Discussion: Holding companies & discounts!

In recent times  Indian markets has seen a few holding companies being listed on the bourses with subsidiaries whose accounts the parents can consolidate. A few that come to mind are:

1)     Grasim – Ultratech

2)     Sterliet – Hindustan Zinc

3)     Network 18 – Tv18 and GBN

4)     UB Holdings– cannot consolidate accounts but holds chunks   

      of United Breweries and United Sprits

Internationally there have been several companies who have been consolidating accounts and in some cases the markets have favored the holding companies(trade at a premium to NAV) and in some other cases these companies have received no favor from the markets and the companies have traded at discounts to the NAV.

Normally the convention has been to value a pure holding company with no operating assets of their own at a discount unless  the markets have been ripe with expectations of merger and consolidation. In such cases the holding is valued at the NAV but in other cases the valuation is at a discount – prima facie.

A good friend of mine pointed out some interesting international comparisons for holding companies. His argument was based that companies that paid dividend would have their listed parents’ trade at significantly lesser discount to those companies that do not pay any dividend.

Nortel Inversroa (NYSE: NTL) is the holding company for Telecom Argentina (NYSE: TEO). Inspite of holding 54.74% of the shares and consolidating accounts it trades at a very steep 50% discount to its NAV. NTL doesn't have a any other operating business of its own. It relies on dividends from its subsidiary (TEO) to meet its debt obligations. The subsidiary does not pay any dividend and the parent has gone without dividend for 7 years ever  since the Argentine crisis.

American Telecom was the holding company for America Movil (NYSE: AMX). It traded at a discount of 10-15% to its NAV. AMX which is a 100Bn$ company paid sizable dividends and the discount wasn't as steep. Recently AMX did a reverse merger with this Parent company, America Telecom. This was driven by an accounting benefit possible under Mexican law.

Carso Global Telecom is the holding company for Telmex (NYSE: TMX). It also consolidates TMX in its accounts. But because TMX is the biggest payer of dividends, the discount to NAV here is <5%.

AFK Sistema a Russina company which holds quite a few assets including leading Russian Mobile operator MTS. trades at a 15-20% discount to its NAV even though there is hardly any dividend from the subsidiaries.

A senior fund manager from Franklin Templeton whom I met last week was also advocating the dividend theory. He said that companies that had listed subsidiaries would always be quoted at a discount of 15%-20%. If the discount widens investors should get in and if the discount narrows investors could exit from the parent into the listed subsidiaries unless there is a case for holding onto the parent company because it owns interesting operating assets.

On the other hand the fund manager of HDFC MF stated that holding companies that can consolidate accounts would not be treated differently from their listed subsidiaries.

Actually there are too many grey areas and it seems that the house is divided with a majority of the smarter guys opting out for the discount in the value of the parent with listed subsidiaries – consolidation or no consolidation.

My Inference: After having seen several parent subsidiary valuations over the past few weeks I have concluded that the general theory of a lower discount of parents owing in dividend paying subsidiaries is valid and justified. Actually the valuation of the parents’ assets should be exclusive of the long term debt that the parent owns on its books.

For example if the parent is listed with a market cap of Rs 5000 crores and a debt component of Rs 2500 crores the total enterprise value of the parent comes to about Rs 7500 crores. Now if we value the assets of the parent and it comes to Rs 7500 crores these assets are the property of the debt owners and then the shareholders so taking a market cap view would make this company trade at a discount to its assets.

When we look at the market cap of Rs 5000 crores and see the value of the assets at Rs 7500 crores we conclude that this company is available at a discount of 33% to its NAV whereas in fact this company is actually available at Rs 7500 crores of Enterprise value (Mkt cap + Debt) or the NAV is at 100%. Now companies that pay a dividend to its parent would facilitate the parent in repaying off its debt and hence the value comes closer to its NAV.

Now if you closely take  a brief look at NTL and TEO http://finance.yahoo.com/q/ks?s=NTL - the holding company in this case has a US $ 1.03 billion dollar debt so the discount in the value of holding in the subsidiary company will be reduced to the extent of this debt which would never be paid because this company has not been receiving dividends.

