How DVRs, hold cos create opportunities for you

The concept of DVR Deep Discount (Differential Voting Rights) is one of the myriad inexplicable mysteries in the markets that evade meaningful rationale.

Financial markets are a fuzzy place. Not everything about them is logical. Though they revolve around concrete numbers, the orbits on which they run can be outrageously off-the-mark from anything rational. There are many such wild spots that are beyond the realm of reasons. The most prominent places where this anomaly comes into action are in the quantum of discounts in the case of DVR shares (to their regular shares) and in the case of holding company shares viz-a-viz their underlying subsidiary units, namely holding-company (hold-co) discounts.

In India, DVR shareholders are entitled to one-tenth voting rights while they are eligible to receive 5% additional dividend than investors in the regular ordinary shares. As a result of this differential voting rights, they trade at a discount to the valuation of their regular shares. That much is understandable. But, much like anything else in the markets, the discounts dance all over the place without any semblance of logic. But there is a method to this madness, at least in global markets. In developed markets like US and Europe, the discounts vary from 5 to 10%, while in Asia, they range between 15 to 20%. Back home, it is only madness, no method. In the last six years, if one looks at the discount in some of the DVR shares, the discount has seen a sharp surge to as high as 60%+ from the lows of 20%+ level without any rationale.

Here is the live chart on Tata Motors DVR shares. In this chart, we have plotted the discount for the last six years since 2014. While it is seemingly all over the place, is there any underlying pattern that one can pick from the plot? Only pattern that one can decipher in this irrational dance of discount is that the discount tends to widen when the underlying regular shares is on a major retreat (medium term downtrend) and the same discount tends to narrow when the regular shares on an uptrend. Beyond that, reasons run out. That does not mean that this pattern is of no value. It does provide an arbitrage opportunity in the DVR shares to savvy investors, esp. when the cycle is about to turn in the regular shares. In such times, DVR provides the double kicker (in returns), one from the turnaround in the underlying shares and another from the narrowing discounts. We may be in such times in the Tata Motors case now, though not certain.

Moving beyond DVR disconnect, there is another segment where reasons find it hard to reverberate is in the area of holding-company discounts (when both the parent and subsidiary units are listed). If one goes by economic ownership, there is no reason for any holding company discounts except for the tax differential (to adjust for tax on cash-out from listed subsidiaries like DDT etc.). But in reality, hold-co discounts go all the way to 60-70%+ in many cases, much in excess of DDT or any other corporate tax in lieu of that. That much for so-called rationality in the markets. But, as in the case of DVR shares, discounts widen or narrow based on the prospects of the underlying business, thus providing special situation opportunities for seasoned investors.

Watch out for the narrowing discounts in stocks like IDFC and Equitas (both are holding companies) in the upcoming turns in the underlying banks (many more such opportunities in the universe). More so, with the RBI’s recent proposal to allow promoter groups to exit the holding company structures if they don’t have any other group entities. Ample opportunities await arbitragers?

This article of mine was published in the online edition of Economic Times (12/02/2021). Glad to share the link: