A few days ago I saw a tweet cross my timeline on X about how undervalued Pinduoduo Holdings Inc.(PDD) - the owner of its namesake Pinduoduo and Temu among other stuff. I can’t quote the tweet here as it was profanity-laden but you can find it in my replies on X. It was getting quite a lot of interaction and to put it mildly, I was horrified and shocked by what I was reading. I decided to provide some clarity and here was my first response.

The ~80% discount did rub some people off it seems and one account that supposedly runs an investment firm called my whole tweet nonsense. Guess what? Blocked the account in 60 milliseconds. What shocked me was influencers with large followings don’t even understand what a Holding Company (HoldCo) discount is and why it exists. It is not some voodoo I concocted, it has existed for ages.

HoldCo Discount

A conglomerate or a holding company typically exhibits the following characteristics:

1. does not have any material business operations of its own;

2. exists mostly to own assets via holding controlling stock or membership interests in other companies;

3. primary revenue is dividend income and interest earnings;

4. operating income tends to be consistently less than the value of its assets.

Here are some of the reasons why a Holding Company discount arises:

1. Holding companies tend to be a sum of disjointed businesses that investors are forced to buy even though they do not like a specific investment of a HoldCo.

2. Holding companies are more complex to analyze. Determining the true value versus the value of their operating assets is extremely hard. Well, valuing a standalone business is hard enough, now imagine valuing a mishmash of subsidiaries, crossholdings, and god knows what is privately held via VIEs (Variable Interest Entities).

3. Holding companies usually are valued based on the liquidation value of the investments. However, such liquidation value may not be realized as the holding company will rarely sell its investments in group companies due to strategic/synergistic benefits.

4. Holding companies are mostly founder(s)-driven companies and hence the actions may not suit the return and risk objectives of minority shareholders.

5. Internal policies could prevent the holding company from realising the value of shares which may also get factored into the discounted pricing.

So, how much discount should be applied to a HoldCo? Globally, I have seen HoldCo discounts ranging from 40% to 80%. Here are some of the drivers of the discount range:

1. Industry, sector, and timing within the economic cycle.

2. Quality of investments held by the HoldCo.

3. The complexity of reporting structure.

4. Minority shareholders tend to discount companies that have complex structures as information on businesses may not be available/accessible on time.

5. Multi-layer of subsidiaries results in the parking of assets/liabilities in VIEs or Special Purpose Vehicles.

6. Minority investors at times, do not have relevant information to value such subsidiaries/investments.

7. Cross-holding in other private companies.

8. Level of earnings from dividend and interest, and subsequent distribution to shareholders of HoldCo.

9. The cascading effect of dividend distribution tax in a multi-tier structure.

Now you understand why the conglomerates in South Korea and Japan trade at such low P/Es. It is a feature of the HoldCo discount and not a bug.

Where Does PDD Stand?

PDD’s corporate structure is complex and hierarchically deep. (Refer to 2023 20-F PDF Page 7). Two direct holdings shown in the 20-F are held through intermediary holding entities - talk about complexity. Then there is the biggie - the VIE. Why?

Essentially, here are the risks that clearly need to be discounted:

1. The interweb of intermediaries at the parent HoldCo.

2. PRC regulatory uncertainty as there is no case law supporting such a VIE structure.

Given that, there is another issue with PDD, namely, the ADS (American Depository Shares) structure. The ADS for PDD converts to the Holdco incorporated in the Cayman Islands. While this issue falls under HoldCo risk factors, this needs to be highlighted as it is not how the majority of ADRs(American Depository Receipts) are structured.

Standard or clean ADRs are where the foreign issuer is listed in its home country and each ADR is a negotiable certificate issued by a US depository bank representing a specified number of shares - usually one share - of the foreign issuer. Simplistically, the owner of the ADR has a direct ownership stake in the foreign issuer and hence, direct access to earnings and cashflows. That is why one can simply do a currency conversion and see that the ADR and the underlying track each other unless there are geopolitical, currency, etc., etc. issues.

Since PDD’s ADS is convoluted and a roundabout way to access its China operations and subsidiaries, this needs to be discounted too.

What does a Retail Investor do?

I don’t invest in HoldCos no matter how good some of its assets may be. Also, I would rather spend a few weeks analyzing 5 to 7 companies than slog it out on a HoldCo. But still, is there a quick way? You can do what I did before I wrote the tweet I mentioned above.

1. Download the current 20-F (Annual Report for Foreign Issuer) from PDD’s website.

2. Go to the company information section.

3. Look for the company structure.

4. Read two pages.

5. Discount out the VIE as the ADS holders have no direct or indirect equity interests in it, i.e. 45.7% discount.

6. Web of intermediaries, convoluted ADS structure, and other PRC legal concerns = 35% discount.

7. Total discount = 80.7%. This is where the ~80% in the tweet came from.

8. Let’s verify if the market agrees.

We are good. The market and I are in the same ballpark. Now, if you are really interested in PDD, you will have to put in the hard work. You will have to untangle the interweb of subsidiaries/holdings and hopefully arrive at a reasonably correct valuation. Practically, people with day jobs and a family to take care of don’t have the luxury of time to do that.

When I was younger, I was naive, suffering from self-doubt about my abilities, went looking for investing ideas on chat boards, in Wall Street analyst reports, and sensationalized short seller reports. It was a painful experience. Hence, I started this blog recently to help you survive and thrive in the markets. Consider me as the Obi-Wan to the inner Jedi in you and sometimes the Q to your inner James Bond.