Yahoo: Conglomerate Discount

I wrote before about what is called "Holding Company Discount".

Bloomberg published an interesting article about this same issue, but calls it "Conglomerate Discount". The article is about Yahoo, and its holdings in Alibaba and Yahoo Japan.

"How Can Yahoo Be Worth Less Than Zero?"

The article is written by Matt Levine, some snippets:

"Yahoo Inc. is a public company consisting of a portfolio of

1. whatever you think Yahoo is,
2. a 35 percent stake in a separate but similar publicly traded company called Yahoo Japan, and
3. a 24 percent stake in a separate, different, soon-to-be-publicly traded company called Alibaba.

My Bloomberg View colleague Matt Klein ran the numbers in March, and non-Bloomberg-affiliated Matt Matt Yglesias ran them again today, and the numbers tell you that 2+3 > 1+2+3, as it were: Yahoo's Alibaba and Yahoo Japan stakes add up to be worth more than Yahoo is worth."

"One obvious question is, how can that be true? The actual Yahoo business -- call it "Core Yahoo" -- still makes hundreds of millions of dollars a year in profits, which theoretically belong to shareholders. A thing that pays you positive hundreds of millions of dollars a year shouldn't be worth negative billions of dollars.

Of course, profits that theoretically belong to shareholders aren't necessarily paid out to shareholders: Yahoo pays no dividend and has a ... checkered management history, so you could easily take the cynical view that Yahoo will plow those profits back into a declining business, be completely mismanaged, run the business into the ground and leave shareholders with nothing."

Core Yahoo is worth less than zero because it's an arithmetic residue of taking a bunch of businesses with very public price tags on them and applying a conglomerate discount.

That discount isn't really about the viability of the core business; it's about the fact that investors don't have direct access to any of the individual businesses, but have to buy them in packaged conglomerate form where any gains on the business they want can be wiped out by losses on the ones they don't.


I learned my lesson the hard way, about 20 years ago. I was quite impressed by the growth of AMMB, but calculated that AMCorp (owning a chunk of AMMB plus some other businesses) was a cheaper entry to AMMB. And on top of that, AMCorp had ICULS that traded at a discount to its shares.

That is a lot of discount on top of a lot of discount, what possibly could go wrong?

Well, in short, a lot:

• AMMB had been growing very fast, but that was actually a red flag, in the Asian crisis fast growing banks would be hit hard; less aggressive banks (like Public Bank) did relatively better;
• AMCorp's other businesses (if I remember correctly, a money-lending business) did very badly, and AMCorp apparently continued to support those.

Years later, AMCorp was privatised by its major shareholder in 2006 for RM 1.40, only a fraction of what it had been trading for a decade before. Soon afterwards AMCorp sold a large chunk of AMMB shares to ANZ (Australia and New Zealand Banking Group).

AMMB: How To Make RM 5.7 million By Doing Almost Nothing

http://www.securitiesarbitrations.com/Securities-Arbitration-Blog/Article/11/2011/174/How-To-Make-$1-8-million-By-Doing-Almost-Nothing

In a curious case of absent oversight, Morgan Stanley Investment Management has been fined $1.5 million by the Securities and Exchange Commission (SEC) for improperly charging a fund it manages for investment advisory services that were never performed.

Morgan Stanley Investment Management is a wholly owned subsidiary of Morgan Stanley. From 1996 to 2007, it charged The Malaysia Fund Inc. about $1.845 million pursuant to a research and advisory agreement with AMMB Consultant Sendirian Berhad. Under the agreement, AMMB was supposed to provide advice, research, and assistance to Morgan Stanley for the benefit of the fund, according to a Nov. 16 cease and desist order from the SEC that serves to settle the charges.

All AMMB did was send Morgan Stanley two reports per year on the state of the Malaysian market comprising information that could have been gathered by anyone with an Internet connection. Nonetheless, for more than 10 years, Morgan Stanley kept passing the AMMB charges onto the fund, despite having agreed to monitor AMMB’s performance, the SEC order said

As a condition of the settlement, Morgan Stanley was censured and will reimburse the fund the $1.845 million it shelled out for AMMB, less a credit of $543,000 that has already been paid back.

Morgan Stanley also agreed to cease and desist from committing or causing any violations and any future violations of Sections 15(c) and 34(b) of the Investment Company Act, and Sections 206(2) and 206(4) of the Advisers Act and various rules thereunder, the order said.

