Merger or demerger—what's the better route to unlock value?

Is one route better than the other for achieving broadly the same goal?
Is one route better than the other for achieving broadly the same goal?

Summary

Tata Motors has announced that it will split its passenger vehicle and commercial vehicle divisions into two separate entities. Reliance and Disney, on the other hand, have chosen to try and unlock value through a mega merger. Which route is better?

Tata Motors Ltd, a $42-billion firm, has announced its decision to split its passenger vehicle (PV) and commercial vehicle (CV) divisions into two separate listed entities. On the other hand, Reliance Industries Ltd and Walt Disney Co. last month announced the merger of their television and media assets in India to create an $8.5-billion entertainment powerhouse.

The two groups have chosen contrary routes to unlocking value and scaling up—increased focus through a demerger, and increased scale through a merger. Is one better than the other for achieving broadly the same goal?

The advantages of the demerger are quite evident. While it would cushion Tata Motor's passenger vehicles business from the cyclical nature of the commercial vehicles market, the overall PV market is moving in a different direction—up the value chain. 

This is especially so for a company like Tata Motor's British subsidiary Jaguar Land Rover, with electric and autonomous vehicles that would require a completely different strategy for growth. 

The new market dynamics will require agility in a company and dollops of cash, which a demerger and listing could bring in.

Also read: Tata Motors business divisions come to a fork in the road

On the other hand, the combined entity of Disney and Reliance will create a mega joint venture in which Reliance will inject 11,500 crore for a 63.16% stake, while Disney will have 36.84% stake.

The new company is expected to have a 40% share of the Indian television entertainment market by attracting an estimated 750 million Indian and non-resident Indian viewers.

Valuing the struggling Disney India at about one-fourth of its prior valuation in 2019, the merger will give it succour to perform better in one of the fastest television content consumption markets without having to contend with the mighty RIL as a competitor.

Also read: All you need to know abou the $8.5-billion Disney-Reliance merger

But make no mistake—mergers are nerve-racking. Several studies, including from McKinsey and Harvard Business Review, show that 70-90% of all mergers worldwide fail. Some of the most common reasons for these failures are cultural dissonance, poor process failures, overpaying, and insufficient due diligence.

Cultural dissonance is magnified when a merger is between entities across borders. The biggest merger failures of all time are Time-AOL, Daimler-Benz, and Chrysler and Alcatel-Lucent. 

Indian companies have had their share of disappointments on this front, too (IDFC-Shriram Finance, Rcom-Aircel and Flipkart-Snapdeal). Yet, companies risk a high chance of failure for the transformative value that successful mergers can bring.

On the other hand, despite the many benefits that demergers can bring, these too have their share of challenges. 

Even though shares of Tata Motors hit a record high on news of the demerger, one of the key difficulties in the medium term will be growing the commercial vehicles business, which currently accounts for only 21% off the company's overall revenue. The remaining 79% is from the passenger vehicles business, with JLR contributing a significant portion.

While the demerger will benefit the passenger vehicles business, the new commercial vehicles entity will need heavy lifting from the Tata group.

Additionally, Statista figures show that between 2024 and 2028, the commercial vehicles market is expected to grow at just 0.01% a year. A flat market could pose a challenge to scaling up this business, whereas a combined business would have allowed the two divisions to lean on each other.

So while there are significant risks in both mergers and demergers, corporations continue to engage in these. After all, risk is a factor that India Inc increasingly needs to appreciate.

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