Market Watch: The burial of embedded value
When a momentum party ends in the stock market, the biggest hangover is always felt by the "themes" that emerged as most popular during the heady days of bullishness. One theme that gained a lot of currency in late 2007 was "embedded value" or sum of parts (SOTP) valuations. Stock prices that could never be justified by current earnings were easily explained by ascribing value to future business streams of the company. Promoters were only too happy to play along: they merrily announced value "unlocking" strategies from diverse businesses and plans to raise humongous amounts of money in these subsidiaries using the then prevalent market euphoria. So analysts and promoters played this game of make believe to the hilt and investors made money for a while, till the music stopped. One look at the screen today will reveal the carcasses of those great SOTP stories.
Power was the area that promoters wanted to exploit the most. Their eyes must have lit up at the IPO valuation of Reliance Power and even more so at the prospect of it doubling on listing. So it became the perfect cue for companies like Sterlite and JP Associates to announce the hiving off of their power businesses and plan placements/listings for them at valuations benchmarked to Reliance Power. Analysts did not waste any time in revising price targets upwards based on this ingenious unlocking of embedded value. HEG and Jindal Steel and Power floated around in similar SOTP bubbles.
Sadly, the script did not play to plan. The list is long: Punj Lloyd was rerated to include Pipavav Port valuations, IDFC and ICICI got great rub-off s from their brokerage holdings as brokerage stocks soared to ridiculous valuations and countless stocks derived embedded value premiums from their real estate holdings. Now the scales have fallen from investors' eyes but too late, stock prices of these companies have collapsed. In hindsight, which is perfect, it was sheer madness. One bit of insanity led to another. First, outlandish valuations were ascribed to a sector, then those valuations were used to pump up stock prices of another company holding fragments of that business. Nobody questioned the fact that the starting point or the very foundation of such "derived" value was completely out of whack. I suppose all things pass in a bull market, at least for a while. It is great that investors and analysts will now get real and come back to the world of tangible earnings. I doubt if this SOTP madness will resurface anytime soon. The next time you hear the word "unlocking", you know what to do. Run.
Executive Editor, CNBC-TV18
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