ITC's demerger plan disappoints investors, market value dips

The proposed structure disappointed investors, sending the share price plunging 3.87% at the end of trading on Monday. (Reuters)
The proposed structure disappointed investors, sending the share price plunging 3.87% at the end of trading on Monday. (Reuters)


The firm’s shareholders will own 60% of the new entity directly

MUMBAI : ITC Ltd, India’s largest cigarette maker, said its board approved a proposal to separate its hotels business to unlock value and foster focused growth, a move awaited by shareholders for long.

Under the new scheme, shareholders of the cigarette-to-hotel major will own 60% of the demerged entity directly and the rest through their shareholding in ITC. The proposed structure disappointed investors, sending the share price plunging 3.87% at the end of trading on Monday.

Before the announcement of the demerger, ITC briefly surpassed Hindustan Unilever Ltd (HUL) as the most valuable Indian packaged consumer goods company, with a market value of 6.22 trillion against HUL’s 6.12 trillion.

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Graphic: Mint

ITC’s scheme of arrangement will be presented for board approval at the next meeting scheduled for 14 August.

ITC said the demerger would help the new entity attract “appropriate investors" and “strategic partners/collaborations" whose investment strategies and risk profiles are aligned more sharply with the hospitality industry. “In addition, it will unlock the value of the hotels business for the shareholders by providing them a direct stake in the new entity along with an independent market-driven valuation thereof," it said.

“The proposed demerger is a testament to the company’s commitment to creating sustained value for stakeholders," said Sanjiv Puri, the chairman of ITC. “The creation of a hospitality-focused entity will engender the next horizon of growth and value creation by harnessing the exciting opportunities in the Indian hospitality industry. In the proposed reorganization, both ITC and the new entity will continue to benefit from institutional synergies," Puri said.

While experts have acknowledged the potential for unlocking shareholder value through a direct stake in the new entity, many noted that the move might not fully meet investors’ expectations.

The demerger of the hotels business resulted in investors booking profits in line with the market dictum of buying the rumour and selling the news, analysts said. The stock, which rose one-way over the past year, fell from a record high of 499.7 to 471.35 at closing, down 3.89% from its previous closing. The stock has risen 56% over the past year.

ITC’s decision to hold 40% of the new unit was the immediate trigger for selling the stock, according to Ambareesh Baliga, an independent market consultant, who termed it a “knee-jerk reaction" coming after a “stupendous rally".

Hormuz Maloo, the director of AFco Investment Services Pvt. Ltd and an ITC shareholder, said ITC probably decided to hold 40% in the new entity to wield the “controlling premium" to avoid the other big shareholder, British American Tobacco (BAT) Plc from selling its share in the hotels business to a third party.

“BAT is not interested in the non-core businesses and would likely sell off its portion in the new entity to a third party, which is why I think the company decided to hold 40%, unlike in other demergers," Maloo explained.

Prashanth Tapse, senior vice president and research analyst at Mehta Equities, said, “ITC’s hotel business demerger approval may unlock shareholder value with a direct stake in the new entity, but it disappoints some street expectations."

He added that clarity on the scheme of arrangement is awaited until the board meeting and cautioned that the stock faces technical pressure, with a close below 468 potentially bringing more challenges, while long-term support near 450 levels warrants caution and observation for potential volatility.

ITC operates over 120 hotels spread across more than 70 locations. The hotel business contributed 2,585 crore, or just 4% of the company’s overall top line in FY23, with an Ebit (earnings before interest and taxes) of 541.9 crore and an Ebit margin of 21%.

Over the last decade, the hotel business has contributed under 5% of revenues and Ebit of ITC. However, it has been a drag on the company’s balance sheet, as it has accounted for more than 20% of ITC’s capex in the past. The hotel business has a 22% share in segmental capital employed as of March-end.

Experts said the hotel business has remained a cash guzzler, and high capex has always been a bone of contention for investors. “In our view, this is a healthy balance between giving enough freedom and also ensuring that the hotel business continues to get the institutional synergies from the bigger entity. Overall, the impact is very limited because the main SOTP (sum of the parts) comes from the cigarette and FMCG (fast-moving consumer goods) business, but this was a key concern that such a low RoE (return on equity) business and almost 20% of the capex was going here. Also, the hotel was a very volatile business, and those issues will go away. Investors who want the hotel business can play that, and investors who want to play the consumer-facing business of FMCG, essentially cigarettes and FMCG, will get a separate entity. So, step in the right direction in our view," said Abneesh Roy, executive director, Nuvama Institutional Equities.

Meanwhile, ITC has been increasingly focusing on an asset-light strategy, and today, slightly over half of the room inventory is through management contracts, while the rest comes from owned hotels.

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