Equitas Holdings on Monday posted one of its steepest single-day fall after the market regulator, Securities and Exchange Board of India (Sebi), rejected the proposal to list its small finance banking (SFB) arm without an initial public offering (IPO).
The shares ended the session nearly 13 per cent lower at Rs 102 as analysts slashed price targets for the stock, citing so-called “holding company (holdco) discount".
To comply with the Reserve Bank of India's (RBI's) guidelines, the company has to list Equitas Small Finance Bank by March next year. Equitas Holdings had approached the regulator with a scheme of arrangements, proposing to hive off and list the SFB, which is its fully-owned subsidiary.
The proposal was turned down by the Sebi as it wasn’t in compliance with a circular on ‘scheme of arrangements’. Instead of re-drafting the scheme of arrangements, Equitas Holdings said it will soon initiate the IPO process and get the SFB listed before the end of the financial year.
The IPO plan, analysts said, caught investors off guard; it would entail a deeper holding company (holdco) discount for Equitas Holding.
Investec Securities slashed the price target on the stock from Rs 190 to Rs 140, saying the “holdco discount to be applied on a larger stake".
Had Sebi approved the listing without an IPO proposal, Equitas Holding would have ended up with a 53 per cent stake in Equitas SFB.
In the IPO, Equitas Holding is likely to dilute just 10 per cent as there is no immediate capital requirement. Therefore, the holdco discount will be on the 90 per cent stake, instead of the earlier projection of 53 per cent.
Why holdco discount?
Holdco discount essentially means that the mark-to-market value of the subsidiary doesn’t get fully reflected in the valuation of the holding company. There are several listed companies with a holding company structure. Some of them are Grasim Industries, Larsen and Toubro (L&T), and Mahindra & Mahindra (M&M). To illustrate: The current market cap of Grasim Industries is only Rs 47,115 crore, even as the value of its 60 per cent stake in Ultratech Cement is valued at Rs 66,000 crore. Similarly, L&T’s market cap doesn’t fully reflect the value of its stake in the three listed arms — L&T Infotech, L&T Finance Holding, and L&T Technology Services.
So why is there a holdo discount in the first place? Essentially, the Street applies the discount as the holding company has no direct control over the cash flows and dividends of the subsidiary. Also, the dividend paid by the subsidiary doesn’t entirely reach the parent due to taxes. There is no thumb rule for the exact the holdco discount. It keeps varying on underlying factors, such as the nature of business and the dividend payout policy.
Holdco discount in the case of Equitas
Analysts said the Street could assign Equitas Holdings a similar holdco discount as IDFC Ltd, which is the holding company for IDFC First Bank. “There are two reasons for a holdco discount — dividend tax leakage and capital allocation concerns. None of these exists in the case of Equitas Holdings given it will own 90 per cent stake in the bank, and the bank is unlikely to distribute earnings in the near term. In the absence of any fundamental reason, the market looks to surrogates, and IDFC, with about 50 per cent holdco discount, becomes a benchmark,” wrote Investec analysts Nidhesh Jain and Utsav Gogirwar in a note.
Kotak Institutional Equities in a note said the concerns over holdco discount in the case of Equitas Holdings are unfounded.
“In our view, the progress in resolving these issues is encouraging, though not in the most efficient way as there would be two companies listed for the same business... The recent news flow regarding the listing of the bank has been a dampener for stock performance given concerns about a possible holding company discount—we believe the concerns are not justified in view of a negligible erosion of value, if any,” Kotak analysts wrote in a note.