Now holding companies are not affected by the debt of the subsidiary so the debt that TEO has taken should not affect NTL.

One of the most interesting observations is that irrespective of what valuation methodology one tekes the returns generated by the holding and the subsidiary company over a 3-5 year period is very similar. That is if the subsidiary gains 300%  so does the parent and vice versa.

Two sets of companies were checked for this and the returns do appear to be stunningly similar:

1)Vedanta with Sterlite and Hindustan Zinc

 

http://www.indiasentiment.com/Graph/ - Vedanta and Sterlite

 

The name of the file is Vedanta.

 

Hello. This is the link to the http://www.theequitydesk.com/forum/forum_posts.asp?TID=429 -

I tried to search what the masters had written on holding companies/listed subsidiaries and the likes. Page 211-213 of One up on Wall street explains some very interesting parent subsidiary valuations and Peter Lynch’s approach to such companies.

In that book Lynch also explains how he bought United Airlines a paremt with interests in several subsidiaries and Ford  Motors which also has several interesting subsidiaries.

There are hidden assets when one company owns shares of a separate company- As Raymond Industries did with Telecom Oilfield services. People close to either situation realized that Raymond was selling for $ 12 A share and each share represented $ 18 worth of Teleco. By buying Raymonds you getting Teleco for minus $ 6. Investors who bought Raymonds got Teleco for minus 6 and investors who didn’t bought Teleco for $ 18.This sort of a thing happens all the time.

For the past several years if you were interested in Dupont, you got it cheaper by buying Seagram which happens to own about 25% of Dupont’s outstanding shares. Seagram became a Dupont play. Similarly a stock of Beard oil sold for US $8 while each share included $12 worth of a company called UPSCL.. In this transaction Beard and all its oil rigs and equipment was yours for keep for a minus $4.

……..It was here that I discovered that I could buy the parent company for less then the value of its subsidiary plus pick up numerous other attractive businesses – not to mention real estate-as part of the deal. While the US stock went up only slightly the price of the parent company’s stock doubled in two years. – This was on Esselt business systems which was listed in the US.

If you followed the food lion supermarkets story, you might have discovered that Dal Haize of Belgium owed 25% of the stock, and the Food lion buildings alone were worth a lot more then the price of a share in Dal Haize.Again when you bought Dal Haize you were getting the valuable European operation for nothing.I purchased the European stock for Megallan and it rose from US $ 30 to US $ 120 while Food lion gained a relatively unexciting 50%.

This seems to have become a thorn in the flesh no one knows the right answer. An analyst with the largest fund house whom I met last week said holding companies should be valued on Dividend discount model! Now what value would you put on Bharti which has never paid dividend in its life - zero!!!

Last week, we touched upon the key points in Warren Buffett's 1979 letter to his shareholders. This week, let us see what the master has to offer in his 1980 letter to the shareholders of Berkshire Hathaway:

"The value to Berkshire Hathaway of retained earnings is not determined by whether we own 100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage."

The maestro made the above statements because in those days he felt that the prevailing accounting convention/standards were not in sync with a value based investment approach (Infact, they still aren't). In the paragraphs preceding the one mentioned above, he painstakingly explains that while accounting convention requires that a partial ownership (ownership of say 20%) in a business be reflected on the owner's books by way of dividend payments, in reality, they are worth much more to the owner and their true value is determined by the 20% of the intrinsic value of the company and not by 20% of the dividends that are reflected on its books. In the Indian context, imagine someone valuing a company like say M&M -if it had say a 20% stake in Tech Mahindra- based on the 20% of dividends that the latter pays out to M&M. This will be a rather incorrect way of valuing M&M, which in effect should be valued taking into account 20% of the intrinsic value of Tech Mahindra and not the dividends.

Source : Equitymaster

Vivek bhai

fund managers have a herd mentality..if kotak can come up with it...then mkt will see more of such schemes....like it happened in case of infra schemes..sbi, tata, rel, hdfc all have them ....