Holdings in Other Firms

            Given that the holdings in other firms can accounted for in three different ways, how do you deal with each type of holding in valuation? The best way to deal with each of them is exactly the same. You would value the equity in each holding separately and estimate the value of the proportional holding. This would then be added on to the value of the equity of the parent company. Thus, to value a firm with minority holdings in three other firms, you would value the equity in each of these firms, take the percent share of the equity in each and add it to the value of equity in the parent company.

            When income statements are consolidated, you would first need to strip the income, assets and debt of the subsidiary from the parent companyÕs financials before you do any of the above. If you do not do so, you will double count the value of the subsidiary.

            Why, you might ask, do we not value the consolidated firm? You could, and in some cases because of the absence of information, you might have to. The reason we would suggest separate valuations is that the parent and the subsidiaries may have very different characteristics Š costs of capital, growth rates and reinvestment rates. Valuing the combined firm under these circumstances may yield misleading results. There is another reason. Once you have valued the consolidated firm, you will have to subtract out the portion of the equity in the subsidiary that the parent company does not own. If you have not valued the subsidiary separately, it is not clear how you would do this. Note that the conventional practice of netting out the minority interest does not accomplish this, because minority interest reflects book rather than market value.

            As a firmÕs holdings become more numerous, estimating the values of the holdings will become more onerous. If the holdings are publicly traded, substituting in the market values of the holdings for estimated value is an alternative worth exploring. While you risk building into your valuation any mistakes the market might be making in valuing these holdings, this approach is more time efficient.

            When a publicly traded firm has a cross holding in a private company, it is often difficult to obtain  information on the private company and to value it. Consequently, you might have to make your best estimate of how much this holding is worth, with the limited information that you have available. One way to do this is to estimate the multiple of book value at which firms in the same business (as the private business in which you have holdings) typically trade at and apply this multiple to the book value of the holding in the private business. . Assume for instance that you are trying to estimate the value of the holdings of a pharmaceutical firm in 5 privately held biotechnology firms, and that these holdings collectively have a book value of $ 50 million. If biotechnology firms typically trade at 10 times book value, the estimated market value of these holdings would be $ 500 million.

            In fact, this approach  can be generalized to estimate the value of complex holdings, where you lack the information to estimate the value for each holding or if there are too many such holdings. For example, you could be valuing a Japanese firm with dozens of cross holdings. You could estimate a value for the cross holdings by applying a multiple of book value to their cumulative book value.