India's holding company discount mystery

Holding companies are quite the craze in India. We have more than a 100 listing firms that hold shares in related business, and the trend seems unlikely to change anytime soon. What is interesting however is not that we have these many holding companies, but that they trade at such a deep discount to what they 'should be' trading at.

In today's post, we understand what a holding company is, the reasons that could drive a discounted valuation, and why the discount Indian markets offer seem a bit too good to be true.

What is a holding company?

Holding companies own shares in listed and unlisted companies. These ownership interests may be small or large. SBI, India's largest public sector, bank for example has ~30% ownership of Jio Payments Bank, ~70% ownership in SBI Cards (listed), and 100% ownership in SBI Capital Markets.

Numerous other firms and groups in India have such holdings, with some groups maintaining intricate cross-holdings to prevent external influence on their business decisions. That, however, is a discussion for another day. Today let's look at why the firms that own the other smaller firms often trade at a sharp discount over the companies they hold

So why do they trade at a discount?

A common thread that you would observe as you start to look at a lot of these firms is that they trade at a steep discount to the sum of the individual parts. A variety of reasons could drive the discount.

For starters there are the real-world costs when you realize the investments - transaction costs you have to pay, capital gains taxes that you would have to pay up, and if it a large chunk you're selling to a private investor some amount of banking fees. Second is the cost of timing - many holding companies in India hold a bulk of shares in group companies, showing very little intent to exit the stakes and realize the said value.

Most Indian holding companies, however, trade at a much steeper discount than the actual costs would indicate, often trading at a ~50% discount. Irrespective of the costs and taxes, this deep discount leaves quite a lot of money at the table.

So how do you think about holding companies?

The Holdco discounts in the Indian context are extremely stick, lasting unchanged for years. Buying a holding company in the hope of the discount compressing, therefore, would not be a very ideal decision to make. While it does make for an interesting upside driver, the time in which it can be realized is anybody's best guess. The good news is that a lot of holding companies in India hold a good mix of high-quality companies.

If you are confident that the discount is already quite stretched, the holding company can be a good way to play on the growth of the underlying stocks, with the reduction in holdco discount as an incremental upside driver.

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