Sunday, March 22, 2009

Value Unlocking (New Listing of Subsidiaries)

The following question was posted by one reader in the comments section and I would like to present my views regarding the same in this article.

Question

“When the stock market was on top a year before, there were many companies like ICICI, HDFC, Sterlite, Kotak and Reliance trying to demerge and list their subsidiary companies and create value unlocking for the share holders... just as the example we saw when two Ambani brothers were divided...

Most of the banks are planning to list their subsidiaries, how do you see this as wealth creation for a particular stock in coming 2 or 3 years as market might be better then and so will the companies go for it.

Don't you think we should consider this value unlocking thing while selecting a stock when planning for 2 - 5 years horizon?”

My Views

Since, there is no straight answer for this question; I wanted to post an article presenting my views.

What is Value Unlocking?

Theoretically we can define value unlocking as a process by which subsidiaries of a large corporation(s) are listed as separate business entities. In general Value Unlocking is considered to be beneficial for both the shareholders and the management. But why do companies do that?

Reasons

The reasons for value unlocking are many and it depends on the situation. I would like to list out few reasons.

1) To optimize the growth: Companies like ICICI and HDFC are private banking organizations and their extraordinary growth has lead them to expand their reach to every kind of business including banking, housing, securities and asset management while keeping the main business as their priority. Hence, the subsidiaries tend to under perform because of the lack of adequate focus on them and to optimize the long term growth companies tend to list their subsidiaries as separate business organizations.

2) Strategic Decision Making Process: Some companies start their subsidiaries and some companies buy their subsidiaries. But many companies lack the business or managerial expertise needed to give meaningful direction for the subsidiaries. Many companies go for acquisitions and if they keep the acquired business as it is, then it would prove to be futile. Very few companies actively determine how much of the group's profits should be generated by their main business against less profitable but faster-growing businesses with greater medium- and long-term potential, and what strategic moves they need to make in the short term to reach their goals.

Without more active management of the subsidiaries, most conglomerates end up with a business mix that is the result of past decisions rather than a strategic choice that makes sense for long-term success.

For example, many conglomerates still hold on to underperforming subsidiaries, preferring to subsidize their losses rather than scrapping them entirely from their portfolio. Compared with the management teams at the subsidiaries, executives at the parent companies often lack the industry-specific knowledge and managerial experience to exercise meaningful oversight. Without a proper dialogue with the subsidiaries, it is no wonder that most centers end up as simply consolidators of financial data. Hence, companies try to list their subsidiaries separately so that they can be administered by a professional management which will be helpful for better decision making process. When you do that, suddenly you tend to see the
under performing subsidiaries turning out to be the “Cash Cows”.

3) Better Execution: Perfect example for this is Reliance – RPL. Many large corporations do this for executing the important projects in a timely manner and once they complete the project they merge it back with the parent company.


What is in there for shareholders?

Value Unlocking is widely considered to be beneficial for the shareholders in the sense that the shareholders of the parent company might get some shares in the newly listed subsidiaries. In another way, some retail investors might not be interested in the business of parent company but they would be interested in the high growth subsidiaries and in such a scenario newly listed ones would be boon to them. Either way it is going to be beneficial. But in my view promoters and large investors stand to get benefited more than the retail investors in the whole process.

Why do companies go for it only during bull market?

Like everyone, companies or promoters also want to make hay while the sun shines. If they do it during the bear market, value will rather get locked. Hence, to get a better market value for the subsidiaries, they do it during the bull market.

Do we need to consider these things while investing for a long term?

You need to focus more on the present valuation of the company as a whole rather than their value unlocking potential in future which might or might not materialize. For example, I believe ICICI stock is pretty cheap at the current price and you will reap rich rewards in the future on the basis of parent company alone and if at all they are going to list their subsidiaries down the line, of course you will get benefited either through shares in the newly listed firm or through rights purchase. So, if you think about value unlocking while selecting stocks, then there is a greater chance, you will buy it over priced thinking that you will be compensated in the future and there is no guarantee for that. Hence, it is better to take a long term view based on the present valuation of the company rather than what is hidden.

I request the readers to share their views on this topic in the comments section.

Kumaran Seenivasan
Stockanalysisonline.com

7 comments:

mohd March 23, 2009 at 11:54 AM  

Hello sir
it is very short and to the point
discussion about value unlocking.
i enjoyed reading and understood concept of value unlocking. thank you for sharing with us. mohd umar

Mahesh March 23, 2009 at 11:11 PM  

Excellent delineation Kumaran.

Now we have to keep an eye on companies that are ready to list their subsidiaries :).

One question i want to ask is, when RPL and RIL merged what process do you guys call for that like the opposite one is called Value Un-locking.

Is merging of 2 listed companies benefit share holders ? and to whom others benefit for merging process. Why do they merge, doesn't it complicated? after merging.

Thank you.

Shabu's March 23, 2009 at 11:19 PM  

Nice again Mr Kumaran. Keep it up.

Anonymous,  March 24, 2009 at 1:08 AM  

Nice article..you have said .."investor should take long term view based on the present valuation of the company"..true to some extent..but we should also give importance to company's future growth potential..for example I invest in undervalued companies whose future growth potential is not considered in current valuations and sometimes their current balance sheet / P & L also do not reflect their revenues

Kumaran March 24, 2009 at 5:48 AM  

Thanks again for all your comments.

Mahesh, RIL has been doing this kind of strategy for a long time and the reason is to protect the parent company from the burden of project execution and also not to bring any debt to RIL balance sheets. Hence, once the new project gets over, they want to merge it now during this bear market so that RIL's balance sheet would become strong because of its size and also to save significant amount of money on the TAX front.So,shareholders and the management stand benefited with the added value.

Regarding the Anonymous comments,
what I meant was, consider the present valuation of parent company and the future value unlocking will anyway going to benefit you. That does not mean we should not look at the future of parent company. Certainly we have to be concerned about that. I just said not to be concerned about future value unlocking while selecting stocks. sO, CURRENT AND FUTURE POTENTIAL PARENT COMPANY is very important.

Chirag Ali,  October 25, 2009 at 6:17 PM  

Dear Kumaran

Nice article.I was little bit confused when analysits talk about value unlocking.Your post explains in a simple manner.

Thank you very much

Chirag Ali

Anonymous,  November 13, 2009 at 5:47 AM  

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Help, please. All recommend this program to effectively advertise on the Internet, this is the best program!

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