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Conglomerate discount wasn’t a concept that I was that familiar with. Conglomerates had gone out of style in the west during the 1960s to the 1990s.
Western conglomerates
Classic conglomerate examples would be
- GEC
- ITT
- Litton Industries
- Lonhro
- Teledyne
- Textron
Spivs and financiers bought in and broke them up into their constituent parts. Or a new CEO would do it themselves to focus on core competencies and release value for shareholders.
Conglomerate discount
A conglomerate discount is when the stock market values a diversified group of businesses and assets at less than the sum of its parts. This is because investors are worried about the management not being able to focus on improving the operational performance and figuring out a coherent strategic direction.
Taking advantage of a conglomerate discount
So our spiv financier could borrow money, buy the company at a discount. Sell off parts to pay off the loan and be left with more money than they initially had to borrow. Many of the constituent companies couldn’t be sold quickly as a going concern. Instead they were shut, machines sold for scrap and their factory land sold for redevelopment.
Asian conglomerates
Asian business people, especially those running Hong Kong and Chinese companies don’t view conglomerates in quite the same way.
The Li family manage two publicly listed companies in Hong Kong. They came out of the merger of Cheung Kong Holdings and Hutchison Whampoa.
Cheung Kong
Cheung Kong Industries was formed in the 1950s as a plastic flower manufacturer during the post-war industrialisation of Hong Kong. It evolved into a property investment company after the 1967 riots and Cheung Kong Holdings was established in 1971. Over the next decades it became one of Hong Kong’s largest developers and land owners.
In 2015, the group went under a reorganisation, the groups property assets were spun off into what is now CK Asset Holdings.
Hutchison Whampoa
Hutchison Whampoa was bought in 1979. HSBC had a strategic holding in the company and sold that on to Cheung Kong. They also provided Cheung Kong with the loan to make the purchase. In 2015, Cheung Kong bought the parts of Hutchison Whampoa that it didn’t already own. It eventually became CK Hutchison Holdings, incorporating all the non-property aspects of the Cheung Kong – Hutchison Whampoa combine.
In addition, the Li family have some of the shares in businesses that they own held in the Li Ka shing Foundation (LKSF).
CK Hutchison and CK Asset Holdings
CK Hutchison Holdings and CK Asset Holdings both trade at a conglomerate discount. However, the Li family has a controlling share in them. This probably explains why they haven’t come under attack by an activist shareholder from within China or abroad.
In his article for Apple Daily Yeung Wai-hong explains how the Li family uses the concept of conglomerate discount to their advantage.
The CK Hutchison Holdings and CK Asset Holdings creation allowed shareholders to see clearly delineated businesses. One focused on property, the other one on non-property assets in 2015.
CK Asset Holdings started to blur the lines buying into businesses that more sensibly fit into CK Hutchison Holdings – aircraft leasing, pubs and utilities. Creating conditions for a conglomerate discount that is disadvantageous to non-family shareholders. The bigger business has a larger turnover. Even if the profit margin is lower, management still have an excuse to raise their salary and benefits.
CK Asset Holdings has a large amount of cash on hand indicating a lack of investment opportunities. Recently CK Asset Holdings bought shares in utilities from LKSF in exchange for shares in CK Asset Holdings.
I’ll let Yeung Wai-hong explain the next bit
…CK Asset promised to buy back shares equivalent to the amount of HK$17 billion and cancel them. Whether the equity will be diluted is up to the minority shareholders. If they do not accept buyback, their equity will be diluted; if they do, then it won’t. The buyback price is about 10% more than the average share price of CK Asset, so the minority shareholders do have a chance to cash in at a “high price.” However, the buyback price of HK$51 per share is only 53% of the net asset value after deducting the debt. So accepting the buyback is like allowing Li’s family to grab a bargain at half price.
Conglomerate discount by Yeung Wai-hong, Apple Daily Hong Kong (March 29, 2021)
If that happened outside Hong Kong there would be shareholder class action suits. The theory goes that these trades slowly put the squeeze on minority shareholders at a discount. Transferring value to the Li family. Eventually allowing for a gradual privatisation of the business at the expense of retail shareholders.
Once this has been done the value of the assets at their full price can be realised. More finance related content here.