Moneycontrol Pro Panorama | A demerger made in heaven

The demerger may not significantly impact revenue, but analysts anticipate that it will enhance profitability.

Dear Reader,

In 2004, when ITC Hotels was merged with ITC Ltd, questions abounded regarding the strategic rationale behind the merger. Prior to this consolidation, the hotel business was jointly owned by ITC Ltd and ITC Hotels Ltd, a separate listed entity, along with its subsidiaries. This merger, effective April 1, 2004, also included the integration of Ansal Hotels Ltd with ITC Ltd.

Fast forward to August 2023, ITC Ltd received board approval for the demerger of its hotel business, including the continued use of the ITC brand name. This move, ostensibly aimed at unlocking value and enhancing focus, has met with resistance.

Proxy advisory firm Institutional Investor Advisory Services (IiAS) has advised shareholders to vote against ITC's proposal to demerge its hotel business into a newly formed ITC Hotels entity. According to media reports, IiAS has raised concerns about the demerger's strategic and financial implications, urging shareholders to reconsider the proposed restructuring.

The rationale behind the advisory firm's position is that ITC will retain a residual 40 percent stake in the demerged entity, effectively preventing shareholders from making a complete exit. The firm is not fundamentally opposed to the demerger itself but advocates a vertical split, ensuring the new business operates independently without financial support from the parent company.

ITC Hotels has significantly benefited from ITC's support. Over the past two decades, ITC Hotels has expanded its portfolio from 4,472 rooms in FY03 to 11,600 rooms in FY23. Additionally, revenues from the hotel division have surged from Rs 349 crore in FY03 to Rs 2,689 crore in FY23. Despite this growth, the hotel business still constitutes only 3.8 percent of ITC's total revenue, which is predominantly driven by its FMCG and cigarette businesses.

The hotel business is not a significant portion of ITC's overall operations. While it contributes 3.8 percent to the company's revenue and 5 percent to its EBIT, it accounts for a substantial 20 percent of the capital employed. Analysts have valued the hotel business between Rs 14 to Rs 18 per share, representing about 3 percent of ITC's share price.

Separating from the parent company could provide the hotel's business with a clearer focus. An independent board and access to alternative funding sources could potentially accelerate its growth. Over the last two years (April 2022 to March 2024), ITC has opened 24 hotels and plans to open 27 more in the next two years (April 2024 to March 2026). Embracing an asset-light model, similar to other companies in the hospitality sector, ITC Hotels is focusing on management contracts across its brands, including Mementos, Welcomhotel, Storii, Fortune, and WelcomHeritage. The company anticipates phased openings in the coming quarters, underscoring its commitment to expansion and growth.

For ITC, the demerger may not significantly impact revenue, but analysts anticipate that it will enhance profitability. Post-demerger, ITC's Return on Capital Employed (RoCE) and Return on Invested Capital (RoIC) are projected to increase by 10 percent each.

For ITC Hotels, the timing of the demerger is ideal. With tourism on the rise in India, ITC Hotels is well-positioned to seize this opportunity. The business will benefit from a focused and agile management team, as well as open access to capital.

Private equity funds, previously hesitant to invest in the hotels segment due to its integration with ITC, can now target their investments specifically at ITC Hotels. This new-found independence is expected to attract significant investment and drive growth.

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