DEMERGER Unlocking value


I
n the recent past, India Inc has been moving into restructur­ing mode, where companies are either demerging their various divi­sions or doing away with the holding structure altogether. For instance, Adani Enterprises Ltd (AEL) recently announced that it’s doing away with the holding company structure of its stake in two listed companies – Adani Ports and Adani Power (as also unlisted companies). Every share­holder of Adani Enterprises expected to receive 14,123 shares in Adani Ports and 18,596 shares of Adani Power for every 10,000 shares held in Adani Enterprises. “The transac­tion is expected to unlock value for the shareholders of AEL by eliminat­ing the holding company discount,” announced the management while declaring the demerger.

Earlier, Max India had also announced that it was splitting into three entities. It would be renamed Max Financial Services and involve the life insurance business. Share­holders were to get one additional equity share for every share held in the new business verticals, which focussed on health and allied busi­ness that comprise Max Healthcare, Max Bupa and Antara Senior Living. This new entity was to be known as Max India. The third vertical was to be known as Max Ventures & Indus­tries, where shareholders would get one new share for every five shares held in Max Financial Serv­ices. This entity would be into man­ufacturing and specialty films. While announcing the rationale for this demerger, the management stated that this action would ‘unlock shareholder value’.

Crompton Greaves was another company that announced the demerger of its consumer durable business, where the shareholding of the new company would mirror the existing shareholding.

So, unlocking value for sharehold­ers is a new theme Indi^ Inc is play; ing out. “At present, capital infusion is the name of the game, where new investors would have the mandate to invest in one particular business and not all the businesses the company possesses,” says Deven Choksey, a leading broker, explaining the rea­son behind this rush. “That is why promoters are de-coupling their vari­ous businesses to drive growth.”

These three are not exceptions. In the last few years, similar activ­ity has been taking place sporadi­cally, but not at the same pace. For example, Marico demerged its skin care and spa business into a sepa­rate listed entity, Marico Kaya, with the shareholders of the parent com­pany getting shares of Marico Kaya, much to their advantage. Wipro also demerged its FMCG and consumer durables business from its iT/ITeS activities to stay more focussed in all business verticals. But as an excep­tion, took the FMCG business private, controlled by the Premji family.

Changing market dynamics

In an era when business is com­petitive and challenging, it makes sense for each company to be more focussed and sharp, so that one is able to respond to the changes in market dynamics in the quickest possible time. It was the same logic that Dilip Shanghvi of Sun Pharma applied when his company demerged its r&d business into a separate company, Sun Pharma Advanced. The Bajaj group also split Bajaj Auto into two new companies: Bajaj Finserv and Bajaj Holdings & Investments, with shareholders of the parent getting stakes in both new entities, which helped unlock value for them.

Now, it may be time for Bajaj Fin­serv in turn to undergo another ver­tical split a la Max India, with its life insurance business, non-life insurance business and NBFC busi­ness deserving separate attention. On the other hand, Bajaj Holdings, which holds a 31.49 per cent stake in Bajaj Auto and 39.16 per cent in Bajaj Finserv, is now commanding a mar­ket cap of just ?15,000 crore, while these investments’ market value itself is close to ?30,000 crore.

Similarly, Sundaram Clayton con­trols TVS Motors, another leading two-wheeler player. It holds a 57.40 per cent stake in TVS Motors, giv­ing its investment a market value of ?8,000 crore, while Sundaram Clay­ton’s own market cap is only ?3,700 crore. Sundaram Clayton is an active player in the auto components busi­ness and has a turnover in excess of ?1,000 crore, which clearly shows that Sundaram Clayton’s sharehold­ers are not reaping as much bene­fit as they should, because of the holding company discount.

Other companies that have demerged in the recent past include Orient Paper, which separated its cement business from the paper and consumer durables business, giving its shareholders new shares in Ori­ent Cement. Kesoram, another Birla group company, which is into vari­ous unrelated businesses like tyres, cement and rayon, was also in the news when it mooted the sale of its tyre business to reduce its debt. But for the time being, the company’s board has decided to transfer its tyre business in Haridwar to a separate subsidiary and may monetise the same at a future date.

Empirical studies suggest that a holding company structure invari­ably fails to unlock value for share­holders. Investors don’t attribute fair value to the holding company, despite it holding substantial stakes in good quality companies. Theoreti­cally, the holding companies’ invest­ments should be valued at a 30 per cent discount but, in real life, dis­counts go as high as 70 per cent, which defies logic. By not doing away with the holding structure, it is doing an injustice to the sharehold­ers (read minority shareholders) of the holding company, who are not able to revise the intrinsic value of their investments.

“Investor appetite for holding companies is less, because minor­ity shareholders have little say in the allocation of funds of the hold­ing company,” explains Choksey. “Due to this, the holding company’s investments in a subsidiary company are valued at 20-30 per cent discount to market value. But, in a bull mar­ket, this discount tends to come down. Also, many a time, the fact that a company is holding valuable assets is not understood by investors, which could also be a reason it is not getting the right valuation in the stock market.” Moreover, the invest­ments are reflected at book or acqui­sition value in the holding company and are not marked to market.

