Investing in Holding Companies

One of the more popular 'theme' in the 'theme-based-investing' categories is investing in Holding Companies.
For the un-initiated, let me first explain in brief what this theme is all about...

• There are some listed companies, whose main 'business' is to own and hold equity shares of other companies, most of which are listed group companies, run by the same management. 
• Basically, instead of the individual promoters owning shares of all their group companies, all these holdings are held in a single company. This is called as the 'holding company'. (May or may not be a 'holding company' from accounting point of view.)
• E.g. Bajaj Holdings and Investments Ltd. is the holding company of the Bajaj Group. It holds 31% stake in Bajaj Auto, 35% stake in Bajaj Finserv and 24% stake in Maharashtra Scooters, among its other investments.

So what is the 'accepted' logic for going about investing in such companies? Well, it goes like this...

• Such companies hold shares of other listed companies. The market value of these investments (since they are also listed) will normally be higher than the value of investments shown in the books of the holding company.
• In many cases, the market value of the holding company's investments (net of debt) is much higher then even its own market-cap.
• So, investors argue that the holding company is undervalued, since it has 'assets' whose market value is greater than its own market-cap.

An example will clear this further;

Nalwa Sons Investments Ltd. (NSIL) is the holding company of the O.P. Jindal Group. It holds shares of Jindal Saw, Jindal Southwest, JSW Holdings and JSW Steel.

If one were to buy NSIL at current market-cap of Rs.500 cr, one would get investments worth Rs.2200 cr. Seems like 'buying a dollar for fifty cents' huh? 

This, precisely, is the investment argument that the believers in this theme of investing put forth. Further, while calculating the 'fair value' of the holding company, investors in general 'give' a discount to the market value of its investments. (The usual norm in the market is to accord a 50%-60% discount.) Thereby, fair value of NSIL should be about Rs.1300 cr (60% of market value of investments). Hence, at the present market-cap of Rs.500 cr, NSIL is a 'screaming buy'.

Now, while this logic seems reasonable, let me ruin your day by putting forth my thoughts on the same...

• Strategic stake v/s financial stake: There are some investments which are financial in nature (to be sold later, preferably at a profit and make money.) There are other investments which are strategic in nature (never meant to be sold, but are meant to be held on and on, as part of some strategy.) Holding companies are created from the strategy point of view and their investments are necessarily strategic in nature. Holding companies stake in other group companies is in the nature of the 'promoter holding'. If this stake is sold, the group will lose control of the company. (In effect, it will never be sold)
• Does market value matter??? Sooo, since the investments made by holding companies are strategic in nature, these will never be sold, but held on till eternity! So, if the market value is never going to be realised (by selling off the investments), should it matter? Should one even bother calculating the market value of the holding company's investments?

Please keep in mind that I am talking about only holding companies. If a company holds shares of an un-related listed company, the market value of these shares should be given due consideration, imho.

Well then how can these holding companies be valued?

• In my view, these companies should be valued like any other business. Its revenue is the income it receives on its investments (dividend). Usually, expenses are limited and most of the revenue is reflected as the profit.
• One can multiply this profit by a PE ratio accorded to a zero-growth company (e.g.Graham suggests 8.5 PE ratio) to arrive at the fair value of the holding company.
• This is merely a suggestion and cannot be the only way to value a holding company. To each his own!
• Further, investments other than those in group companies should be given their fair market value.

Of course, when one values holding companies like this, the resulting 'fair value' will be far farr farrrrr lower then the prevailing market cap, meaning that these companies should not be bought. Well, this happens to me all the time and till date, i have ended up buying only one holding company...

I am well aware that not everyone will agree with me. (In fact, i think most investors wont!). Valuation is an art and is very relative. The way I look at holding companies will not be the way you do!

But isn't that the beauty of investing? Well can all agree to disagree on certain fundas and still, all of us can earn money!! E.g. My good friend Ayush is a firm believer in the holding company investing theme (and I am not!) And i know it for a fact that he has earned a lot of money in this theme (and I have not!) Ayush, party-time dude!

As usual, the purpose of this post is to start off discussions on the topic. I do not claim that my views are right and others' are wrong...

Do pitch in your views on this theme..

Cheers and happy investing!!