Quick Thoughts on Holding Companies and Conglomerates Trading at "Discounts"

Why do holding companies and conglomerates usually trade at discounts? Straight up - the market is correct in valuing these at large discounts to NAVs. Not irrational! Primarily, these discounts exist because insiders control the voting shares or majority of shares.

Recently, Liberty Media, the owner of $FWONA, $LSXMA and $BATRA re-attributed a lot of cash and its liquid investments in $LYV from $LSXMK to $FWONK and $FWONK to $LSXMA, respectively, and gave LSXM stake in BATR and FWON. Confusing, right? Complexity Discount!

Debatable who got better deal, but this transaction would‘ve never been approved, had John Malone and Greg Maffei not control the board. Even when both Diller and Malone are anti-conglomerate and known for unlocking value, their cos. trade at discount. Imbecility Discount!

In 2020, $BRK, the Warren Buffett Conglomerate did ~$25Bn in FCF from operating businesses, annually. The company had $337Bn in cash and liquid investments. The market cap was ~420Bn. The market was assigning ~4x earnings multiple to its businesses. Reinvestment Risk Discount!

There are many reasons for lower multiple, including low ROIC and reinvestment opportunities, size, and Buffett’s age. But there continues to be another reason - once Buffett was asked whether there is a chance of activist involvement in $BRK, and he said “They (Activists) won’t win.” Buffett and his allies control the board, and are the only authority. This is deemed risky, and the perception of risk is part of many variables that drive market caps. Buffett did not buyback stock during Covid-19 crash; no shareholder liked it, but they can’t do much. Intractability Discount!

Frank Stronach controlled $MGA; he charged huge sums as consulting fee, from the co., short-changing equity holders. The stock gained a lot when he was de-throned. Ethic Discount!

But sometimes, even in not so great companies, the discounts are not usually because of unethical management; discounts exist because shareholders don’t expect management to unlock value because of either inertia or lack of will. Zeal Discount!

Sometimes, shareholders misunderstand the discounts because the cash moves between businesses, making them actually solid, but when the management doesn't communicate well, they languish at "discounts”. If you can't unlock maximum value, “full” NAV is irrelevant.

A good example of that is Bajaj Holdings and Investment Limited in India. BHIL has no debt and owns quality businesses like Bajaj Auto and Bajaj Finance. While the underlying businesses sometimes sell between ~25x and ~50x earnings, the holding company in May 2020 traded at a 50% discount/NAV. The management has 49% stake in BHIL, and it has never communicated how it plans to close this discount, even when the company has compounded shareholder wealth at >20% CAGR. I don’t think they plan to do so ever. Communication Discount!

But sometimes, these holding and capital structures help management focus and stave off activism that may damage the business’s long term value. It’s better to trust those who’ve rarely short-changed shareholders, or look somewhere else. Sceptic Discount!

SOTP? It’s worth a glance, but thinking we would realize the full value of underlying businesses is a fantasy. It is best to look at the management track record and discounts to NAV over very long periods in context of assets held. It’s somewhat monotonous work.

What are we betting on? We just can’t add up a few numbers, and hope to always make a killing. We’re betting on the fact that divergence would somewhat get wider during bear and narrower during bull markets or even reverse, and analyzing which part offers the most upside.

Discount, what? Thinking of divergences as “discounts” is fool hardy. This is not a Walmart sale. This is stock market. The more naïve you get, the easier you’re creamed. These are very real prices, and even values. Just adding/subtracting and believing the market is inefficient after reading/quoting Warren Buffett will mess one up. I’ve learned it’s better to only buy if you are confident in the stability/growth/value of the underlying assets. ✌🏼

The original post was written here in the form of a Twitter thread in May 2020.