Structural maze

One case in point is Bombay Burmah, the holding company for the Bombay Dyeing group. It holds more than a 50 per cent stake in Britannia Industries through its various step-down sub­sidiaries. The present market value of Bombay Burmah’s stake in Britan­nia is more than ?12,000 crore but Bombay Burmah’s own market cap is a mere ?3,300 crore, which does not reflect its true investment value. In fact, Bombay Burmah also owns quite a few other assets, including a 14 per cent stake in Bombay Dyeing.

Of course, the holding compa­ny’s stake in Britannia Industries is through various step-down subsid­iaries, the major one among them being Associated Biscuits, which
holds a 44.95 per cent stake in Bri­tannia. Associated Biscuits, in turn, is a 100 per cent subsidiary of Leila Lands, which itself is a 100 per cent subsidiary of Leila Senderian Berhad, a 100 per cent subsidiary of Bombay Burmah. Due to this structural maze, there is little awareness among the investors that Bombay Burmah is the holding company of Britannia. There may have been historical reasons for Bombay Burmah to hold the stake in this fashion, because it is these com­panies that had the case to make the acquisition but that does not justify the fact that the investors of Bom­bay Burmah are not able to reap
the real benefits coming from its stake in Britannia.

Discounts of the holding company, often well above 20-30 per cent are common. For example, Grasim Indus­tries, the flagship company of the Aditya Birla group, owns a 60.25 per cent stake in UltraTech Cement, the investment market value of which is ?50,000 crore. But Grasim’s own mar­ket cap is only ?35,000 crore. Also, Grasim has other businesses which are valuable, in particular its viscose business in which it is the dominant player, and stakes in other compa­nies such as Idea Cellular, in which it holds a 4.76 per cent stake.

If Grasim does away with the hold­ing structure, the company’s share­holders would reap rich dividends, because they would get the shares of UltraTech too. Aditya Birla Nuvo, another Aditya Birla group company, also functions as a holding com­pany for many of its businesses, such as finance, insurance and broking, as well as retail (Madura Garments), including brands like Van Heusen and Louis Philippe. It also holds a 23 per cent stake in Idea. If Aditya Birla Nuvo decides to demerge the businesses into various verticals and give shares of each business vertical to its sharehold­ers, it can unlock huge value for them, as each of the businesses has become quite valuable on its own.

In developed countries, there are instances where minority share­holders have forced companies to either split the business or sell it. “The shareholding pattern of compa­nies in India gives little headroom to investors to force moves like restruc­turing. The controlling shareholder will eventually take this call. This is in contrast to the west, where inves­tors have successfully fought for the break-up of companies like Motorola, eBay and Yahoo,” says Amit Tandon of proxy advisory firm, Institutional Investor Advisory Services. But many times there are genuine reasons for companies to keep various businesses in one company initially with later plans to demerge the same. As time passes even promoters forget about the splits or demerger of the business as they don’t wishes to disturb the

existing structure. “You can make an argument for a new business to be housed as a division within an exist- | ing company – it can be more cost effi- 5 cient through sharing resources and manpower. However at some time ‘value’ must be realised – unless there are strong forward and backward linkages. This can happen, through sale of (part or the entire) business, or through a restructuring by listing the two businesses – as we have seen in Max and the revised structures in Crompton Greaves,” adds Tandon.

Reverse route

There are instances where a com­pany has taken the reverse route too. One such case is the Vedanta group, which made Sesa Sterlite its holding company for the various group com­panies. But the shareholders were not happy with this kind of structure and, hence, the company has not been able to outperform the broader market. Similarly, ITC too has many businesses housed within one com­pany and there seems little possi­bility of these businesses getting demerged into various verticals.

However, ITC may like to hold on to this structure for the foreseeable future, as it helps it shed the image of a tobacco-stained company. Inves­tors don’t mind the holding company structure, as long as the company is able to generate wealth for its share­holders, which has been case with ITC. Problems arise when the com­pany underperforms the broader mar­ket, doing an injustice to minority shareholders.

Similarly, institutions like HDFC, where there are no identifiable pro­moters, may continue to hold on to this structure, as it allows various verticals to use HDFC brand equity in their businesses. What is in HDFC’s favour is the fact that despite its hold­ing company structure, the company has been able to generate wealth for its shareholders, which makes them happy with the way the company is performing. Hence, despite the holding company structure, HDFC does not suffer from any substantial holding company discounts.

In the case of corporate giant Reliance Industries, its various new businesses like retail and telecom have little synergy with its petro­chemical and refining business. But retail is in a growth phase and the telecom business is about to be rolled out. The holding company structure works only as long as new businesses need initial funding and support. Once they gather critical mass, they should be demerged and allowed to grow at a rapid pace, which would benefit shareholders and also improve the image of the promoters. There is a probability that Reliance may offer shares of retail and telecom to its shareholders to unlock value from them, ril had done this in the past too, when it gave shares of its tele­com, financial and power genera­tion & distribution businesses to its shareholders in 2005-06.

Going forward, many companies are likely to take the demerger route to unlock value for the shareholders. This may be more a compulsion than a choice for many promoters, as the pressure to perform and win inves­tor confidence would be the name of the game. Such activities gather pace in a rapidly rising market as mar­kets would push and incentivise pro­moters to be more investor-friendly. There is reason to believe that com­panies like Grasim, Aditya Birla Nuvo and Sundaram Clayton will move away from their holding struc­ture to create wealth for their share­holders. This would be good news for minority shareholders.

♦ SUNIL DAMANIA [email protected]

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