Public Bank Bhd's (PBB) acquisition of a 44.15 per cent stake in insurer LPI Capital Bhd (LPI) for RM1.72 billion is expected to boost earnings of the country's third-largest banking group by assets. This would make LPI a subsidiary of PBB, as PBB will be able to exert management control over LPI.
PBB got the stake in LPI at a bargain compared to the market price of LPI. PBB is paying RM9.80 for a share that was last traded at RM13.00 before the announcement—a 24.6 per cent discount.
The second positive for PBB is that the acquisition would allow PBB to offer a broader range of complementary financial services, establishing a stronger presence in the country's general insurance market, which is expected to be value-accretive for the enlarged group—a universal banking model of sorts.
There are concerns about a plan by the late bank founder Tan Sri Teh Hong Piow's family to reduce their stake in PBB to 10 per cent via a restricted offer for sale (ROFS) of about 2.6 billion shares, which could potentially lead to a share overhang. But this is expected to be done over five years, and as such, the immediate impact may not be as significant.
The question then is why was there a muted response of the share price of PBB to the deal?
It could possibly be due to elements of the holding company discount.
PBB is now a holding company. Investors who want to invest in PBB as a banking pure-play will soon not be able to do so, as every investment in PBB will involve an investment in its LPI subsidiary.
The slightly better share price performance of LPI after the announcement of the deal is probably also due to the fact that LPI continues to be an insurance pure play company.
The Holding Company Discount
The "holding company discount" is a phenomenon where the stock of a holding company—one that owns stakes in other companies—is valued by the market at a price lower than the sum of its parts, or the combined market values of its individual subsidiaries or investments. This discrepancy between the aggregate value of the subsidiaries and the stock price of the holding company is commonly referred to as the holding company discount.
The concept of the holding company discount is particularly relevant for investors because it shapes their investment preferences, often inclining them toward "pure play" companies—those that are focused on a single line of business—over diversified holding companies.
Why Investors Prefer Pure Play Companies
In contrast to holding companies, pure-play companies focus on a single industry or line of business, offering investors a "clean" way to gain exposure to a specific market without the additional complications associated with a diversified structure.
Greater Transparency and Simplicity
Pure-play companies typically operate in a single line of business, making it easier for investors to understand their business models, financial performance, and competitive positioning. This transparency allows investors to evaluate the company's value with greater confidence, reducing the risk of hidden liabilities or operational inefficiencies.
Focused Strategy and Management
Pure-play companies generally have a more straightforward strategic direction, which can lead to more efficient operations and better management focus. Management is fully dedicated to optimizing one business, which often leads to more prudent and effective decision-making. In contrast, holding companies may lack this focus as their management divides attention among multiple industries or sectors.
Higher Valuation Multiples
Pure-play companies often attract higher valuation multiples because they represent a focused bet on a specific sector, making them more attractive to investors who want exposure to that sector's growth potential. Investors are more likely to assign a premium to pure-play companies that are market leaders or show strong growth potential in a particular industry. By contrast, holding companies can trade at a discount due to their diversification, which investors may see as a dilution of potential returns.
Clearer Performance Benchmarking
With a pure-play company, it's easier to benchmark performance against industry peers, which helps investors track how well the company is performing. For instance, an investor in a pure-play renewable energy company can directly compare it to other renewable energy companies, making it easier to gauge whether the investment is paying off. For holding companies, by contrast, performance metrics can be complicated by differing industries and business cycles, making direct comparison challenging.
Higher Liquidity and Lower Risk Perception
In many cases, investors perceive pure-play companies as more liquid and less risky due to their simplicity and straightforward revenue generation model. This perception is particularly appealing to institutional investors, who prefer liquid investments that can be bought and sold with ease. The straightforward business model of a pure play company also mitigates risks associated with internal capital allocation decisions and operational complexities, making them attractive for investors looking to minimize hidden risks.
The Drawbacks of Pure Plays and Holding Company Discount Implications
While pure-play companies are often preferred by investors, they aren't without their drawbacks. For example, pure plays are generally more exposed to sector-specific risks, as they lack the diversification benefit of a holding company. A downturn in a single industry could have a more profound effect on a pure-play company than on a holding company with interests across different sectors.
Yet, despite this risk, investors frequently find pure-play investments more appealing because the risks are easier to understand and manage. Investors would rather control their own diversification through a portfolio of pure-play stocks than invest in a holding company that undertakes diversification on their behalf.
The holding company discount is a well-recognized market phenomenon that results from a combination of factors, including complexity, governance issues, and perceived capital allocation inefficiencies. While holding companies provide a measure of diversification, they also introduce risks and complexities that many investors would rather avoid.
In contrast, pure-play companies' simplicity, transparency, and focused business models make them more attractive, especially for investors looking for direct exposure to a specific industry or asset class. By investing in pure-play companies, investors can maintain greater control over their portfolios, avoid the hidden pitfalls of complex holding structures, and often benefit from higher valuation multiples.