From ITC to Tata Motors, Indian companies have been on a demerger spree for the last couple of years. The exercise is usually undertaken in the name of “value unlocking”. Promoters, who make these decisions, should ideally consider the interests of all shareholders when making these decisions. While the track record is patchy, some demergers have proven to be good for minority investors.
Vedanta:
Shareholders of this global mining behemoth have attended many EGMs to vote on corporate restructuring programs that the promoter has mulled upon – from reorganization to delisting. The latter was the attempt by promoter Anil Agrawal to buy the non-promoter shareholders out when the stock plummeted to double digits during COVID. The resolution failed to get the required votes. The most recent attempt at restructuring is the demerger of all of its mined/produced commodities i.e. aluminum, copper, steel, iron ore, etc. into separate businesses. Creating clear silos and verticals can help investors ascribe the appropriate value to each business.
ITC:
The demerger of the hotel business from the mainstay tobacco, paper, and agri businesses received a mixed review. While some investors wondered about the ability of the hotel business to survive on its own, a section of the market believed that the separation would reduce the strain on ITC’s return ratios. Separating different businesses may clear the path of independent progression for different products and/or services.
Tata Motors:
The automobile behemoth has worked through heavy debt and cyclicality. But with the turnaround and rapid surge in the JLR business, the restructuring of the DVR shares, and the now positive outlook on capital goods, Tata Motors has driven into the elite list of top 10 most valuable auto firms globally, topping even the behemoth General Motors. In addition to this, the CV business also has the market excited. The proposed demerger makes a clear demarcation between the company’s CV and PV business. With PV, EV, and JLR under one roof, technological synergies with respect to autonomous vehicles and vehicle software can be harnessed.
Demerging the promising businesses
Did a business get a new patent? Does it enjoy a competitive moat? Or is it in a fast-growing industry? If the answer to any of these and similar questions is yes, the demerger is being done for precisely the reason of value-unlocking. Carved-out businesses like these often find it easier to raise low-cost capital than when they’re a part of legacy companies which also helps improve return ratios.
Demergers with questionable swap ratios:
While some companies allot shares of the promising demerged entity to the shareholders of the parent company, there have been instances where shares are allotted to the parent company. This lets promoters of the parent retain indirect control over the demerged business. This might be something minority investors could examine carefully. It’s also important to consider and understand swap ratios to make sure that the promoters are conducting a fair process.
Tata Motors demerger –
Tata Motors is an example of a demerger that ticks all the right boxes. Its CV business may be growing a notch slower but carries a higher margin. EV/EBITDA multiples assigned to the business are much, much higher (Nomura pegs it at 11x) than the 3.5x assigned to JLR. PV on the other hand is growing at a faster clip, but the non-JLR part of the business carries a lower margin. What’s more, the investments required for both businesses differ. While the capital expenditure cycle for CV is largely coming to an end, for PVs, it’s just kickstarting with product development being a key focus. It makes sense to separate the two as return expectations and consequently share valuations are going to be highly different.
And then there’s the ‘new age business’ demarcation, namely Tata Motors EV. The company wants to launch 10 EV models by 2026 and has an EV capital expenditure plan of Rs. 3000 crores. Favourable policies in two of its regions of operations – India and the UK – could help drive this ambition too.
Every demerger has to be assessed on a case-to-case basis. In many cases demerged businesses that have been listed have delivered good returns to shareholders. But there are a few bad sheep in that list and the best we can do as parent-company investors is to study each plan on its own merits and decide to stay or exit based on the research.