“Conglomerate” is often a scary word for investors. But conglomerates are simply companies that own businesses in various industries. The benefit of owning a conglomerate as an investment is that it often provides instant diversification. And if it operates efficiently, it can still deliver strong returns.

There are certainly examples of top-notch conglomerates that have done well for shareholders. Of course, the prime example is Berkshire Hathaway (NYSE: BRK-B). It helps that the CEO — Warren Buffett — is one of the world’s smartest investors, who has an uncanny ability to efficiently allocate capital.

But Berkshire is not an outlier. In fact, there are other best-of-breed conglomerates, although, they are often overlooked.

The reason conglomerates are often overlooked is because these companies have historically ravaged many portfolios. Examples include AOL/Time-Warner and Tyco (NYSE: TYC). There is actually an investing concept known as the “conglomerate discount,” in which investors tend to drive valuation of a company lower because of the disadvantages. Some of the problems include corporate bloat, culture clashes and lack of focus and vision. The solution is often to spin-off the divisions.

Despite all this, one of the standouts is Washington, D.C.-based Danaher (NYSE: DHR). Founded in the late 1960s, the company develops equipment and solutions for a broad array of industries like dentistry, life sciences, diagnostics and industrial testing.

In the past five years, revenue has risen from $7.9 billion to $13.2 billion, with earnings per share (EPS) climbing from $1.31 to $2.31. Much of the growth has been through an aggressive mergers & acquisitions (M&A) strategy.

And investors have certainly benefited nicely. For the past 20 years, the stock’s total return has been a whopping 4,994%, compared with Berkshire’s 1,289% and only 446% for the S&P 500.

Why the success? After all, just about every academic study shows that M&A deals tend to underperform — that is, for the buyer. Often the price tag is too high and the expected deal synergies fail to materialize. A prime example was the AOL/Time-Warner acquisition. Melding an online service with a traditional media company resulted in more than $100 billion in shareholder destruction.

Interestingly enough, Danaher’s stock price actually increased 3% on news of its recent deal for Beckman Coulter (NYSE: BEC), a biomedical testing company based out of Brea, Calif.

Like anything, success often comes from practice. As for Danaher, M&A is part of its corporate DNA. As a result, Danaher usually derives substantial revenue and cost synergies from its deals.  This is evidenced by a climb in gross margins from 30% in 2001 to more than 50% in 2010. This allows the company to pay premiums for its transactions and snag top-notch targets.

Look at its latest deal for Beckman. Beckman has a strong portfolio of complex biomedical testing technologies, with an installed base of about 200,000. At a purchase price of $7 billion, the Beckman transaction came to roughly 8.6 times earnings before interest, taxes, depreciation and amortization (EBITDA), the cheapest-ever deal for a medical instrument maker, according to Bloomberg. Danaher was able to beat out private equity powerhouses like the Blackstone Group (NYSE: BX) and the Carlyle Group.

The Beckman acquisition should double Danaher’s exposure to the life sciences market, which has a strong long-term growth outlook, while also creating roughly $250 million in cost synergies. With the aging population, there will certainly be more demand for sophisticated medical instruments and devices. There are also large growth opportunities in emerging markets. True, Beckman has had problems with quality (there was a recall of a heart testing product that has resulted in an FDA investigation), but Danaher’s experience and track record indicate that it should be able to improve in this area.  

Action to Take–> Danaher has a diversified platform of businesses, many of which are in industries with positive trends such as healthcare and environmental markets. The firm has also been aggressive in moving into emerging economies. Four of its business units earn more than $100 million in annual revenue in China.

However, Danaher is not just about finding efficiencies and cutting costs. It’s also been an innovator. Keep in mind that last year it launched roughly 1,800 new products.
Danaher trades at roughly 18 times earnings and 2.5 times revenue. This is roughly the same as Berkshire Hathaway. But Danaher is much smaller than Berkshire and should be able to post stronger growth. The deal for Beckman will add about $3.7 billion annual revenue as well as a steady stream of free cash flow — which will definitely be a nice boost for the next couple years. If you’re thinking about holding a company like Berkshire Hathaway as a core component of your portfolio, you may do better with Danaher instead.

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