Cross-Holding, Cross-hedging - Investment projects...

Cross-Holding

In situation 5.4, we saw how the implementation of a project H, which was not very interesting from a commercial point of view, proved to be beneficial to the company, since it allowed us to claim a larger amount of cheap borrowed capital.

A similar effect can be achieved by another system effect, called cross-holding, or cross-ownership of companies by each other's shares.

If the company carries out several different projects, following the strategy each project is a separate company (other options-the head structure is a holding or enterprises and financial market institutions are part of a single financial and industrial group), the ownership of companies by each other's shares can externally improve financial leverage and improve the rating in the eyes of the lender. Of course, all this will be achieved through formal receptions and will not reflect a real increase in the creditworthiness of potential borrowers.

But it's not that important, but the fact that the system gets an opportunity to claim a larger amount of debt than the sum of its disparate elements.

From the point of view of macroeconomic consequences, the cross-holding effect increases capitalization in the stock market, and in different countries to varying degrees. So, it is estimated that the cross-holding almost doubles the capitalization of the Japanese stock market, where, as is known, financial and industrial groups have gained considerable distribution.

Illustration of a cross-holding company

In related companies, "Third Rome - 3" and Zhilpromstroyalians the balance sheets are larger as follows. Third Rome - 3

Asset, million USD		Passive, million USD
Primary Tools	250	Authorized and additional capital	180
Production Reserves	30	Profit	20
Cashier	5	Bank loans	150
Settlement account	115	Accounts payable	50
Total	400	Total	400
Zhilpromstroyalians
Primary Tools	1000	Authorized and additional capital	2300
Production Reserves	2000	Profit	200
Long-term financial investments	200	Bank loans	800
Settlement account	300	Accounts payable	200
Total	3500	Total	3500

Profit tax for both companies - 35%, refinancing rate of the Central Bank - 25% per annum, interest on liabilities is exempt from tax at the rate of refinancing rate +3%.

For the implementation of the new project, JSC "Third Rome - 3" needs a loan of 100 million cu. at 30% per annum. However, the creditor limits the balance sheet financial instrument (the ratio of liabilities and equity O/E) to the maximum value of 1. This is the financial lever for this company:

Therefore, this enterprise can not claim additional credit. However, the following situation is possible:

• Third Rome - 3 issue shares, ordinary or preferred, for the amount of 100 million cu. They are acquired by the company "Zhilpromstroyalians";

• At the same time, the company "Zhilpromstroyalians" issue shares for the same amount and sell them to the company "Third Rome - 3", returning to itself back money, as if paid for the shares of JSC "Third Rome - 3".

As a result, the balance of the enterprise "Third Rome - 3" now looks like this:

Asset, million USD		Passive, Million USD
Primary Tools	250	Authorized and additional capital	280
Production Reserves	30
Long-term financial investments	100	Profit	20
Cashier	5	Bank loans	150
Settlement account	115	Accounts payable	50
Total	500	Total	500

Now the financial leverage is D/E = (150 paws + 50 million cu)/(280 million cu + 20 million cu) = 2/3 and the company can apply for an additional loan of $ 100 million, which she will bring DIE to a critical level:

By obtaining this loan, the company "Third Rome - 3" will increase its market value by the amount of the reduced tax bill which, in the limit to infinity and subject to the limitations of United States legislation, will be equal to

In addition, the estimated capitalization of the company's shares, "Third Rome - 3" may also be affected by the fact that the net book value of assets per share will also increase (due to the appearance of the article "Long-term financial investments", which is taken into account when calculating net assets according to the accepted methodology).

Of course, an attentive lender will not enthusiastically refer to such an "inflated air" of the borrower's own capital and may refuse to provide additional debt for such dubious security.

But we do not consider the cross-holding company from the point of view of the recommendations in the "how to deceive the lender" series, but as a systemic effect that, under certain conditions, can increase the market value of the project complex, change its profitability and influence its structure.

Cross-Hedging

The financial-industrial group or a set of interrelated projects have the advantage that individual projects-enterprises within the framework of a single investment program often insure each other's risks. In this case, the stability of the entire project complex as a whole increases.

The forms of such mutual insurance can be different. Here are just a few of them:

• The provider is created specifically for a specific consumer, which insures the operational risks of the consumer project;

• The consumer is created for a specific vendor, which reduces the vendor's market risk;

• One project from its income forms an insurance fund for another single-complex project;

• the coordinator of a single project complex lobbies interests in local authorities, reducing the legal and political risks of his investment portfolio;

• One project advances capital in creating the assets of another project as a result of the future delivery of products by the second project after entering the operational phase. At the same time, market and capital risks are insured;

• several projects constitute a diversified set, smoothing each other's seasonality (for example, the production of winter hats and swimsuits);

• the assets of one project are further used at the sites of the other, which reduces capital and operational risks;

• mutual settlements between projects are optimized, which leads to reduction of commercial risks.

These and other examples illustrate mutual risk insurance, or cross-hedging, within a project complex.

A negative feature of such a system of interrelated projects is that in case of excessive distribution, it can become a monopolist and damage the effective development of the economy, lead to a reduction in initiative and enterprise, the condition for which is a competitive environment.

CONCLUSIONS

A variety of projects within a single project complex should be combined so that:

• Meet the overall strategy of the company and contribute to the achievement of the global goal pursued by investors;

• create conditions for attracting external financing and at the same time minimize the need for additional resources, including financial resources;

• Ensure internal consistency and sustainability of the project complex, minimizing its risks;

• Maximize the commercial effectiveness of a system of interrelated projects.

Such an approach does not mean that the most effective investments from a commercial point of view should be implemented first of all. It is important to maximize the commercial effect of the entire project complex as a whole.