Investing in a holding company? Read this first

Some industries(banks/infrastructure) have predominantly listed holding companies due to legal/contractual requirements, while others(conglomerates, MNCs) prefer it to encourage managerial autonomy, ascertain market valuation, ensure ease of divestiture, and ring fence other companies in the group from any one unit's bankruptcy. Whatever be the reason, investors should note the following points before investing in holding companies

1. Greater risk of fraud:- Forget management fraud, even employee fraud is difficult to track across so many companies. And if the operating subsidiaries have different auditors, then the resultant coordination problems may render fraud more hard to detect
2. Upstreaming of cash/assets may not happen:- Consolidated accounts implicitly assume that the subsidiaries/affiliates can upstream/side stream cash among themselves. If anything happens to restrict this free flow, then the value may fall(for example exchange restrictions). Watch for this disclosure in the company's annual report(s)
3. Subordination of debt to the subsidiary creditors:- Unless the subsidiary itself guarantees the parent debt, the holding company creditors will find themselves subordinated to the subsidiary's creditors/counterparties in case of insolvency proceedings. Note the disclosures in this regard.

Being cognizant of these risks, more holding companies(especially banks) try to raise capital locally, have their subsidiaries guarantee their share of parent debt, and use transfer pricing as a tool to upstream dividends in the guise of interest, fees, royalties etc.