In the lifespan of a typical business, companies often start as single entities, focusing on one primary product or service. As they grow, they may diversify into additional ventures, which start as small units managed within the existing corporate structure to minimise administrative costs and complexity. However, as businesses expand, they often reach a point where their operations, financial performance, and market conditions make it essential and beneficial (from a tax and growth perspective) for stakeholders to demerge them into separate legal structures. This is often done through corporate actions such as spinoffs, divestitures, hive-offs, or equity carve-outs, also known in common parlance simply as a ‘demerger’. It provides several benefits, including greater shareholder value, operational efficiency, and sectoral specialisation.
Dhanendra Kumar, Chairman of Competition Advisory Services India LLP
Why Companies Demerge?
One of the key reasons for demergers is the recognition that different business units may have distinct strategic needs. Indian companies across sectors—from pharmaceuticals to infrastructure—are increasingly adopting demergers as a strategic move to unlock shareholder value. The rationale behind demergers is to create focused entities, each with its own strategic direction, better resource allocation, improved management oversight, and, ultimately, higher profitability.
For instance, Reliance Industries, a conglomerate with interests ranging from petrochemicals to retail, decided to demerge its financial services business in 2023. This allowed the demerged unit to focus on its own growth trajectory, attract dedicated investors, and operate under a regulatory framework more suited to its industry. Larsen & Toubro (L&T), a diversified conglomerate, has also undertaken several demergers to streamline its operations.
Take the example of Raymond Limited, a diversified group with interests in textiles, apparel, consumer care, realty, and other sectors. The company has proposed a demerger with the objective of unlocking value for shareholders through the creation of sector-focused entities. Under the scheme, the listed entity—Raymond Ltd—will demerge its lifestyle business into Raymond Lifestyle Ltd (RLL), offering investors a choice to invest in a pure-play lifestyle company, counted amongst the top players in this segment globally. Investors will also get exposure to its wedding business, which is a unique proposition in India in terms of its target addressable market. The demerger also involves the amalgamation of Raymond’s consumer trading arm with RLL, creating more focused entities. Considering India’s focus on boosting domestic consumption, reducing imports, and expanding the GDP beyond $5 trillion, the demerged entities will be better placed to cater to separate markets.
Mining major Vedanta Limited is also on track with its demerger plans that will result in the creation of six independent “pure play” companies once the demerger is approved by stakeholders. Under Vedanta’s proposed demerger scheme, shareholders holding one share of Vedanta Limited will additionally receive one share of each of the five newly listed companies. The company’s demerger rationale is that each independent entity will have greater freedom to grow to its potential via an independent management, capital allocation, and niche growth strategies. Vedanta’s demerger will also simplify the corporate structure and create sector-focused independent businesses that will provide investment opportunities to Indian and global investors.
Unlocking Shareholder Value
Demergers are also driven by the need to enhance shareholder value. When a company is diversified across unrelated industries, its stock price may not fully reflect the value of its individual business units, something also known as the conglomerate curse. By demerging, the company can create separate entities that are easier for investors to evaluate, leading to long-term value. For instance, throughout more than eight decades of its existence, the original Hewlett-Packard Company (HP) demerged or spun off businesses at various junctures. In 2000, it completed the separation of its medical, analytical, and semiconductor businesses, leading to the creation of Agilent Technologies. Conglomerates like General Electric, DuPont, United Technologies, and others have also undergone similar exercises.
Demerging allows each business to cater to its specific sector, derive benefits from various growth cycles, and maintain exclusive focus. In the case of Raymond, the demerged businesses catering to lifestyle and other sectors will help attract investors with matching knowledge and appetite. Similarly, Vedanta’s demerged businesses will individually focus on their respective sectors—aluminium, oil and gas, power, base metals, and steel and ferrous metals. As sectors have their ups and downs, the separation of businesses will provide adequate exposure.
In today’s dynamic corporate environment, where agility and focus are crucial, demergers have proven to be a potent tool for Indian as well as global companies seeking to enhance shareholder value. By allowing companies to concentrate on their core competencies and create more focused business entities, demergers facilitate better management, improved operational efficiency, and increased profitability. As India Inc. continues to embrace this strategy, shareholders stand to benefit from the significant value unlocked through these carefully executed restructuring processes. Far from being a passing trend, the surge in demergers reflects a strategic evolution that aligns with the needs of modern businesses and their stakeholders, ensuring sustained growth and profitability in a competitive market.
(Dhanendra Kumar is the First Chairman of CCI, former Executive Director at World Bank for India, Sri Lanka, Bangladesh and Bhutan, and Secy. GoI. He is currently Chairman of Competition Advisory Services India LLP)
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
First Published: Aug 28 2024 | 11:43 PM IST