Holding companies, interesting investment plays

Investment in holding companies makes for an interesting play. It offers some great arbitrage opportunities. Here is how - holding companies are usually pure investment vehicles that hold shares in either the group's flagship company, or investments in a host of other listed/non-listed group companies. An article in Outlook money explains this well. Here's a excerpt from the article:

A holding company can be a pure shell company with investments in one asset block or in many. For instance, Vardhman Spinning, the holding company of Mahavir Spinning, has no manufacturing business of its own; it owns 10.2 million shares in Mahavir Spinning. Then there’s UB Holdings, which transferred its beer business to a subsidiary, United Breweries, and now holds 48 per cent equity stake in McDowell’s, and 100 per cent in Kingfisher Airlines and UB City. A similar story is seen in KojamFinvest, the holding company for the Nicholas Piramal group.

In India, such holding companies are valueed at deep discount to their real market value. The discount is as high as 65-70 per cent. But, if one were to monitor the twins (ie. the market value of the holding company vis-a-vis the market value of its holdings) there can be a case for an arbitrage play.

The arbitrage should, however, be done with the assumption that the "upper limit" for the holding company is around 30-35 per cent of the mkt value of the underlying holdings. Thus, any deviation from this on the lower side can be used as an opportunity. I've listed down example of two such cases in which i've been trading in the last one year, with reasonably good success.

Case 1 - Morarka Finance.

The company is a holding company of Dwarikesh Sugar Industries Ltd (DSIL). It holds 2,348,818 shares or a 15.1 per cent stake in DSIL. At current prices (Rs.257 as on 31-Mar-06), DSIL is valued at Rs.400 crore. Value of Morarka Finance' holding in DSIL thus comes to around Rs.60 crore (15% of Rs.400 crore). Given that holding companies in India are valued at 30-35 per cent of their true market value, Morarka Finance should be valued at Rs.18-20 crore. But, at Rs.30.5 per share, Morarka Finance's mcap is only Rs.13.5 crore. Morarka Finance shares therefore seem to be undervalued to the extent of 33-48 per cent.

Disclosure: I've an open position in Morarka Finance (bought day before yesterday @ Rs.30.5). I intend to sell it once the arbitrage is no longer available. ie, when, - 0.3 * Value of Morarka Finance' holding = Mcap of Morarka Finance.

Case 2: SRF Polymers.

SRF Polymers is a holding company of SRF Ltd. The company holds 36.5% stake in SRF directly and through its 100% subsidiary - SRF Polymer Investments Pvt. Ltd. At Rs.331 per share, market capitalisation of SRF Ltd. comes to Rs.2,142 crore. Value of SRF Polymers holding thus comes to around Rs.781 crore. Thus, the approximate the market value of SRF Polymers should be in the range of Rs.234-274 crore (30-35% of true market value). But, at current prices (Rs.214), SRF polymer shares are quoting at a mcap of Rs.140 crore. Clearly, there seems to be an upside of 67-92 per cent from current levels.

Disclosure: I do not hold any shares in SRF Polymers. I tried buying them in the last two trading sessions, but unfortunately the damn thing was stuck at the 5% upper circuit. Hope to get in on Monday.

There are many such other companies listed on the bourses. However, I've restricted myself to these two. Some of the other companies include - Zuari Industries, Vindhya Telelinks, UB Holdings, Nahar group companies, Winsome Textiles Industries, Shree Rajasthan Syntex and Shree Rajasthan Texchem, etc. Investors are advised to do a thorough study before taking any investment calls made out on this or for that matter any other blog.

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Any contrary views on this style of investing ?

Happy investing.