A very common business structure used across the world for business control and management is that of Holding Companies. Business Promoter Groups hold shareholding interest in entities through the process of intercompany shareholding, everything finally rising to the top into a company which is called the ultimate Holding Company of that Business Group.
The purpose of this article is not financial analysis but to attempt to understand the reasons for variations and what could be the takeaways for corporate businesses.
These Holding Companies could have reporting entities (mainly subsidiaries) on a geographical basis (subsidiaries overseas) or on different business basis (national or international).
The writer analysed ten entities which have standalone businesses and investments in subsidiaries / joint ventures / associates. For the purpose of further discussion, two entities were dropped – one had losses and the other had negative working capital. The remaining eight entities are:
1. Infosys Ltd.;
2. Hindustan Unilever Ltd.;
3. Tata Chemicals Ltd.;
4. WIPRO Ltd.;
5. Tata Consumer Products Ltd.;
6. Maruti Suzuki Ltd.;
7. Godrej Consumer Products Ltd.;
8. Dr. Reddy’s Labs Ltd.
These entities were analysed for six Key High-Level Ratios at Standalone Business and Consolidated Financials basis:
a) Net Profit Before Tax to Total Revenue – as %;
b) Earnings before Interest and Tax (EBIT) to Total Revenue – as %;
c) Earnings before Interest, Depreciation, Amortisation and Tax (EBITDA) to Total Revenue – as %;
d) Return on Capital Employed – as % of EBIT divided by Capital Employed;
e) Turnover of Capital Employed – Number of Times Capital Employed is turned to get Total Revenue on annualised basis;
f) Working Capital Turnover – Number of times Working Capital is turned to get Total Revenue on annualised basis.
In ratios (a) to (d) above, the higher percentage is better and in the last two turnover ratios, a higher number of times indicates improved efficiency. For all eight companies, a comparison of the ratios at standalone and consolidated entity were done and the following were the results.
Findings from the ratios:
1) In two specific companies all six ratios at the Consolidated Financials stage were lower than at standalone stage;
2) In four companies, five ratios at CFS were lower than standalone entities;
3) In one company, four ratios at CFS were lower than standalone entity;
4) In one company, two ratios at CFS were lower than standalone entity – it was the only case where consolidated financials could be said to be stronger than standalone financials.
Clearly, the performance of the satellite units is NOT adding value to the standalone Holding Company.
The questions that one needs to ask are:
(a) Through the process of creating multiple subsidiaries, are we losing supervision of performance and management control on the business? This is a serious issue at the stage that India is – since inefficiency of Financial / HR / Management resources results in less than optimum performance;
(b) The Holding Company for whatever reasons – emotional on retaining / nurturing businesses or improper analysis of business study – thereby holding on to companies / businesses that it should legitimately divest;
(c) Is the financial reporting of business performance of a good quality so the right red flags are raised, or do matters suddenly blow up and management is left wondering what could have gone amiss;
(d) Are subsidiaries allowed a free run, with inadequate supervision or manned by a management cadre which is not up to the task? Are there no demands of performance on them since the subsidiaries are small businesses, not paid much attention to;
(e) Is there excessive management focus on holding company standalone businesses and the focus on other related entities is much less, resulting in great surprises when things go wrong.
Whatever may be the reasons, the recent IL&FS and DHFL cases have shown the need for much superior monitoring of conglomerate structures. Often, many skeletons start coming out of the closet on a trigger event occurring and they impact the ultimate Holding Company. There is no doubt that Boards of Directors, Auditors, Rating agencies, Capital markets (mainly minority shareholders) have been stung by these two cases. The need to focus on Consolidated Financials Statements is being felt stronger than ever before. CFS is no longer an accounting exercise devoid of practical applications.
One way of improving Indian corporate efficiency is ensuring that the variation in performance parameters in standalone and consolidated financials is not too significant to create cause for concern. In the eight companies forming part of this study, the variations were quite significant, reflecting the need for tighter management review and control.
It is my opinion that all companies which are listed Holding Companies and entities which are not listed but have a certain large size on Total Revenues and / or Net Worth, must have the following done for their fulfilment of legal requirements:
1) Look at the possibility of Holding Company dividends being considered not at standalone entity level but at consolidated financials level so that there is proper emphasis on performance and linking the same with dividends payouts;
2) Managerial remuneration under the Companies Act MUST BE guided not by standalone entity performance but by Holding Company (CFS) level performance.
There is reason to believe that both the above actions will force Promoter Groups to focus on overall performance rather than on standalone performance.
Note – The author wishes to thank the professionals that he has connected with for the purpose of clarifications on the subject of this Article.
