Demerged entities: Value creators

Historical trend shows these companies have given handsome returns to investors after listing, in most cases

Demergers and subsequent listing of subsidiaries is a trend picking up in India, as well as globally. There have been demerger announcements by global metals and mining giant BHP Billiton and domestic companies  Crompton Greaves and Max India, among others in recent times.

BHP Billiton plans to demerge to simplify its existing businesses from 41 assets to only nine in five key areas, Crompton will demerge its consumer durables business (fans, lights, etc) and Max will de-merge its businesses into three entities -- life insurance, general insurance/health care and speciality films.

What reasons drive these demergers? Greater focus on each of the entities formed and unlocking of shareholder value are some reasons. BHP Billiton Chairman Jac Nasser said recently, “The demerger will simplify BHP Billiton and has the potential to unlock shareholder value, while creating a new global diversified metals and mining company with a significant industry presence in each of its major commodities.”

Such restructuring is more in vogue during tough times than in boom years and the move seems to be prompted by plunging commodity prices. Despite the division, BHP will remain the world’s largest miner.

Historical data over recent years for demergers in India suggests they resulted in significant value unlocking for both parent and demerged entities (see table). Over the past three years, companies that have been listed after demerger from their parents have generated handsome returns for investors. Of the top 11 demerged entities (by market cap), six scrips have given returns of 112-662 per cent, one has risen 48 per cent and four have fallen by four to 52 per cent.

"History shows demergers and spinoffs in India have huge upside potential, provided they are not misused by promoters to sort out family and balance sheet issues. Investors play the demerger theme before, rather than after, corporate actions. Backed by sound business reasoning, demergers and spinoffs can generate significant alpha", believes Saurabh Mukherjea, chief executive officer, institutional equities, Ambit Capital.

Stocks such as NRB Industrial Bearings, Orient Cement, Star Ferro and Cement, Marico Kaya, Welspun Enterprise and Gulf Oil Lubricants are top performing demerged stocks. Intellect Design Arena, products business of information technology company Polaris, has given 48 per cent returns since listing on December 18, 2014. These companies were demerged for the right reasons, which have aided significant value creation, believe analysts.

Anand Tandon, market expert, says: "Whether demergers work depends on the motivation. If there is a greater focus, a new management team and specialists rather than generalists managing the show, the chances that the business would grow faster is higher. It also helps if you are in a bull market."

In the case of parent companies, though, demergers have resulted in mixed stock performance. Yet, that has to be seen in the light of the fact that the value of the parent is no longer a sum of the parts but of a single entity. If the returns of the parent and demerged entities are taken together, the gains are significant.

Among parent companies, three stocks — Orient Paper, NRB Bearings and Century Plywoods — have rallied the most, by 229-722 per cent after demerging their subsidiaries. Marico, which demerged Marico Kaya in July 2014, has rallied 57 per cent since then. Polaris has run up 43 per cent since December 2014, when its demerged business of Intellect was listed. The scrips of Future Retail and Jindal Poly Films have rallied 36 per cent and 29 per cent, respectively.

On the other hand, the share price of Gulf Oil Corporation, Welspun Corporation and Zuari Global have fallen by four to 36 per cent after demerger. But, if one were to consider the returns of the demerged entity, the total returns are respectable, except in Zuari’s case.

One reason that aids the parent firm’s stock performance is gradual disappearance of the holding company discount. Analysts typically assign a holding company a discount of 15-30 per cent on parent entities holding multiple subsidiaries. The reason, according to Ajay Bodke, a head of investment strategy at Prabhudas Lilladher, is that conglomerates normally trade at a discount due to opacity in capital allocation. After demerger of these entities, this discount disappears and aids stock performance of the parent. Subsequently, the share price tracks the financial performance of these companies.

Going ahead, among larger companies that have scope to demerge and separately list their businesses, thereby unlocking shareholder value, are Reliance Industries, Aditya Birla Nuvo, Mahindra & Mahindra and Larsen & Toubro. However, none of these have mentioned such plans.