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burnrate00
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Posts: 20
Joined: July 3rd, 2015, 7:08 am

Holding discount

December 27th, 2016, 8:32 am

Hello! I am currently studying the market for corporate control and the types of discounts that are usually applied when valuing companies. An interesting one is the holding discount, which is a company-level discount applied to conglomerates. The rationale for this discount is that diversifying at company level is seen as non-optimal for investors, since they can diversify at portfolio-level at lower costs. My question is, is this always true? I mean, my idea is that if you diversify with stocks you may be missing diversification at business level, and economies that you can obtain only by putting companies together in the "real life" and not in a portfolio. How would you model that? 

Thanks! 
 
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DavidJN
Posts: 1750
Joined: July 14th, 2002, 3:00 am

Re: Holding discount

December 27th, 2016, 7:04 pm

You have identified a valid value trade-off regarding conglomerates: financial diversification that investors can surely achieve themselves more cheaply, versus operating synergies within conglomerates (e.g. shared services like HR, accounting, treasury) that investors cannot achieve on personal account. My sense is that outsourcing opportunities might attenuate the synergy argument to some extent, that might be a useful angle to look at.

There is another concept called the managerial incentive, namely, that conglomerate diversification makes management feel more secure about their jobs, presumably by making net operating results less volatile. There is a literature on this topic, you might look there for some modeling ideas. 

You might also find ideas looking at the Merger and Acquisition and Leveraged Buyout literature. My sense that it is driven by fee-seeking investment bankers who really don't care what happens afterwards. An example would be Mitt Romney, who extracted tons of fee money out of companies that ended up falling apart after he levered them up. 

Never forget the great Dilbert cartoon, where Catbert visits the Boss and announces "I am an investment banker. I can help you loot this place and escape!".
 
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burnrate00
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Posts: 20
Joined: July 3rd, 2015, 7:08 am

Re: Holding discount

December 28th, 2016, 8:10 am

Great! Thank you! This may be a good topic for my thesis and I am trying to understand if it is worth to look into.  My idea is to try to find a way to make the two strategies comparable, so that - under some simplifying hypotheses - managers can decide to step into an operation of this kind or not, based on the expected feedback of the market.  I thought about comparing the performance of an hypothetical portfolio to the one of a conglomerate and keep track of the impact in terms of diversification benefits of the different strategies: what happens when I add a stock of a certain company to my portfolio (well known and modeled)  and what happens if the conglomerate buys the company. I appreciate the fact that there are tons of variables that you may want to take into account when valuing an acquisition/ merger, so that it can be difficult to model. In addition, I believe that there would be some issues of comparability in terms of returns... I was thinking about a business return like ROC or ROE (since I am looking at equity side) and stock return. Also metrics are different: I am trying to compare the purchase of a whole company to the purchase of (possibly) a single stock.. Any advice is appreciated! 
 
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acastaldo
Posts: 1416
Joined: October 11th, 2002, 11:24 pm

Re: Holding discount

December 31st, 2016, 10:23 pm

You can find the Dilbert cartoon here:

https://books.google.com/books?id=tcawt ... &q&f=false
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