What does the new SEBI order mean for holding company stocks?

Market regulator SEBI has stepped in to iron out the kinks of investing in holding company stocks. Raising red flags on holding companies' steep discounts to their underlying equity investments, the regulator announced on June 21, 2024 that it will introduce a mechanism of special call auctions to allow fair price discovery of holding company stocks.

What it means

In India, holding company stocks can be seen trading at sharp discounts of 70-80 per cent to their book value (underlying investments). The steep undervaluation is on account of several drawbacks that come with investing in holding companies like high taxation and illiquid nature of underlying investments. The reasons are explained in detail in this story .

Such sharp discounts have deterred investors from investing in holding company stocks, which can be ascertained from their low trading volumes. In SEBI's words, the sharp variance is 'adversely affecting liquidity, fair price discovery and overall interest of investors in such companies'. Hence, realising the illiquidity of holding company stocks, the regulator is seeking to narrow their wide discounts to increase investor participation and unlock value.

For this, it has mandated that stock exchanges conduct annual special call auctions without any price bands (upper and lower circuits) for holding companies from October, 2024. For the uninitiated, a call auction is a process where buyers and sellers submit their prices for a stock, and trades happen at a set time based on the best prices that match up. Call auctions are held for illiquid stocks, providing them an organised and controlled trading environment to enable price discovery with limited volatility.

The announcement led to a sharp outperformance of holding company stocks on Monday, June 24 as investors hoped to offload the shares during the special call session at higher prices. See table titled 'On the front foot'.

Which holding companies will be traded in special auctions?

The regulator has laid out certain criteria that holding companies must meet in order to trade in the special call auction:

• The company must fall under the holding or investment company segment in the uniform industry classifications provided by stock exchanges. The list includes 72 stocks in total.
  
• The company should have been listed and available for trading for at least one year, without being suspended.
  
• The company's listed equity investments should constitute at least 50 per cent of its total assets.
  
• The company's six-month volume weighted average price (VWAP) should be less than 50 per cent of its book value. Simply put, the company's discount to its book value should at least be 50 per cent. This will ensure only companies that have a deep discount to their holdings will be considered for this exercise and not the ones that already are valued close to what their investments are worth. Take for instance Tata Investment Corp, which meets the above three criterias, but its six-month VWAP is Rs 5,956 with a book value of Rs 5,922, thus, not meeting this particular criteria.

Investor's takeaway

We believe that the development will likely narrow discounts of holding stocks even before the special auctions are undertaken. The sudden spike in shares of these companies on June 24 attests to this. That said, investors must carefully examine the given criteria to identify a holding company, which will be eligible for trading in the auction. This is important as many holding company stocks, like Bombay Burmah Trading Co , whose key holding is Britannia , may not necessarily fall under the industry classification list or meet the other criteria.

Also read: You may gain from this chemical manufacturer despite expensive valuations