When reasons defy reality! How DVRs, hold cos create opportunities for you

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When reasons defy reality! How DVRs, hold cos create opportunities for you


The concept of DVR (differential voting rights) deep discount is one of the myriad inexplicable mysteries in the markets that evade rationale. Financial markets are a fuzzy place. Not everything about them is logical. Though they revolve around concrete numbers, the orbits on which they run can be outrageously off the mark from anything rational.

There are many such wild spots that are beyond the realm of reasons. The most prominent places where such anomaly shows up are in the quantum of discounts in the case of DVR shares (to their regular shares) and in the case of holding company shares vis-a-vis their underlying subsidiary units, namely holding company (hold-co) discounts.

In India, DVR shareholders are entitled to one-tenth of voting rights, while they are eligible to receive 5 per cent more dividend than investors in ordinary shares. As a result of this, differential voting rights trade at a discount to their regular shares in terms of valuation. That much is understandable.

But much like anything else in the markets, the discounts run all over the place without any semblance of logic. But there is a method to this madness, at least in global markets. In developed markets like the US and Europe, the discount varies from 5 per cent to 10 per cent, while in Asia, they are in the 15-20 per cent range. Back home, it is only madness, no method.

In the last six years, if one looks at the discount that some of the DVR shares are enjoying, there has seen a sharp surge to as high as 60 per cent plus from the lows of 20 per cent plus without any rationale.

Here is a live chart of Tata Motors DVR shares.

ET CONTRIBUTORS

In this chart, we have plotted the discount for last six years since 2014. While it is seemingly all over the place, is there any underlying pattern that one can pick from the plot? The only pattern that one can decipher in this irrational dance of discount is that it tends to widen when the underlying regular stock is on a retreat (medium-term downtrend) and the same tends to narrow when the regular stock is on an uptrend.

Beyond that, one runs out of reason. That does not mean this pattern is of no value. It does provide an arbitrage opportunity in the DVR shares to savvy investors, especially when the cycle is about to turn in the regular shares. In such times, DVRs provide the double kicker (in returns), one from the turnaround of the underlying stock and another from the narrowing discount. We may be in such times in the Tata Motors stock now, though not certain.

Moving beyond DVR disconnect, another area where reasons defy reality is in holding-company discounts (when both the parent and subsidiary units are listed). If one goes by economic ownership, there is no reason for any holding company discount except for the tax differential (to adjust for the tax on cashout from listed subsidiaries like DDT etc.). But in reality, holding-company discounts go all the way to 60-70 per cent-plus in many cases, much in excess of the DDT or any other corporate tax in lieu of that.

That much for the so-called rationality in the market. As in the case of DVR shares, hold-co discounts widen or narrow based on the prospects of the underlying business, thus providing special situation opportunities for seasoned investors.

Watch out for the narrowing discounts in stocks like IDFC and Equitas (both are holding companies) in the next turns in the underlying banks (many more such opportunities in the universe). More so, with the RBI’s recent proposal to allow promoter groups to exit holding company structures if they do not have any other group entities. Looks like ample opportunities await arbitragers there!

(ArunaGiri N is Founder CEO & Fund Manager at TrustLine Holdings. Views are his own)





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