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In a bear market, real value counts

Posted by fairval on October 14, 2007

Last week’s events show investors put a large discount factor when incorporating subsidiary valuations into the parent

The stock market last week confirmed what this column wrote Monday week – the market was beginning to behave like a bubble. And true to form – when market needed a correction, the government supplied one. The market has close at lower circuit three times in this bull run – and every time because of a government or regulator pronouncement.

The way some individual scrips reacted last week may have taught a investors a few more lessons about share price valuation. When market fall like this, share prices of companies react differently, but there is nearly always a good relation to underlying fundamentals.

In this last phase of market rally, deal news was beginning to drive a few leading stocks. Some of these deflated last week all of sudde.

Reliance Energy (REL) fell 16% last Friday, when overall market fell only 2.5% or so. At Friday’s closing of Rs 1334, the stock is also down 32% from its peak of Rs 1959. Last week, we had written this stock had tripled from Rs 600 levels in a short time of a month of so. The buzz was that the stock would go to Rs 2500. This may have built a lot of speculative position in the stock, some of which may have been through the PN route.

Whether the stock is worth Rs 2000 or more is critically dependent on the success of Reliance Power IPO. In other words, the stand alone REL business is nowhere close to this kind of valuation. Falling markets create a time of uncertainty, and investors rush to discover rush to real value, rather than perceived value.

The task before the REL or Reliance Power management at this point would perhaps be to covert the perceived Reliance Power valuation to real valuation as early as possible. One way to do that could be to do a pre-IPO placement at the valuation the management wanted the IPO to happen at. If the market perceives that the ongoing market turmoil would lead to either an IPO postponement or a lower valuation, then the REL scrip would be hit further.

Hindustan Construction (HCC) was another scrip which had enjoyed a good run in recent weeks. It was able to weather the storm last week somewhat better since it managed to announce an external investment in its Lavasa Corpoation, a real estate subsidiary of HCC, which is housed in a subsi. On Thursday last, the company announced that Deutsche Bank picked 5% stake for Rs 500 crore, valuing the project at Rs 10000 crore. HCC reportedly has a 65% stake in Lavasa Corp; the stake thus can be valued at Rs 6500 crore. HCC still 8.7% down at around Rs 171.6 on Friday. It is down 18% from its peak of Rs 209. It valuation currently is Rs 4400 crore. So technically, the stock still has an upside. This shows how investors still put quite a discount factor when incorporating subsidiary valuations into the parent, even when a basis for valuation is clearly established.

There was deal news from Aban last week. It announced plans to go ahead with an IPO of its subsidiary Aban Singapore last Friday. Aban plans to offload 13-15% for $500mn, giving the subsidiary a valuation of around $3.5bn. Aban’s own market cap currently is around $3.8bn. This means the subsidiary is potentially a good 75% or so of the parent valuation. Perhaps influenced by this announcement, the stock fell only 4% or so on Friday. Aban’s share price at Friday closing was Rs 3882, down 11% from its peak of Rs 4359.

If the market remains bearish in the next few months, companies may need to look at establishing subsidiary value on an urgent basis. In a bearish scenario, stock prices need a strong basis for support. If stand alone fundamentals don’t give it, then perhaps a clearly established subsidiary valuation can serve that purpose to some extent.

But finally, there is no substitute for valuation based on earnings of the parent listed company. Infosys for example stood firm on Friday, and was indeed up 1%. Having been beaten down earlier, it is perhaps now at levels where clear value from fundamentals, and not from some iffy subsidiary type value drivers.

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