Holding company discount impregnable even in bull run

In quite a few business groups in India, the holding company (holdco) owns the family silver. However, stock markets continue to treat them like copper or brass.

An analysis of some of the largest holding companies from the Nifty 500 index indicates that despite the markets having a record run in the last one year and valuations becoming forbiddingly expensive, holdco discounts have held fort. For this analysis, we have excluded holding companies with relatively significant standalone operations (like Grasim) and have only taken those that derive a substantial part of their value from underlying investee companies.

Market hesitance intact

Normally in a bull market, as investors realise that some of the best-in-class companies are trading at stretched valuations, holding companies turn out to be attractive options to ride on the prospects of the underlying company. This trend, however, has not played out in the current bull market with the holdco discounts, in fact, increasing for some of the players from leading business groups.

At a broader level, a simple average of the discount for some of the largest holdcos in NSE 500 has increased from around 58 per cent at the beginning of FY21 (when markets were at a low) to 64 per cent now, when markets are at all-time high. The discount would be even higher if one assigns value to the standalone businesses that some of the holding companies have. For example, in the Nifty 500, holding companies like Sundaram Clayton, Bombay Burmah and Cholamandalam Financial have robust, albeit relatively small, standalone business/other unlisted investments or both which have not been factored in computing the holding company discounts. Taking these into account would make the discounts even wider.

All these companies analysed ( see table ) have solid balance-sheets with no concerns over leverage or corporate governance. Hence, the reasons of the discount appear to be other factors, mainly the perception that status quo will be maintained.

Globally, too, the whole is less than sum of the parts. But the discounts are substantially higher in the Indian context. For example, in French company Christian Dior, which is the holding company for LVMH (luxury goods conglomerate and owner of Louis Vuitton), the holdco discount usually ranges between 10 and 20 per cent. Similarly, Berkshire Hathway would get nowhere close to its current valuation if analysts or investors applied large holdco discounts to its operating and non-operating investee companies like Apple, Bank of America, Coca-Cola etc.

The holdco discount in India appears similar to the difference in stock prices between shares with full and differential voting rights here, while the same is not significant in the developed world. Earlier, one could attribute it to other factors like double taxation of dividends. The dividends that holdcos receive were taxed when paid out to them (Dividend Distribution Tax) and taxed again, when paid out to their (holdco’s) shareholders. With the removal of DDT from FY21, this inefficiency is plugged. Corporate governance is not a concern for the companies analysed in the list as they are business groups in existence for multiple generations, have inducted professional managers to run the company, and have a built a reputation to protect.

Perception driven

Thus, this discount appears largely perception driven and may provide an opportunity for long-term investors. According to a closed-ended PMS fund that aims to tap opportunities from higher-than-warranted holdco discounts, opportunities may arise in this space as promoters feel the heat of the change in regulatory landscape. In their opinion, thrust by MCA and SEBI on higher compliance requirements time and again could prompt promoters to consider delisting their holding companies, leading to value unlocking. This PMS scheme has earned 23.44 per cent returns (TWRR) as on April 30, since its inception in May 2014.

Another factor that may work in the long-term is that as the next generation takes over in business groups, it may not be possible to continue to retain majority control via these holding companies as ownership gets split. This may give rise to situations where the holding company could distribute its stake in the underlying companies directly to its shareholders, resulting in significant unlocking of value.

Thus, for long-term investors, holdcos represents value, provided the long-term fundamentals of the underlying companies are steady. However, the wait for a catalyst or an event to unlock value could be testing.

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