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A Lesson of Valuation: Non-Controlling Interest

Some time ago I received a question email from a friend, which he asks, 'Dear sir, in an article about Toba Bara Sejahtra (TOBA), you stated that the net profit of TOBA for First Quarter 2014 was US$ 7.7 million. But I see in the paper, the profit was US$ 12.8 million. Which is right?' I could say, both are right. How come? Well, here’s the explanation.

Overall, TOBA made a net profit of US$ 12.8 million in the first quarter of 2014, in which US$ 7.7 million of which belong to shareholders of the company, also called the equity holders of the parent entity, and the rest belong to the non-controlling interest, or also called a minority interest. This means that if you hold a 100% stake in TOBA, the profit you earned is US$ 7.7 million, while the rest belonged to the other party that helped put up capital/asset to TOBA without becoming a shareholder of the company, and also not in control of company’s operations (so they called non-controlling interests).

More specifically, non-controlling interest is part of ownership in subsidiaries that is not held by the parent company, but other parties. For example, TOBA is a parent company of PT Adimitra Baratama Nusantara, which TOBA holds a 51% stake at Adimitra, and the remaining 49% is held by other parties. Because TOBA is the majority shareholder of Adimitra, then Adimitra regarded as a subsidiary in which the assets of Adimitra are consolidated into assets of TOBA (Adimitra’s assets are considered as part of TOBA’ assets), including the 49% stake that was actually held by the other parties earlier. Then, in the financial statements of TOBA, 49% of Adimitra assets that held by the other parties is regarded as non-controlling interests.

Large companies in the Indonesian Stock Exchange which has many subsidiaries usually have an account of non-controlling interest in their financial statements, because they are usually not holding their subsidiaries in a whole, but share it with other parties. When Agung Podomoro Land (APLN) built the Senayan City Mall (Sency), the company cooperated with several other companies, but APLN remains the majority shareholder of the Sency (51% or more), so that all assets of Sency are consolidated into the assets of the company. While part of ownerships of Sency that is not held/owned by APLN, in the APLN’ financial statements are as non-controlling interests.

The bottom line here is, non-controlling interest isn’t belong to shareholders. In the first quarter of 2014, the equity value of APLN was Rp7.4 trillion, in which Rp1.3 trillion of which is the non-controlling interests, so that APLN’ equity that is held by the company’s shareholders was onlu Rp6.1 trillion. So when you buy a share of APLN, for example, then you become one of the owners of the net assets of Rp6.1 trillion instead of Rp7.4 trillion, because the difference of Rp1.3 trillion is not belonged to APLN’ shareholders.

I myself just realized that the factor of non-controlling interest is very important to note, because it could lead to misleading in determining the valuation of shares. For example, Astra International (ASII) had a total equity of Rp113.1 trillion in the first quarter of 2014, so its PBV at the price of Rp7,425 per share is 2.7 times, aka low enough for the standard of the blue chip stocks. But if we remove the non-controlling interests, then ASII’ net equity became Rp88.9 trillion only, so its PBV become 3.4 times, aka a bit overvalue. In accounting, a valuation method that remove the non-controlling interests could be wrong, because the non-controlling interest was clearly written as part of equity. However, for conservative reasons, I myself from now on will only taking the value of equity outside the non-controlling interests, in calculating the PBV of a stock.

It was related to equity, which is directly related to the PBV of a stock. While related to corporate net profits, the existence of non-controlling interests is also important to note. For example, TOBA, that in the first quarter of 2014 made a profit of US$ 12.8 million (profit for the year, instead of comprehensive income), but only US$ 7.7 million of which belonging to shareholders of the company, or called 'attributable to equity holders of the parent entity'. As a result, EPS of TOBA also calculated based on the income of US$ 7.7 million, so its EPS was US$ 0.004 per share, and its annualized PER on stock price Rp840 per share became 4.8 times.

If you notice, in the financial statements of any company, it has been shown that the EPS is calculated based on the net profit belonging to shareholders of the company, excluding non-controlling interests. So the number of PER when you’re dividing the price of a stock by its EPS is already right. However, when calculating the PBV, some analysts/investors (including myself) are still incorporate the equity that is not belong to shareholders, ie the non-controlling interests, and consequently the PBV figure could be considerably lower than it should be.

Okay, I think I have said what it needs to be said. I'll see you next week.

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