Sical Logistics announced demerger of Sicagen India in October 2006.
How splits created wealth
Price:THEN Rs 172 NOW Rs 209
Reliance Energy created Reliance Power as a separate entity in September 2007.
Price: THEN Rs 1,206 NOW Rs 1,600
Indiabulls Financial Services spun off Indiabulls Real Estate in July 2006.
Price: THEN Rs 245 NOW Rs 639
Zee Telefilms demerged three new entities in January 2006.
Price: THEN Rs 165 NOW Rs 242
Current share prices as on 28 February
Whenever the board of a company meets, its shareholders wait with bated breath. An announcement of a bonus, a stock split or even a generous dividend can boost the share price-and the value of their investment. But this conventional way of rewarding shareholders through bonus shares and dividends may soon become a thing of the past. What many shareholders now want to hear are announcements of demergers or the spinning off of a subsidiary into a listed entity.
If a company hives off a division and lists it as a new company, the combined valuation of the demerged entities is often greater than the market price of the parent company before the split. After the parting, one plus one is not two but almost three. That's because though there is no addition to the assets of the two companies, the new company is usually more focused.
Also, the split unlocks the value of assets such as real estate and cross holdings in other group companies and brings the subsidiary's contribution into the limelight. As a result, the market rerates the parent company and assigns a value to the newborn entity.
"Demerger of group entities brings greater investor focus onto the subsidiary company and its business potential," explains Sonam H Udasi, director (research), Prime Broking Company. Not only does the market get the much needed information about the subsidiary's contribution to the parent company, the parent company also sees a substantial rise in valuations. Idea Cellular was not fairly valued as long as it was privately held by the Aditya Birla Group.
|The demerger of a group brings greater investor focus onto the subsidiary company and its potential becomes clearly defined. That leads to a re-rating by the market|
Sonam H Udasi, Director (research), Prime Broking Company
|Sum-of-the-parts valuation is used for businesses in a diversified company whose earnings do not impact the consolidated firm’s earnings right now but will in future|
Nandan Chakraborty, Head of research, Enam Securities
The potential demergers
|Parent company||What may be hived off||Contribution of demerging entity to||Stock price|
|Turnover (Rs cr)||Profit (Rs cr)|
|Videocon Industries||Crude oil and natural gas business||379.89 (15.84%)||134.53 (44.91%)||424|
|Triveni Engineering||Turbines and gear businesses||137 (39.50%)||34.5 (48.52%)||139|
|S Kumars Nationwide||Brandhouse Retail, which has over 250 retail stores||NA||NA ||153|
|Reliance Communications||Tower company Reliance Infratel||NA||NA||584|
|Larsen & Toubro#||Infotech business||1,280 (7.28%)||170|
|Kesoram Industries||Cement and tyre businesses||433.46 (48.55%)||145.71 (93.97%)||405|
|Jaiprakash Assoc||Infrastructure business||Yet to start operations||NA||269|
|ITC||FMCG business (including cigarettes)||2,348.47 (67.91%)||896.61 (72.15%)||202|
|ICICI Bank||ICICI Securities and insurance companies||257|
|Reliance Capital||AMC business||1,231.3 (10.65%)||282.1 (19.16%)||1,90|
Results are for the quarter ended 31 December 2007. # Results are for the year ended 31 March 2007. HDFC's % does not include income from subsidaries. ICICI Securities profits are after tax.
That's because Reliance Energy holds about 45% stake in Reliance Power. What that means is that the intrinsic value of Reliance Energy shares went up with the listing of Reliance Power.
"The investments of Reliance Energy in its power subsidiary got a huge premium," says Chinmay Desai, a research analyst at Finquest Securities. Similarly, Pantaloon Retail rose from Rs 539 in September 2007 to Rs 626 when the IPO of its subsidiary, Future Capital, came out in January 2008. There's more.
The Mahindra & Mahindra stock, for instance, has been re-rated positively in light of its subsidiary Mahindra Holidays reaching the final leg of its IPO journey. Mumbaibased investment banker Enam Securities valued the new company at Rs 3,400 crore, which adds Rs 122 per share to the value of the parent company.
Some Of The Parts (SOTP) valuation
SOTP valuation of Bajaj Auto
The feud between the Ambani brothers might have forced them to carve several companies out of Reliance Industries, but there are also financial reasons for the split. Sun Pharma demerged its research arm in April 2007 to mitigate the risks involved in the expensive drug discovery process. Reliance Power was hived off to raise funds for the huge capital expenditure.
There are different ways of valuing the diversified interests of a company. The most common tool is sum of the parts (SOTP) valuation. This essentially takes the non-core business units into consideration and assigns monetary values according to their value addition to the company as a whole (see box).
If you pick up a company after it has made its demerger plans public, the gains would be limited. It is best to buy before the plans are formally announced. Money Today zeroed in on some potential demergers that investors can benefit from when the split happens.
The financial services industry has several demerger candidates, notably ICICI Bank, which is in the process of listing its broking arm, HDFC and Reliance Capital. "In the case of ICICI Bank, its broking business is doing well on a standalone basis. Investors will see value unlocking in this stock," says Desai. Reliance Capital has already divested a 5% stake in its asset management company (for Rs 500 crore), valuing the subsidiary at Rs 10,000 crore.
The demerger of ITC's FMCG business also seems possible, given the fact that the packaged food business grew by an impressive 60% in the quarter ended December 2007. Of the total revenues of Rs 5,351.89 crore for the quarter, packaged foods contributed around Rs 655 crore.
However, it's not all positive. Demerging and listing need not always translate into monetary benefit. "Often, promoters create special purpose vehicles or holding structures and then keep bringing new investors in without any big vision or strategy for growth," says Udasi.
Analysts are also quick to caution investors against companies investing through a web of cross-holding structures, where the parent company never lists the subsidiary company. These holding companies do not generate cash flows on their own; they only hold stakes in a web of companies that actually generate revenues.