stable sales growth
Since 1995, the companies in the Credit Suisse family-owned businesses universe have shown annual sales growth of 10% compared to 7.3% for MSCI ACWI companies. Since 2006, this sales growth has averaged 8.5% for family companies versus 6.2% for the benchmark. The reasons for this superior growth profile are multifold, but a longer-term corporate strategy is fundamental to the structural nature of this higher and less volatile growth. The importance of product or service quality, the development of long-term customer relationships and brand loyalty, along with the focus on core products and innovation in these core products rather than diversification are elements that help to explain this outperformance.
Asian family-owned businesses rely on greater external funding and leverage for growth
Much is made in academic research of family-owned businesses relying on internal funding for growth and investment in order to preserve ownership and independence. The Credit Suisse analysis shows this to be true for US and European family-owned companies, while Asian family-owned businesses have relied on greater external funding and leverage. There are three likely reasons: Firstly, the companies are relatively young in the region, so founders are still trying to maintain control and fund growth rather than risk dilution. Secondly, the companies are smaller in terms of market capitalization and may not have required as much funding for growth. Thirdly, founders may not have had access to savings, capital provided by family networks or other means, for instance, many Chinese companies have resorted to more venture capital funding as a source of financing for development.
Family business growth is also organic. Since 1990, family-owned businesses have spent an average of 2.1% of sales on M&A annually compared to 5.8% at non-family companies. This is more than 60% lower in absolute terms and goes hand-in-hand with lower R&D, underpinning the interpretation of conservatism and a reliance on organic rather than acquisition-led growth. Family businesses also make better and cheaper acquisitions as they drive better growth and returns in the three-year period post-acquisition. The average increase in CFROI is 21% at family-owned businesses after three years versus 9% by all acquirers, while growth averaged 22% after three years at family acquirer companies compared to just 7% at all companies.
“Survivorship” of family businesses - 50% transitions from first to second generation
The report also analyzes the potential risks and weaknesses of family businesses such as related party risks, closed pools of managers, employment of under-qualified family members and different voting rights. Succession and the business risks around succession within a family-owned company are cited as a key potential cost to external investors. The report analyzes the survivorship rates relative to the first generation, and shows that 50% of the family businesses in the database are transitioning from the founder to the second generation, 22% making the third generation and 10% to the fourth generation.
Companies in sectors that have higher intellectual property, such as healthcare and IT show families selling down earlier than in other sectors with more tangible asset business models. This may reflect that successor generations do not share the founder’s vision or interests. These succession risks are reflected in lower share price returns and accounting quality, particularly in second generation ownership.
76% of CS Global Family 900 universe in Asia; greater weighting of companies in the technology, consumer discretionary and staples sectors
76% of the CS Global Family 900 are businesses in Asia, which reflects the different and more recent pattern of economic development compared to Europe and the USA, where there is more fragmented ownership and many families selling out over time. 42% were listed after 2000 and 3% in the past five years, with the vast majority of these have been Asian companies underlining both the more recent economic development of the region and the long established role of entrepreneurship.
In terms of total market capitalization by country, USA has the greatest representation in the CS Global Family 900 universe, reflecting the capitalist, entrepreneurial development of the economy and the lack of state ownership of assets, while China has the second highest representation, underscoring the very dynamic and entrepreneurial development of the economy over the past 35 years. Emerging markets make up 40% of these companies by market capitalization and illustrate the importance of family-owned companies in the expansion and advancement of these economies in the past 50 years.
Relative to MSCI World, there is also a greater weighting of companies in the technology, consumer discretionary and staples sectors, with few financials, specifically banking stocks. This concentration implies lower barriers to entry in these sectors from an initial capital investment point of view and in the case of technology, less competition, i.e. proprietary intellectual property.
- 76% of the CS Global Family 900 are businesses in Asia
- More than 50% of the top 50 family-owned businesses in this universe by market capitalization are in Asia
- In terms of total market capitalization by country, India has the third highest representation in the CS Global Family 900 universe, following USA and China
- Companies in sectors that have higher intellectual property, such as healthcare and IT show families selling down earlier
- Among the top 50 family-owned businesses by market capitalization covered in the study conducted by Credit Suisse include Tata Consultancy Services, Reliance Industries, Sun Pharmaceuticals Industries Limited, Tata Motors Ltd., HCL Technologies, Wipro Ltd.