ITC Demerger: Everything you need to know

The long-awaited breakup that the industry has been anticipating is now on the verge of occurring. ITC, the diversified conglomerate, has finally made the big move - announcing the demerger of its hotel business segments. 

Investors, known for their cautious nature, might be a bit worried about how the demerger will play out. 

• What will be the financial impact of the demerger? 🤔
• What is the purpose for this demerger? 🤔
• What are the details that one must know? 🤔
• Also, why is the share price is not reflecting the positive vibe? 🤔
• The overall strategy behind the move could be creating uncertainty, right?

Do not worry, I have all the solutions! Consider me to be your personal genie🧞ready to address all of your concerns regarding the demerger. 

First things first, let's quickly review the current state of ITC. This well-known corporation is a significant player in a number of industries,and the number is big!

About ITC

Fast Moving Consumer Goods, Hotels, Paperboards and Packaging, Agri Business, and Information Technology are just a few of the industries in which ITC works. The company is recognized as one of India's most valuable corporations, below is the graph with past five years’ Revenue and the Profit After Tax 👇.

Now that we have a better understanding of the company's overall income and profit, let's examine the segment-by-segment breakdown to comprehend the profits produced by their hotel division.

ITC's FMCG and Agri sectors have historically generated the majority of their revenue, whereas the hotel industry has contributed significantly less to their overall earnings. Despite this, there has been continuous discussion about the hotel industry within the company.

The move aims to unlock the true potential of the hotel business and pave the way for growth in both the consumer and hospitality sectors. With a focus on enhancing its core areas, ITC looks forward to nurturing the newly formed entity, ITC Hotels Ltd. This action aims to give the hotel industry focused attention and uncover all of its possibilities.

Despite facing challenges due to the pandemic, the Indian hospitality industry has shown a strong bounce, experiencing significant improvements in room rates and occupancy levels, as reported by ITC.

Currently operating in over 70 destinations and managing a portfolio of more than 120 hotels, ITC Hotels Ltd. has the potential to leverage its position in the hospitality sector and embark on a promising journey of growth and success. A simple strategy that the company has been using and will use in this case, will be to enhance its capital allocation strategy of focusing on assets and offering higher dividend distribution.

The strategic rationale behind the demerger

The decision to demerge was made for a number of tactical reasons:

1. Independent Growth Path: The hotel business has matured and is now ready to pursue its own growth path as a separate entity. By doing this, it will be able speed up its growth and capitalise on ITC's institutional advantages and strong brand image.

“The proposed demerger of the Hotels Business is testament to the Company’s commitment to creating sustained value for stakeholders. 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," said Sanjiv Puri, Chairman, ITC.

2. Focused Growth: Establishing a separate company that is only concerned with hotels enables a more focused strategy to take advantage of particular market dynamics in the hospitality sector. This guarantees a more focused approach to corporate operations and creates the foundation for ongoing shareholder value development.

3. Optimal Capital Structure: The new entity will operate with an ideal capital structure, enabling it to raise funds for growth either through equity or debt markets. By attracting the appropriate investors, business associates, and partnerships, the hospitality sector's investment objectives and risk profiles will be more closely matched.

4. Value Unlocking: The demerger aims to unlock value for ITC shareholders by providing them with a direct stake in the Hotels entity. The new entity's valuation will be driven by market forces independently. 

And ITC will continue to access cross synergies which means that after the demerger, the two entities can still benefit from shared resources and services. 

ITC Hotels Ltd. be like “Bhagwaan ka diya sab kuch hai, Daulat hai (dedicated capital 🤑), Shauhrat hai (ITC brand recognition), Izzat hai (competitive edge)”

Details about the demerger

Here's a simplified explanation of the demerger plan:

1. Shareholder Ownership: After the demerger, ITC shareholders will hold approximately 60% direct stake in the new Hotels Co., in proportion to their existing stake in ITC. The remaining 40% stake in the hotel business will continue to be held by ITC. This means the economic interest that ITC shareholders have in the Hotels Business will remain unchanged.

2. Transferring Assets and Employees: Assets, liabilities, contracts, and employees that are part of the Hotel business will be transferred to the Hotels Co. This ensures a smooth transition and allows the new entity to operate independently.

3. Use of 'ITC' Name: The Hotels Co. will be given a license to use the 'ITC' name as part of its corporate name and some of its properties' names, subject to customary conditions.

4. Approval Process: The proposed demerger plan is subject to the final consideration and approval of the Board of Directors and its Committees, based on inputs from advisors. If approved by the Board on August 14th, the demerger scheme will then need to be approved by shareholders, creditors, stock exchanges, SEBI, NCLT, and other regulatory authorities, as required.

Aspects of the demerger that were covered in the investor presentation

The company's management made a number of interesting comments during the investor presentation regarding the demerger and its prospective effect on the company's financial performance.

First off, it is predicted that the demerger will improve the company's financial ratios. This shows that creating separate legal entities for the business might improve its efficiency and financial health.

Second, with an anticipated growth of 18% to 20%, the segment Return on Capital Employed (ROCE) is predicted to experience a significant improvement. This suggests that the demerger will probably release value and raise the profitability of the various company sectors.

The newly created firm as a result of the demerger will furthermore have access to priceless goodwill and brand assets. This customer-centered strategy is likely to give the company stability and encourage prospects for faster expansion, which may be good for shareholders and potential investors.

The demerger has been carefully planned by the management to benefit the current shareholders. This suggests that the business unit is organised with their needs in mind, hoping to add value and possibly raise shareholder returns.

The new firm will start its activities with a healthy balance sheet and good free cash flow, which is another benefit of the demerger. If further funding is needed, this strong financial basis could help and could be seen favourably by investors.

Overall, the demerger strategy chosen by the management seems to hold promise for the future success of the business and the interests of its shareholders. It exhibits a customer-centric strategy and a concentration on releasing value to fuel future growth. 

However, as with any significant company decision, the final results will rely on how well it is carried out and how the market is behaving. To determine the genuine impact of the demerger on the performance of the company, investors should actively observe the demerger's development.

The Bottom Line

The demerger is anticipated to help the new business by attracting strategic partners and investors with investment strategies and risk profiles that are closely linked with the hospitality sector. Additionally, it will enable the Company's shareholders to access the value of the Hotels Business by giving them a direct ownership in the new independent entity, whose valuation will be determined by market forces. This tactical movement further supports the company's more focused capital allocation strategy, which is best illustrated by the recent change in the Hotels Business to a "asset-right" approach.

Additionally, before we part ways, be sure to check back here to learn more about the demerger as the company will be holding a conversation on the topic on July 27. As promised, we'll make sure to send the information as soon as it is available. 

Who needs Netflix when the stock market drama is available? Keep checking back till then since ITC's journey has just started a new chapter.

*Disclaimer: The stocks and companies discussed above aren't a recommendation from Insider by Finology and shall not be construed as a replacement for professional advice. Consult a professional or conduct the necessary research before making investment decisions.