MC Explainer: Are ITC investors overreacting to the BAT stake sale news?

ITC

ITC’s shares are falling sharply today, Thursday, February 8, and were down by around 4 percent at 3.30 pm. The immediate provocation is major shareholder BAT announcing that it intends to sell some of its stake in the cigarettes-to-flour major. Investors appear to have taken fright at the possibility of a flood of shares in the market that could put pressure on the share price. Are their fears well-founded? Here are some of the main issues at stake.

What has BAT said about its plans to sell its stake?

BAT said, after declaring its quarterly results, that it regularly reviews its stake in ITC, that it has a significant shareholding, and that offers it the ‘opportunity to release and reallocate some capital’. BAT has a 29.03 percent stake in ITC although it is not classified as a promoter. ITC is one of the few companies, and L&T is another, that does not have an official promoter. LIC is another major shareholder, with a 15 percent stake.

This is not the first time that the stake sale news has emerged. In December 2023, in a conference call, an analyst posed a question to the management whether they plan to sell their stake in ITC. In response, the company management had said that ITC has been a well-performing company, done well on the bourses but is still undervalued compared to its peers.

How much stake does BAT intend to sell?

In the December call, BAT said that it does not need more than a 25 percent stake to have a strategic influence over ITC, including veto rights. Since it has a 29.03 percent stake, it gives it the ability to sell a 4.03 percent stake and that translates to a value of around Rs 21,000 crore at current prices. Going by this statement, it would appear that BAT intends to retain a 25 percent stake. If that’s the case, then the market’s reaction does appear to be over the top, as there should be enough interest among a wide range of investors to buy the 4.03 percent stake that BAT may seek to sell. Additionally, BAT may spread this over a longer period to minimise the impact on its shares of additional liquidity.

However, there is a catch.

Why BAT needs regulatory approval to sell its stake in ITC

The BAT management, in December, had made it clear that it’s not easy for them to divest their stake in ITC, despite their willingness to do so and raise some funds. There are two major pain points, the company said. One is the Indian government’s ban on FDI in tobacco. While that may not prevent them from selling their stake to domestic companies, BAT’s management said that not being able to sell to international companies will limit the universe of buyers. The implication is that a smaller set of potential buyers and the high value of the tranche on sale could result in an unacceptable discount. The other pain point it spoke about is the permissions required from RBI for any action about their stake, again likely linked to the ban on FDI in tobacco.

If this was already known in December then what is new now? Nothing has changed, officially speaking. But BAT’s release says: “We have been actively working for some time on completing the regulatory process required to give us the flexibility to monetise some of our shareholdings and will update you at the earliest opportunity.”

What this implies is that BAT has been making efforts to find a solution to their problem and the wording implies they have made some headway in finding a solution or at the least, the door has not been slammed shut on their faces on this request.

What happens next?

BAT’s management confirmed in a conference call today evening, that they are not seeking to lower their stake to below 25 percent at this point, as that is the minimum they need to retain influence as per local laws. That means a 4.03 percent stake is what is likely to be offered if they get approvals. They have been working hard at the process. Because they have a shareholding going back to the 1900s, they are tracing its evolution and history and there have been inorganic events such as acquisitions and then bonus issues. Therefore they are working with ITC (to get the paperwork in order) but also with relevant authorities such as the RBI to secure approvals. But, they also said they have no visibility on the timelines. The two conclusions that follow is that the current intention is not to sell beyond a 4.03 percent stake and secondly, that there is no timeline. However, the uncertainty on whether they will get approval to sell it to foreign investors or will have to sell to domestic investors, and whether this event opens the door for future stake sales will remain.

Should shareholders be really worried?

There is one scenario that investors fear the most. If the stake goes into the hands of portfolio investors –such as mutual funds or foreign funds—then it adds to the floating stock, leading to more shares being traded. In the short run, more supply of stock can be seen as a negative but in the longer run, the stock’s fundamentals should play a bigger role in the stock’s valuations. Also, note that Rs 21000 crore of shares being sold on a market cap of Rs 5.2 lakh crore does not appear that significant of a dilution.

But if they intend to sell a higher stake or if investors perceive this development as opening the door to future stake sales, then these could prove to be an overhang over the stock.

However, another scenario can calm their frayed nerves. If BAT manages to get the flexibility to sell a 4.03 percent stake to international companies, who come on board as strategic investors, then investors are likely to view it more favourably. A strategic investor will hold its investments as a long term holding and is unlikely to seek an exit in the short to medium term, or even long term.

For now, it’s a wait-and-watch for ITC’s investors.