The large discounts to fair values in the case of conglomerate stocks reflect the markets general discomfort with capital allocation and diversification associated with such structures, the Kotak Institutional Equities said in a report.
However, a bigger issue may be possible inability of conglomerates to face disruption. It remains to be seen if recent de-merger announcements by large global conglomerates will provide sufficient inspiration to majority shareholders and managements of Indian conglomerates to evaluate similar de-mergers, the report said.
The report said the recent de-merger announcements by large global conglomerates may reflect two factors growing challenges of managing diverse businesses in an increasingly disrupted world and increasing gap between market capitalization and SoTP value of conglomerates leading to rising shareholder frustration.
The managements of these companies probably acquiesce with the former in that individual companies may have better chance to create value through increased management focus on individual businesses. Activist shareholders have taken note of the latter and are challenging company managements to ‘unlock’ value through de-mergers/splits, the report said.
The shareholders (majority or minority) of Indian conglomerates appear to be agnostic to the disruption across industries that could pose challenges to the business models of the weaker businesses in diversified conglomerates and accepting of the large discount to the fair values of various businesses in the parent entity or subsidiaries. India is yet to see any major shareholder activism given the majority or large ownership of majority shareholders, the report said.
“We note that several Indian conglomerates trade at large discounts to the fair value of their individual businesses in the parent or in subsidiaries. The implied P/E or market capitalisation of the main businesses in the parent entities appear to be quite low after adjusting for the market value of the companies’ holdings in their subsidiaries or associates. We note that current large holding company discounts may also be the result of the steep increase in market capitalization of subsidiaries in several cases; they may well be over-valued,” the report said.
The majority shareholders of conglomerates with a mix of unrelated businesses may want to reconsider the ownership structure of their companies and review their business mix given that the market is unlikely to accord the fair value of the businesses in the market capitalization of the holding/operating company, the report said.
The inability of companies to survive and thrive in many different businesses simultaneously in an increasingly ‘disrupted’ world should force a rethink among majority shareholders about the ‘financial’ (control) benefit of continuing with such structures versus potential irrelevance in many businesses in the future and the market’s reluctance to give value to the businesses at present anyway, it added.
