Demerger – The tail part of Merger.
Merger and Demerger can be rightly described as the head and tail part of the same coin .The demerger process is now gaining importance more and more because of the added benefits,so corporate are no more only interested in going for mergers but also are opting for demergers .Mergers have many advantages ,so there is always a question when 2 big giant joining hands bring fruitful result to the entity formed then why the need for demerger .
But there is also an answer to this _ joining is not always better than disjoint and this can be proved by the help of some live examples where bigger giants have disjointed into several segments and the result is very outstanding .My point of writing this article is to go in details about how demerger have been a success and is going to gain more and more success in long run.
What is Demerger actually? What it does specify? --------------
Demerger as the name suggest converse of Merger/Acquisition, where the shareholders or owner of the parent company gains
direct ownership of the demerged entity .Or in other words Demerger refer to the process of the separation of companies or Business units which are operating under one single umbrella .
Below is the explanation of how demerger affects the shareholder’s interest before and after the demerger process.
Figure a before Demerger Figure b shows after Demerger
In simple words when one company, say X Ltd. having 10 undertakings, transfers one or more of its undertakings to a new company, say Y Ltd., it is a case of demerger. X Ltd. is the demerged company and Y Ltd. is the resulting company.
Now we all know that Unity is the diversity, so why then go for demerger .The case is similar to the debate “Joint family Vs Nuclear family”. We all know that a Joint family have lots of advantages regarding all round development of a child ,sharing of thoughts and emotions with each other ,economies of scale by sharing expenses and savings with each other ,better capability to adjust with unforeseen circumstances and many more .But it is also true that all that sounds well is not necessary well all times .So the popular proverb – “Two utensils bought together will definitely produce sound” The same theory may apply here so the process of demerger .But this is probably one of the reason for Demerger .
There are obviously various reasons for Demergers which vary from company to company, country to country and industry to industry .But some common reasons may be:
1. To adjust with changing economic and political conditions.
2. Parent company’s inability to maximize return, thus giving chance for others.
3. Correction of any false investment decision made regarding stepping into a totally different field of no expertise.
4. To raise capital gains from the assets acquired at the time of underperformance of the entity.
5. Utilization of financial and human resources for better profitable opportunities compared to the prevailing entity.
6. Selling of unwanted surplus in the business thereby carrying out the restructuring/reorganization strategy and get rid of the sick entity.
7. One more reason for demerger can be facilitating Indian entity to get demerged from the foreign entity with whom it has merged before so that foreign company draws out its investment.
8. Maximization of shareholder’s value –since it is felt that the value of the business when separated will be more than the value of the group.
9. To Focus more on the activities of various business units which is not possible by the giant corporate.(Similar to the proposition of forming a separate state for better administration and development –Jharkand and Bihar ).
10.To get relief from strict government regulations which the entity may face before demerger as a result of other business.
11. Rating of the corporate becomes an easy affair relating to the specific business in which they have the expertise.
12. Changes in IT act 1999, which have made demergers tax neutral have motivated the companies to go for demergers
13. Split between family members lead to the demerger gaining its importance.
Reasons are unending and continue thereafter.
Some of the live examples of Demergers cases which took place in India
1. Demerger of Dabur India in July 2003 – FMCG group and Pharma group -beneficial for both the group – After demerger FMCG Group registered a compounded annual sales growth of around 12 per cent over the past three years, with net sales of Rs 1,048.5 crore and net profit of Rs 72 crore in 2002-03.
For The pharmacy business, on the other hand, net sales have doubled in three years . This division reported a net profit of Rs 13.1 crore on net sales of Rs 184 crore in 2002-03.
Pharma Brand have already 20 % market share in oncology products and have also got various products for exporting to 27 countries.
Reason for the above demerger – better growth for both the entity . The main reason for the demerger was to harmonise strategies, create operational efficiencies and maximize pharma’s penetration into global market the main growth drivers during the fiscal were its globally expanded anti-cancer range of products and brands like Liv-fit, Ulgel, Honitus and Contrastin.
2. Reliance industries –Demerger- August 2005
Reliance Industries, which focuses on exploration and production (E&P), refining and retailing, and petrochemicals is under the chairmanship of Mukesh Ambani and his younger brother Anil took charge of businesses comprising Reliance Communication Ventures, Reliance Energy Ventures, Reliance Capital Ventures, and Reliance Natural Resources.
The reason probably was rift between brothers but the move has benefited both.
Earlier Reliance was basically into industrial products but now with demerger it has entered into other segments like reliance telecommunication with a vision to bring mobile communication to post card cost .And other privates are fighting back to break the image which Reliance mobile have created in the mind of customers by the slogan “karlo Duniya Mutthi Me”.
Even the newer entity under Anil Ambani is trying to tap the untapped food processing segment. Also RIL is making its way into retail industries by developing a model of promoting partnership with farmers ,logistics operations, small shopkeepers ,traders .The demergers have not affected Mukesh’ Petrochemical business and he gained the position of no 1 ranking business tycoon all over the world thereby defeating Bill gates .
3.Demerger of L & T cement division to a new entity CEMCO.The demerger process need to take place in 3 steps .
In the ist phase L&T would hive off the cement business into a separate company, Ultra Tech CemCo, where it will hold 20 per cent. The balance 80 per cent will be held by the existing L&T shareholders proportionately.
In the second phase, Grasim will buy 8.5 per cent in CemCo from L&T at Rs. 342.60 per share and make an open offer for another 30 per cent at the same price.
If fully subscribed, the open offer will make the Aditya Birla group's holding in CemCo to 51 per cent and L&T will realize Rs. 362 crores on sale of its stake in Ultra Tech CemCo.
In the third step, L&T Employee Welfare Foundation will acquire the Birla's 15.3 per cent stake in the residual engineering company.
Various other demergers have taken a row Great Eastern Shipping, which is demerging its offshore business; Eveready Industries separated its tea business into McLeod Russell; Auto ancillary company Rane Madras transferred its investments into separate company and the investment company was also listed. The demerger list also includes Vardhman Spinning and Morarjee Realities.Also demergers of Bajaj Auto group are on the process. Gabriel Indiais also looking at demerging its engine bearings division and may also sell its Mumbai property. Cairn India on the reorganization of Cairn Energy PLC's Indian business prior to flotation.
So now trend is changing,after the long merger process taking place ,demerger is now taking its seat .The main aim behind demerger is to concentrate on the specific business in which they have expertise and allow other business units to raise their own capital .Also we are aware of the concept of “shareholder wealth maximization” which is thereby enhanced more due to demergers than by mergers .
The author is the Finance faculty in INC ,Nagpur and can be contacted at email@example.com