Should Holding Companies trade at a discount?

The answer is ‘it depends’.
Controlling Stake: With the controlling stake in the portfolio companies, the holding company can take many decisions like cross-subsidizing, cross selling, saving taxes by taking optimal debt etc. Internal group companies know each other better and hence can raise money amongst them at fair value. Depending on these synergies created, the holding company is valued.

Taxation: Sometimes, the holding companies have to additionally ‘leak’ tax to the government which will decrease the stock price. For instance, the long term capital gains tax has to be paid for all off market transactions. While this might be a negative, there is a positive. If someone wants to hold a stake in holding company without knowing when the company would sell its holdings and pay capital gains tax, she pays less option price as the volatility of the portfolio is less than that of the constituents.

Agency problem: There is a possibility that the management of the holding company may take bad decisions which will undervalue the holding.

Management fees: As the management is actively managing the portfolio, their management costs are higher than that of mutual funds but less than that of hedge funds.

Diversified risk: If a shareholder were to buy the portfolio companies individually, she would incur transaction & portfolio costs. As she achieves the same through the holding company she would be willing to pay more.

Undervalued Assets: If a holding company chooses assets that are undervalued, then it commands better valuation than its networth. The best example in this regard is Berkshire Hathaway. The opposite situation is when the company chooses bad assets.

Liquidity: If the holding company wants to sell its stake, there is a chance that the price of asset reduces as it is a bulk deal. In this case the stock price of holding company is at a discount. However, if the holding company has a controlling stake, the buyer could pay a premium for that stake which will help the holding company to get a premium.

Noise Traders: The traders who think they know the value of the company may take the asset prices high or low depending on the market which creates a deviation from the holding company’s fair value of the asset.

Private Benefits: If the holding company has a larger stake, depending on their ability to take decisions, the market views positively or negatively.