Investors from India are attracted to MNCs because they assume that there is a higher level of governance, technological proficiency and transparency. Investors have the choice – they can either (1) invest in these MNCs through the US stock market or (2) invest in the Indian subsidiaries of these companies since they are publicly traded in India.
Which approach was better in 2019?
For the period of 2019, we found that investing in the Indian subsidiaries of these MNCs resulted in the following:
- Both approaches delivered about the same returns (investing in the Indian subsidiaries of these MNCs on average generated 3% higher returns for 2019, likely boosted by the Indian corporate tax cut in September 2019).
- However, had you invested in the Indian subsidiaries, you would’ve been paying much higher multiples (on average about 3X more expensive) and would have experienced higher volatilities.
But that was 2019, what about 2020 and 2021?
Which approach was better for the period of January 2020 – March 2021?
Clearly, 2020 and 2021 to date has been an unprecedented period for the US and the Indian stock market. The global lockdown and its macroeconomic impact hit both the US and the Indian economies pretty hard, but the stock markets in both countries rebounded rather quickly.
Comparing valuations of parent MNCs their Indian subsidiaries
To compare the valuation between the parent MNCs and their Indian subsidiaries, we chose to use Enterprise Value (EV) to EBITDA ratio from the last twelve months (as of the second week of March 2021). This multiple ratio is a good metric to look at because it takes into account debt levels of the companies and ignores the distorting effects of corporate taxation policy differences between the US and India.
The EV/EBITDA ratios are shown in Figure 1. Blue bars represent the parent MNCs, traded in the US exchanges, while the grey bars are the Indian subsidiaries, traded in Indian exchanges.
As you can see, fourteen out of fifteen MNCs examined here have Indian subsidiaries that are valued more richly. For some, the difference in valuation is quite staggering.
- On average, the Indian subsidiary is valued 3.8X higher than the MNC parent company.
- The Indian subsidiaries of 3M and Whirlpool have an EV/EBITDA that is more than 10X higher than the US parent company ðŸ‘€.
- These MNCs are not high-flying technology companies (with the exception of Oracle, which even though is a tech company, is not a fast growing one). In fact, most of these MNCs are in the materials, industrials, pharmaceutical, and consumer packaged goods industries – mature companies which should have lower multiple valuations.
- The valuation of the MNCs in the US look more sensible for mature companies, less so their Indian subsidiaries. At 125X EV/EBITDA, 3M India Limited is valued almost as highly as Tesla (which has an EV/EBITDA ratio of 135X as of this writing) and is 3-4 times higher than that of Google’s, Amazon’s and Microsoft’s (which all have ratios ranging from 22-28X).
OK, so the Indian subsidiaries are a lot more expensive, but they’re worth it, right? Since they deliver higher returns?
Figure 2 shows the average returns had you invested equal amounts in the Indian subsidiaries (green line) and the parent MNCs (for the time period of January 1st 2020 to March 17th 2021).
On average, the return profiles are pretty similar. In the past six weeks or so, the average returns of the Indian subsidiaries outpaced their MNC parents (green line), by 10%, largely because of the rally seen in Linde India Limited. If you exclude Linde, the returns would be identical (about 22% returns for the given period).
What about the volatility?
Figure 3 compares the 1-year annual volatilities of the companies. The higher the volatility, the more the share price moves throughout the year, and the riskier the investment tends to be.
For the most part, the Indian subsidiaries (grey bars) have higher volatilities than the parent MNCs (blue bars). Eleven out of the fifteen MNCs examined here have Indian subsidiaries that are more volatile over the past year (note, however, that the difference in volatilities may not be statistically significant).
High correlation between the parent MNC and their Indian subsidiaries
For some of these companies, the share price correlation between the parent entities, which are being traded in the US (1 trading day behind India) and their Indian subsidiaries are quite high.
Figure 4 shows the return profiles of Oracle (top) and Colgate-Palmolive (bottom) against their Indian subsidiaries. Notice how the jaggedness and the patterns are quite similar. When the share price of the Indian subsidiary goes up, the share price of the parent company tends to go up as well. Also notice that the price movements of the Indian subsidiaries (grey lines) are more volatile.
Figure 5 shows the correlation coefficients of the share prices of the MNCs and their subsidiaries. Correlation coefficients range from -1 to 1. If the value is positive, the share price movements tend to move towards the same direction. The closer the value is to 1, the stronger the co-movement.
For the most part, the share price movements between the parent MNCs and their Indian subsidiaries show strong correlations. The correlations are quite low, however, for the pharmaceutical companies (Abbott, GSK, Procter and Gamble ðŸ¤”).
To conclude, similar to 2019, the Indian subsidiaries tend to be more expensive (about 3.8X more) than their parent MNCs. Investing in them deliver about the same returns, but investors are also exposed to higher levels of volatilities.