We cover why companies go for demergers and what it means for investors.

The News

On 25th Nov, Hindustan Unilever, one of the largest FMCG companies in India, announced the demerger of its ice cream business into a separate listed entity. It owns brands such as Kwality Wall’s, Cornetto, and Magnum.

Interestingly, this isn’t an isolated event. A few months ago, Tata Motors announced the demerger of its commercial vehicles segment (trucks and loaders) from its passenger vehicle business, and ITC too decided to demerge its hotel business.

We often hear companies doing mergers and acquisitions to create synergy and expansion, but why are these companies demerging their businesses into different entities?

Let’s explore the strategy behind demergers and understand why companies go for it.

Decoding Demergers

A demerger is when a company splits itself or some segment of the business to form distinct entities. Let’s understand it with a real-life example.

Imagine you’re fascinated by India’s booming retail industry and want to invest in a company in this space.

You come across Reliance Retail, known for brands like Trends, JioMart, Ajio, and Hamleys. It seems an attractive buy. So you buy shares of its parent company, Reliance Industries.

But then you realize something—Reliance Industries isn’t just about retail. It’s involved in oil, telecom, digital services, textiles, media, and more. Retail is only one part of its massive business.

If your focus is solely on the retail segment, Reliance Industries is no longer an attractive buy anymore because you’re forced to invest in Reliance’s other businesses as well. Likewise, you can not just invest in Jio Telecom separately.

So, what you’d do here? Probably limit your investments or maybe withdraw investments you’ve made in the company.

The same goes for ITC. It operates in FMCG, cigarettes, hotels, agri-business, and even an IT business.

As you’ve observed, it creates two major problems. It limits the valuation of a company and there’s little strategic flexibility to exploit.

The solution? Demerging the different segments into separate business entities.

Why do companies go for a demerger?

  1. Unlocking Shareholder Value
    Demergers create independent entities, allowing investors to assess and invest in the businesses separately. This often leads to better valuation for both the parent company and the demerged entity.
  2.  Attracting Specialized Investors
    A standalone entity can appeal to niche investors who prefer specific segments. For example, Tata Motors’ passenger vehicle segment focuses on EVs might seem attractive than its commercial vehicle segment.

Let’s look at some historical demergers in the recent past and how they have paid off.

Demerger strategies seem to work wonders for companies, don’t they? In the past year, companies have gained more market value after the demerger.

While the growth varies across companies, it looks like splitting up can often boost market performance.

To Conclude

Demergers can be a profitable restructuring strategy, helping companies focus on core operations and unlock more value for investors.

For investors, these events provide an opportunity to reassess their portfolios and align their investments with specific business segments they believe in.