What exactly do we understand by the concept of a holding company? It is the company that holds the promoter shareholding in group companies. The stake in group companies may either be a controlling stake or a minority stake but the value of these investments actually becomes the portfolio value of the holding company. Some of the most well-known holding companies are Tata Sons (the holding company for the Tata Group) and Bajaj Holdings (the holding company for the Bajaj Group). While Tata Sons is still a closely held holding company, Bajaj Holdings is listed and also traded in the markets.
Similarly there are other holding companies like Birla Wellness for the Yash Birla Group, ABCL for the financial services business of the AV Birla Group, Kirloskar Investments etc. The interesting point is that many of the holdings companies that are listed are available at fairly attractive valuations. For example, Bajaj Holdings which has a blue chip portfolio quotes at a P/E of just 12X. This is substantially lowered compared to other financial services companies in the banking and NBFC space. The anomaly in many cases is that the market cap of the holding company is almost at a discount of 50-60% of the value of its portfolio. That surely looks like a clear arbitrage opportunity. So the question is whether one can buy holding companies that are quoting at reasonable P/E and at a steep discount to their investment value. You will have to exercise some caution here. Here is why!
Do you remember the holding company discount?
When Cafe Coffee Day listed on the bourses under 2 years back, almost everyone gave the stock a resounding thumbs-up. What most people ignored was that Coffee Day Enterprises was actually the holding company of the VG Siddhartha Group. Under its banner, the holding company also had other businesses like retailing, coffee plantations, coffee trading, financial services, logistics services as well as the prominent CCDs. Nobody had bargained for such a motley combination of businesses under one roof and that explains the lacklustre performance of the stock post listing. In fact, the recent corruption charges against the promoter has only made matters worse for the company, which brings to the next point of investment value uncertainty.
Investments are value driven and that is determined by the market..
The best of companies in India and around the world go through prolonged cycles. We have seen companies like Bajaj Auto and Tata Consistently lose value over the years as the industry got disrupted in multiple ways. If you look at the balance sheet of a holding company then you just have 3 principal items. On the liability side there is the equity capital and on the assets side they have investments and current trading stock. The value of these holding companies, therefore, is entirely and inordinately dependent on the value of the investments. With markets being vulnerable to shocks, the discount to market value of investments is likely to stay, as is the trend world over. In fact, higher the volatility, higher will be the discount.
Should valuations focus on dividend flows or on investment value?
This is another important question to be addressed. A holding company pays out dividends, which become the earnings for the holding company. Since most operating companies are valued based on their earnings, how should these holding companies be valued? Unlike normal operating companies, the holding company does not directly control the operations of the various businesses. It stake in the company is in the form of the holding and therefore the better way to value these companies will be through the investment value discount route. The dividend yield on such companies may not be too relevant from a valuation standpoint.
Holding companies trade at a discount for genuine reasons..
We have already seen the case of vulnerability of investment value as one of the reasons for holding companies to trade at a steep discount to the market value of its investments. There are also other reasons why it quotes at a discount. Firstly, the holding companies are normally valued based on the liquidation value of the investments. But that is something that cannot be realized as the holding company will rarely sell of their investments in the group companies. Hence the market value for such holding companies is more theoretical than practical. Secondly, there is the all important aspect of capital gains tax that has to be paid if the shares are transferred. This will anyways reduce the effective value of the investments. Lastly, internal policies will prevent the holding company from realizing the value of shares and that is also factored into the discounted pricing.
How can holding companies realize a better valuation in the market? Remember, in the market there is a premium paid for control. Normally, holding companies with lower outside equity and greater controlling stake over subsidiaries tend to quote at a lower discount to their investment value. For investors, that could not be an important clue as they can play for the narrowing of the discount in these cases!
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