The cease and desist order also directs Morgan Stanley to implement and policies and procedures within 45 days to improve its Section 15(c) processes and its oversight of advisers and sub-advisers, principal underwriters, administrators, and transfer agents. Section 15(c) concerns the renewal of services contracts and the gathering of information to ensure accurate evaluations of such contracts.

The policies and procedures include requiring Morgan Stanley personnel with direct knowledge of a service agreement to review and verify the services performed, obtain an annual certification from the service provider that the services were performed, and provide accurate descriptions of the service providers and their services to its clients, the order said.

This latter measure includes ensuring that personnel with knowledge of a given agreement and the services it covers will review descriptions of the services providers contained in a registration statement, application, report, account, record, or other document filed or transmitted pursuant to the Investment Company Act, as well as any financial statements and marketing materials.

Morgan Stanley was also directed to certify to the SEC that it has implemented these policies and procedures within 60 days of their completion.

The Malaysia Fund Inc. is a closed-end investment company launched and managed by Morgan Stanley in 1987 to invest in the equity securities of Malaysian companies. As of June 30, 2011, the fund reported net assets of $93.8 million. Morgan Stanley is the fund’s the primary investment adviser.

The two signed a written advisory agreement in 1987 for investment management services, including investment trading and maintenance of the books and records. The fund pays Morgan Stanley an annual fee of 0.90 percent of the fund’s first $50 million of average weekly net assets, with the percentage decreasing incrementally to 0.50 percent of the fund’s average weekly net assets in excess of $100 million. Morgan Stanley is also the fund’s administrator, for which it receives additional fees.

AMMB, of Kuala Lumpur, Malaysia, is a wholly owned subsidiary of AM Bank Group, one of the largest banking groups in Malaysia. It was an investment adviser registered with the SEC from 1987 until February 2008, when it withdrew its registration.

As part of the agreement between the fund, Morgan Stanley and AMMB, Morgan Stanley was supposed to assist AMMB in making the relationship as productive as possible. It was also supposed to give guidance to AMMB on working procedures -- and most to the point -- monitor AMMB’s performance of services, the order said.

The funds board of directors approved AMMB’s fees each year based on Morgan Stanley’s representations, the SEC order said. As a result, it paid $1.845 million to the sub-adviser between 1996 and the end of 2007 for advisory services it did not receive. In early 2008, after the SEC began to look into the fund’s relationship with AMMB, its services were terminated.

Per the service agreement that the fund paid out on for so long, AMMB collected fees at an annual rate of 0.25 percent for the first $50 million of average weekly net assets, 0.15 percent for the next $50 million and 0.10 percent of assets in excess of $100 million.

Every year the contract lasted, AMMB sent a report to Morgan Stanley that falsely claimed it was providing specific research, intelligence, and advice to Morgan Stanley. The purpose of the report, according to the SEC order, was to provide the fund’s board of directors with the information it needed to evaluate the terms of the sub-adviser agreement.

In each of these reports, AMMB said that it provided the following services to Morgan Stanley on behalf of the fund: research on Malaysian companies to identify and recommend stocks for investment; statistical reports to help with investment decisions; market intelligence on local corporate developments; and advice on changes in economic and political conditions in Malaysia. The report also listed personnel and included AMMB’s unaudited financial statements, the order said.

Despite the fact that very little of the information listed above was ever imparted to Morgan Stanley, the investment management company submitted these reports to the fund’s board as it considered renewal of the AMMB advisory agreement.

Morgan Stanley also submitted two compliance reports to the fund and its shareholders that indicated AMMB was providing the advisory services, when actually these services were limited to two minor monthly reports, which Morgan Stanley’s portfolio management team did not even use.

Section 15(c) of the Investment Company Act requires an investment adviser to furnish such information as may reasonably be necessary for its client to evaluate the terms of any contract whereby any person or entity agrees to act as investment adviser.

The SEC’s order stated that Morgan Stanley did not provide The Malaysia Fund’s board with information reasonably necessary for the board to evaluate the nature, quality, and cost of AMMB’s services. Morgan Stanley represented to the board and the funds investors that AMMB was providing advisory services for the benefit of the fund when it was doing no such thing.

Full text: http://www.sec.gov/litigation/admin/2011/ia-3315.pdf