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.
- 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.
- 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?
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.