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Is it advisable to buy a subsidiary of a highly levered parent company?
16-06-2020, 10:35 AM.
Post: #1
Is it advisable to buy a subsidiary of a highly levered parent company?
While looking at stocks in Singapore and HK, I find quite a few examples of the following:

- A subsidiary which is cash rich and/or has good cashflows, with no debts
- The parent of the subsidary has many diverse business, and has a lot of debts

My rather simplistic thinking is that the parent would be motivated to compel the subsidiary to pay out dividends, thus aligning the interest of the parent company and the OPMIs vested in the subsidiary.

In such a situation, is there any dangers or downside to buying stocks of the subsidiary company? For example, the parent bypassing the OPMIs when extracting cash from the subsidiary, in the form of loans with unfavorable  terms etc.
Would appreciate thoughts of any buddies who have some thoughts or experiences investing in such a situation.

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16-06-2020, 10:59 AM.
Post: #2
RE: Is it advisable to buy a subsidiary of a highly levered parent company?
They probably will have figured out the most tax efficient means for the parent company to extract value from the subsidiary, especially if the parent and subsidiary are of different tax jurisdiction.

So if the parent is managed by what can be considered to be honest people, then it is unlikely for investors of the subsidiary to be surprised by any such negative developments.

The parent can extract more value by charging the subsidiary with higher fees, perhaps for corporate or licensing purposes. Or by getting the subsidiary to purchase good and services at slightly higher market rates. But generally, such related party transactions are supposed to be arms-length, and if it isn't, they have to explain their rationale. Not that any explanation is of use to opmi, of course.

The Kingboard Copper Foil thread is a very good case study.

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16-06-2020, 11:03 AM. (This post was last modified: 16-06-2020, 11:07 AM by opmi.)
Post: #3
RE: Is it advisable to buy a subsidiary of a highly levered parent company?
"For example, the parent bypassing the OPMIs when extracting cash from the subsidiary, in the form of loans with unfavorable terms etc."

To add, another common way to bypass OPMI is by assets from parent co or related private holding co. Then the cash or cash from new financing transferred to parent or substantial shareholder.
the relatively better one do these related parties transactions. The more chao ones go buy some overpriced assets and then split with the vendors under the table. These kind cannot prevent.

Some may also supported their other businesses (dying) by buying bonds/notes of related companies. These companies may not be deemed as related companies as the boss may owned less than 20%. Must see the track record. If you want "whiter than white" and obvious to everyone, then it wont be at a big discount. Must know where are the "warts" and whether you can live with it.

Also you cannot assume the major shareholders dont turn rogue or greedy. Big corp or long history of dividends dont mean anything. Can only hope for alignment of interests for the moment.
Better if there is another strong non-family substantial shareholders on the shareholders list. Can counterbalance the greed. But it is a rare structure.

There were happy endings. Like the parent do a dividend in specie of the subsi. Spinoffs or privatisation/sale of the subsi at less discount. etc.

Good book to read if you want to know more about the smelly tactics... 財技密碼 周顯 or Webb-site Reports..
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"... but quitting while you're ahead is not the same as quitting." - Quote from the movie American Gangster

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16-06-2020, 11:12 AM.
Post: #4
RE: Is it advisable to buy a subsidiary of a highly levered parent company?
(16-06-2020, 10:59 AM)karlmarx Wrote: They probably will have figured out the most tax efficient means for the parent company to extract value from the subsidiary, especially if the parent and subsidiary are of different tax jurisdiction.

So if the parent is managed by what can be considered to be honest people, then it is unlikely for investors of the subsidiary to be surprised by any such negative developments.

The parent can extract more value by charging the subsidiary with higher fees, perhaps for corporate or licensing purposes. Or by getting the subsidiary to purchase good and services at slightly higher market rates. But generally, such related party transactions are supposed to be arms-length, and if it isn't, they have to explain their rationale. Not that any explanation is of use to opmi, of course.

The Kingboard Copper Foil thread is a very good case study.

I think following when 張國榮 buy or sell Kingboard, can make money...but not its subsidiaries.

Kingboard shareholder structure also make alignment of interest better for OPMI. I guess.
=========== Signature ===========
"... but quitting while you're ahead is not the same as quitting." - Quote from the movie American Gangster

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16-06-2020, 04:51 PM.
Post: #5
RE: Is it advisable to buy a subsidiary of a highly levered parent company?
Thank you, karlmarx and opmi.
The Kingboard thread is educational. My takeaway is that before buying subsidiaries, its good to:
- Look at related parties transactions that disadvantages the subsidiary
- Look at reputation of the parent (This is the hard part, I feel, not easy to judge honesty easily)
- Check for any disputes between controlling shareholder again other significant minority, which may cause the controlling shareholder to give "collective punishment" to all minorities

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16-06-2020, 06:13 PM. (This post was last modified: 16-06-2020, 06:18 PM by ghchua.)
Post: #6
RE: Is it advisable to buy a subsidiary of a highly levered parent company?
Dear all,

The title of this topic is very general, and there are various considerations in my thoughts when I decide whether to join in this discussion. Because there are just too many variables.

Firstly, when you look at the whole structure, you cannot just look at the listed subsidiary that you intend to invest and the parent company. You have to look at the big picture, which is the whole entire group structure. Many questions that I can think of.

1. Is the parent company even listed in the first place?
2. What about all the subsidiaries under the parent company? Are they all listed, some listed or only one listed?
3. Any associates or JVs under the parent company? Are they all listed, some listed or all private ventures?
4. Shareholding structure of the parent company, subsidiaries? etc

Let me give you a generic example. There is one listed company which has another 3 other listed subsidiaries. So, altogether 4 companies listed, all on the same exchange. The parent company acts like a holding company, basically having its own business but also consolidated all the other 3 listed subsidiaries companies accounts. Each of these 3 listed subsidiaries companies have their own unique business. Subsidiary A is a capital intensive business, so it has not paid any dividend since listing. Subsidiary B is a profitable but receivables heavy business, so it pays dividend but mostly declare scrip dividend and had conducted a few rights issues since listing. Subsidiary C is a mature company holding mostly operating and investment assets, and had been divesting assets and returning cash back to parent company (and opmi of course) via special dividend payouts for many years. The parent company also pays out dividend, but in small amounts yearly.

With the above structure, we can see that an investor in each of these 4 listed companies will experience different outcomes. Obviously, an investor in subsidiary C will be most happy with the dividends, while I cannot say the same about investors in the other 3 listed companies.

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