Investing in holding companies

Holding companies make a good target for the value investors. I have
used this quite effectively in the past in case of M&M/Sterlite etc.
The principles I follow in these cases are as follows;

1.Analyze the companies independently to judge the prospects of
subsidiaries by themselves.

2.Find out the triggers of unlocking the value in the subsidiaries.
That may not necessarily mean that subsidiaries need to be made public
or sold. it simply means whether they would achieve the critical mass
to make the market realize their worth. In fact if a holding company
has stake in a strong subsidiary then by the value investing
principles it may not make sense to divest the stake.

3.Find out the pitfalls.
a.Figure out why such holding structure is created. Many times the
companies do this to hide debts in the books of subsidiaries. The
extreme example of this is pyramiding capital structure, a la Enron.
b.Check if the parent company is using transfer pricing to sell the
products at higher price then it can get in the markets and booking
profits whereas the subsidiary is suffering from losses.
c.Avoid complicated structures with substantial cross holding

4.Check if there are any synergies in the business of parent company
and the subsidiaries. History shows that diversified companies making
everything from steel to software are unable to remain focused in
disparate businesses.

5.Check if the managements of the subsidiaries have enough expertise
and freedom to shape the future of the subsidiary.

6.Having done all of the above mentioned analysis, evaluate the value
of the interest of the parent company in the subsidiary. You can get
this by looking into the consolidated accounts. Here a catch is that
the accounting norms do not force the company to consolidate the
accounts for the subsidiaries where the parent company holds less than
505 stake. Reliance Infocomm is the case to the point.

7.If you can determine with reasonable degree of confidence that that
the total value of the consolidated enterprise is more then what
market estimates buy it. But you got be very patient in such cases
because it may take years before market realizes that.

Posted: June 20, 2005

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