Why it makes sense to hang on to MNC shares

During the Unilever earnings call in London, the management was asked if the company should be vertically split between fast-growing emerging markets and sagging developed markets. While everyone laughed it off, it underlines the importance of growth for foreign multinational companies outside their parent or holding location.

On the ground in India, companies like Nestle and Unilever have begun strengthening their holding in the listed Indian subsidiaries. For years, MNCs were happy with a 51 percent and above holding in the Indian subsidiary. Over the past one year though companies have begun to slowly consolidate their holding (See table).

While consumer companies like McGraw Hill, Nestle and Unilever have opted for creeping acquisitions, Siemens and ABB made an open offer to Indian shareholders to raise their stake. Creeping acquisitions are small share buys made through the stock market. Even a private company like Vodafone, consolidated by buying out the Ruias in Vodafone Essar for $5 billion.

[caption id=“attachment_13980” align=“alignleft” width=“380” caption=“If revenue and profits are going to be higher in India, MNCs need to have a majority control and bulk of those profits.Photo be Phillip Put”] [/caption]These companies now clearly see India as a growth engine for revenue and profitability. Yes, India was important earlier too. It is just that now the country matters to the balance sheet as well.

What does this mean for Indian owners of MNC stock?

Many Indian minority shareholders rely on multinational companies as they pay high dividends each year. MNCs repatriate profits through dividends.

The stock market performance of MNCs is tracked by CNX Nifty index. Over the past one year, this index rose 13% while the broader S&P CNX 500 index gained merely 6.7%.

The injection of additional capital by controlling shareholders of MNCs has resulted in a reduction in the free-float or shares available for other investors.

“Given a choice, many MNCs would want to opt for taking their subsidiaries private,” said a managing director at a Mumbai-based securities company. This means Indian shares are better off holding on to their stake in most MNC companies.

Many like Cadbury and Alfa Laval have executed plans to completely take their Indian subsidiaries private. Indian rules are now clear on companies wanting to de-list their shares from stock exchanges. They protect minority shareholder interest. This has also resulted in many individual investors looking to buy MNC stocks. The logic is simple. If revenue and profits are going to be higher in India, MNCs need to have a majority control and bulk of those profits.

For years, MNCs operated in India through subsidiaries. They were forced to list on Indian stock exchanges in the late 70s due to the enforcement of the Foreign Exchange Regulation Act. Over the years, litigation between MNCs and the state continued over issues like parent company holdings, royalty paid to the parent, minority shareholder interests and so on.

As many pundits have predicted the bulk of the growth is expected to come from emerging markets. According to a report in the McKinsey Quarterly, in 15 years’ time, 57 percent of the nearly one billion households with earnings greater than $20,000a year will live in the developing world. “Seven emerging economies - China, India, Brazil, Mexico, Russia, Turkey, and Indonesia-are expected to contribute about 45 percent of global GDP growth in the coming decade,” the report says.

The high growth in these economies has also created a valuation dichotomy. For example, Nestle and Unilever trade at a forward earnings multiple of 14 in their parent locations of UK and Switzerland. However, their Indian listed subsidiaries get double the valuation at 28 times their expected earnings per share. This could perhaps be one reason why the parent companies could be interested in putting additional capital into Indian subsidiaries.