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 Ð 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.