The holding company structure has for years been an immensely attractive option as a control strategy in building a Business Group with varied businesses under its belt. A pure holding company’s legal character was not a problem until regulation decided otherwise. While this probably forces a Hobson’s choice on such a holding company structure, the alternative of an using an operating company as a holding company, long an established reality in India, will see ‘renewed’ growth.
‘The market for corporate control’ sounds like an academic essay but is a pressing reality for some companies. There is this theory in investment which believes (and practices it) that investors seeking diversification will pursue different kinds of businesses to invest their monies. As a logical corollary, goes the argument, they will shun companies who hold, under a single legal entity, several businesses, forming what is called a conglomerate. And, extending the corollary further, such investors will apply a ‘discount’ to the ‘values’ of such conglomerates, because they prefer companies operating in one business.
In sum, the argument is that the capital market will seek diversification according to its own set of preferences. Hence the argument for ‘unlocking greater value’ by hiving off businesses from such a conglomerate to be pursued as separate businesses. India has never been a home to this theory dominated as it is by large conglomerates holding within itself multiple businesses.
Holding Company
One possible compromise is a holding company that is only an investment company, that is, a company which holds controlling stake in its operating companies but does not itself operate any business and remains private, not listed, thus preempting any attempt by anyone to wrest control. Yes, it cannot raise capital from the public, but has the advantage that it is not answerable every quarter to investors and analysts. In a growing conglomerate (most inevitably are), this, coupled with the regulatory regime, could become a problem, if not an obstacle.
For many years, there was no problem to such entities in India, but new regulations have posed problems for them forcing them into making a Hobson’s choice. How such holding companies navigate this cliff-hanger situation will hold lessons for other conglomerates. An outstanding book originally published in 1990 and later in 1993 – The transformation of corporate control by Neil Fligstein – opened a new way to understand the logic behind the holding company structure. According to Fligstein, it is not market forces but the state policy towards business that has shaped the holding company structure. How true it rings today!
The chief advantage of the holding company structure is that it is an efficient vehicle for control and direction, of the group and its constituent operating companies. If one single aspect must be singled out in this control and direction it is capital allocation. The late CEO of a large group saw capital allocation as his principal duty and function. Capital allocation is what we could call a composite function because it is a function which must necessarily consider several factors and objectives. It is an inherently political act as group entities have their own plans to pursue and each would claim they have the best chance of producing appropriate returns.
An unlisted holding company enjoys a degree of freedom in building new businesses and creating value in the long run. This is a tricky decision as the conglomerate consists of both listed and unlisted companies, with the former answerable to its own shareholders. On the other hand, there is a group strategy at play which inevitably involves balancing competing interests, which, in certain circumstances, may even mean sacrifice the rate of growth of some business, leading to a reduction in share price and thereby raising the cost of capital: the stock market spares no one. Since such a company is a separate company with its own shareholders it does create problems.
Operating company as a holding company
The alternative is to use one operating company as a holding company, a strategy that has been successfully practiced by Reliance Industries Limited (RIL), which has held within itself business completely different from its principal business (Retail, Fashion, Green Energy, Digital, Communications etc) and hiving them off at appropriate times to create value, not only for the hived off entity but also for itself as it can book a substantial gain in its books when that company hits the capital markets.
RIL has done it more than once but surely its biggest success is Jio, which has now become a huge business by itself. It has become as big a brand as RIL, having become a platform attracting substantial FDI and also spawning other businesses such Reliance Jio Infocomm (telecom network), Jio Mart (e-commerce), Jio Cinema (OTT streaming), Jio Saavn (music), Jio TV, Jio Money Haptik (AI chatbots), and Radisys (5G/telecom solutions) – Source – Wikipedia. Incidentally, Jio is arguably the biggest new business brand in India to emerge during the last twenty-odd years.
The key – sustained and robust cashflows; the anchor
The task is to zero in on the appropriate group company that can hold in its fold several unrelated businesses without facing a problem over its share price (for reasons mentioned above). And when you have a company that enjoys, largely and with minor spikes, robust and sustained cash flows, it is the perfect vehicle to be the holding company.
The challenge is communicating the potential of large gains accruing to existing (and future) shareholders when such ‘values’ created within are hived off as a separate entity at an appropriate time and working towards listing.
In the US, Amazon did this during the early days of the commercialization of the internet growing by acquiring new companies, paying with its stock and cash, because it managed to convince the Wall Street of its potential to be not just a success but a game changer. Although there were well known analysts who were completely skeptical of Amazon’s business, it remained a darling of Wall Street, and its stock price helped it in its acquisition strategy.
The task then is to choose that one group company which enjoys robust and sustained cashflows to hold several babies and communicate to investors of the soundness of its logic. Both strategies, the business strategy and the communication strategy must work together to produce the desired result.
Of one thing, we can be sure: the holding company structure is not going away.
