there are rumors that ITC Ltd. had been looking to spin off its hospitality division for some time, and on Monday the group announced the development.
The hotels division of the diversified conglomerate will be demerged under a scheme of arrangement with the stake in the new company allocated proportionately. That is, ITC as the lead company will hold approximately 40% stake in the new entity, and the remaining 60% will be allotted to shareholders in proportion to their existing shareholding in ITC.
Following the news of the proposed demerger, ITC stock immediately fell over 4%, while the market welcomed the news.
Let’s uncover this apparent contradiction.
The hotels and hospitality business was an integral part of ITC, which will now directly own only 40%. Hence the revenue and profit from that segment ceases to reflect directly in the accounts of ITC.
But ITC will retain management control as the largest shareholder with 40%. The largest shareholder in ITC itself is the giant multinational company BAT, which holds about 29% of ITC. Therefore, BAT should own the other 29% of the new entity. Therefore, the operational control will remain with ITC Group and ITC will receive dividend from the new entity, if any, and report its share of profit from the new business in its P&L account.
Making several assumptions, this means that investors get a good deal. A scheme of arrangement has to be approved by the shareholders and the court – let’s say this happens and then the new company has to be listed separately.
This means that anyone holding a stake in the new listing will see the value of the hotel business reflected directly in the price of their shares, whenever it happens. Investors who do not want any part of cigarette and agri-business can buy only hotel business and vice-versa.
It is a reasonable assumption that the market value of the new entity will be higher than the current impact on the share price of ITC from the demerger and that going forward, the market value of ITC plus the market value of the hotel business will be higher.
ITC is a huge conglomerate. In FY23, it reported a net revenue of 65,427 crore, operating profit (Ebitda). and net profit of Rs 23,944 crore 18,753 crores. It has several related business segments and some unrelated business segments.
The Fast Moving Consumer Goods (FMCG) division includes cigarettes and other products and contributes 61% to the topline. There’s the agri-division, and the paperboard and packaging division, which together contribute 35%. All these are related to each other. Raw materials for cigarettes include tobacco (a cash crop) and paper (an agricultural product) and the company naturally moved into other agri-businesses and other FMCG products and packaging as it sought to integrate and gain control of its supply chain from behind.
The hotel is inherently not conducive to paper, agri-products, cigarettes, and so on. Hotels Division Contributes 2,585 crore in revenue and 542 crore in profit before tax and Rs. 832 cr in operating profit in FY23. The department had reported the loss Its revenue in FY22 was Rs 183 crore 1285 crore and operating profit 78 crores. Year-on-year comparisons are not very useful because of the pandemic.
But company presentations said revenue per available room is above pre-Covid levels in FY20, and operating profit has almost doubled since then. Operating margin till Q4 FY23 was around 35% and for FY23 it was 32%, which was much up from FY20 margin of 23-24%. Growth is being driven by retail, leisure spending and weddings and a “healthy pipeline of management contracts under the WelcomeHotel, Mementos, Story and Fortune brands” with new openings phased in for the next few quarters.
The company used the pandemic period to permanently cut costs. The operating margin is in the same range as the leading listed hotel stock, Indian Hotels, which had an operating margin of 32-33% for FY23. As a standalone listed company, the new hotel entity should get valuations at par with the market leader.