Some intermediate gains aside, CESC Ltd’s shares have largely been somewhat cool to its demerger plan. The stock is down 7% from its demerger announcement last year against a 3% gain in NTPC Ltd and a 13% rise in the Sensex. Over the weekend, CESC said it will see a three-way split instead of the initial plan of a four-way demerger, as more approvals are awaited. The company set 31 October as the record date.
The retail and other ventures businesses will be demerged as planned and are expected to be listed before mid-December. The electricity generation and distribution businesses will await approvals and operate under the listed entity.
The delay in separation of the generation and distribution businesses has come as a dampener. The creation of a pure play distribution firm with a higher return profile was expected to unlock significant value for shareholders. With the process now delayed, the power business may not get the desired valuation multiples, says ICICI Securities Ltd.
Still, ICICI Securities adds that CESC’s loss-making retail business has seen a notable improvement in its financial performance after the initial demerger announcement. It has turned profitable at the operating (earnings before interest, tax, depreciation and amortization) level last fiscal year and the unit is returning to growth.
What’s more, reports say that CESC is in talks to sell a stake in the unit. These talks come at an opportune time. A stake sale will help the company set a valuation benchmark for the retail unit before listing.
What CESC lacks are positive triggers in its power business. The Chandrapur power plant lacks enough long-term power purchase agreements (PPAs) to curtail losses in the long run, though it has secured a short-term PPA that will reduce losses in the near term.
The lack of clarity about long-term loss reduction is a drawback. “We believe that the existing CESC (comprising distribution and generation business) may not unlock the desired value, especially for its distribution segment, unless it is further demerged. This is primarily due to the risk associated with its loss-making Chandrapur project, which lacks long-term PPA for 300 mega-watt of its capacity," Emkay Global Financial Services Ltd said in a note.
“Accordingly, we now revise our FY20 P/BV multiple for its Kolkata distribution segment to 1.9 times, a discount of 14% to the earlier multiple of 2.2 times, and to 2.7 times for its Noida business vs the 3.3 times earlier."
Thus, while the demerger should help shareholders monetize CESC’s investments in the retail business, the partial demerger and lack of an earnings trigger for the power business are a drawback.