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Reaping what they had sown

Many companies are planning to divest their stakes in unlisted subsidiaries and associate companies. Here's how such moves could affect shareholders.

R. Sree Ram        Print Edition: May, 2010

When HDFC indicated its plans on March 26 to divest its stake in the unlisted subsidiaries that are not part of its core business, the stock went into a tizzy. Over the next 10 trading sessions, it rose 8.1 per cent to a 52-week high of Rs 2,853. During the same period, the Sensex rose by a marginal 1.2 per cent.

The reason for the surge in investor interest is obvious: selling the unlisted businesses will unlock value for HDFC. The move will boost the company's profit as these investments are currently quoted at historical values in account books. HDFC's investment in non-core businesses is Rs 363 crore, while analysts peg the value at Rs 1,800 crore.

Over the years, several companies have diversified into non-core businesses. With private investors eliciting an interest in these businesses, the parent companies are looking to offload their stakes. Though the valuation of unlisted firms is tricky and estimates could vary greatly depending on the methods used to calculate, the improved investing environment is likely to help them fetch a good price.

Listing of subsidiaries
The next big trigger for the companies that have diversified investments is likely to be the divesting of their stakes or listing of associate firms. Companies such as HDFC, ICICI Bank, SBI, Kotak Mahindra, Aditya Birla Nuvo and Reliance Capital have promoted insurance, mutual funds and broking ventures, which are not yet listed. After 10 years of starting operations, most private sector insurance companies are either making profits or are close to breaking even. General insurance companies turned profitable a couple of years ago, while life insurance firms are improving their profitability.

The listing of insurance ventures is expected to result in a substantial creation of investor wealth. The existing shareholders will benefit as higher value will accrue from the issuance of proportionate new shares or an increase in the holding value.

Analysts believe HDFC might list its life insurance business in the next one year. "The HDFC management expects that the listing of HDFC Standard Life in the next 12 months and transfer of strategic stakes in non-subsidiaries and associate companies to a separate company will help the HDFC group in unlocking value from investments that have been made over the past 8-10 years," say CLSA analysts Aashish Agarwal and Prakhar Sharma.

Boost to SOTP values
The sum of the parts (SOTP) valuation method looks at each business of a company separately and assigns a value to it. These are then added up to calculate the total value of the company. In the past six months, the improving business environment has led to a substantial jump in the value of the subsidiary and associate companies.

For instance, the valuations of the insurance ventures of SBI, HDFC and ICICI Bank have jumped 40-72 per cent in the past one year. Life insurance businesses currently contribute 5-50 per cent of SOTP values to the companies' share prices. The values are expected to rise further as most of the firms are through with the investment phase and are now on the verge of breaking even.

Selling the stakes or listing the associate companies is expected to give a boost to SOTP valuations, which, in turn, can act as a positive trigger for the stock prices. However, investors should remember that crossing the regulatory hurdles could take considerable time. So, they should invest in these stocks only if they can hold for the long term, that is, at least for two years.

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