ITC’s Hotel Demerger Explained: An Acceleration of Growth and Value Creation

ITC Ltd, the Kolkata-based conglomerate with a diversified business portfolio, recently announced the demerger of its Hotels division into a separate entity. The move is anticipated to enhance shareholder value by permitting each business line to grow individually. This article will provide an in-depth understanding of the demerger and its potential implications for ITC.

What is a Demerger?

A demerger refers to the corporate strategy of splitting off a section or sections of a company into separate business entities. The decision could be driven by various reasons, such as optimizing operational efficiency, focusing on core business, regulatory requirements, or unlocking hidden value for shareholders.

In the case of ITC, the demerger decision is focused on unlocking shareholder value by allowing the Hotels division to focus on its own operations, capital allocation, and growth strategies.

What is ITC?

Why is ITC and ITC Hotels Demerger Happening? Explaining it to a 8 Grade Student

Imagine if you had a big box of toys, with different types of toys all mixed together. Some of these toys are more popular and some are less so, but it’s hard to tell which is which because they’re all in one box. But what if you could sort these toys into separate boxes based on their types? Then, it would be easier to see which toys are more popular and which ones aren’t. This is similar to what ITC is doing with its hotel business.

The Hotel Business has Grown Up: Just like a teenager ready to go to college, ITC’s hotel business has grown up over the years. It’s now ready to stand on its own two feet, using what it has learned from being part of the big ITC family.

A New Strategy for Growth: After the split, the hotel business can have its own game plan. Instead of owning lots of buildings, it can focus more on managing hotels and providing excellent service, kind of like a football coach who doesn’t play but makes sure the team performs at its best.

More Focus on Hotels: When the hotel business becomes its own separate thing, it can pay more attention to what hotel customers want and need. It’s like when you focus on just one subject for a test, you can do much better in that test!

Easier to Get Money for Growth: With the split, the hotel business can get its own pocket money. It can use this money to grow bigger and better, just like how you might use your pocket money to buy more books or toys.

Better for People Who Own ITC Shares: People who own shares in ITC (think of them as having small parts of ITC) will now also own parts of the new hotel business. They can benefit if the hotel business does well, kind of like how you feel happy when a toy you picked becomes popular among your friends.

In short, splitting the hotel business is like giving it its own room to grow and become better. This can make the hotel business and the people who own parts of it very happy!

Rationale Behind ITC’s Demerger

ITC’s decision to separate its Hotels business aligns with its aim to focus on its core businesses, that include Fast-Moving Consumer Goods (FMCG), Agriculture, and Paperboards & Packaging. This strategy would allow the conglomerate to direct resources and capital towards these segments, facilitating improved growth and profitability.

Simultaneously, the demerger would allow the new entity, ITC Hotels, to operate independently with a dedicated strategy. This strategic move would help streamline operations, allow for dedicated capital allocation, and facilitate faster decision-making processes.

The demerger of ITC’s hotel business into a standalone entity is driven by a combination of strategic and financial objectives, all designed to create sustained value for its shareholders.

Maturation of the Hotels Business

Over the years, the hotel segment of ITC has matured considerably and is well-positioned to chart its own growth trajectory. With a solid foundation and track record, the hotel business is ready to function independently, leveraging ITC’s institutional strengths and brand equity.

Adoption of an Asset-Right Strategy

As a separate entity, the hotel business can adopt an ‘asset-right’ strategy. This approach aims to accelerate growth, primarily through leases, management contracts, and franchises rather than property ownership, optimizing the use of capital and mitigating risks associated with property ownership.

Sharper Business Focus

Post-demerger, the hotel entity can focus more intently on its unique business proposition, aligning its strategies with specific market dynamics in the hospitality industry. This laser-sharp focus could lead to a more significant competitive edge and enhanced profitability.

Optimal Capital Structure and Access to Capital Markets

The demerger will enable the hotel entity to operate with an optimal capital structure, efficiently balancing debt and equity. It will have the autonomy to access equity and debt markets for funding growth requirements, attracting investors, strategic partners, and collaborations whose investment strategies align with the hospitality industry.

Unlocking Shareholder Value

The demerger will unlock value for ITC shareholders in multiple ways. Shareholders will hold a direct stake in a pure-play hotel entity, potentially benefiting from an independent market-driven valuation. The focused new entity is likely to attract more targeted investments, which could drive the share price upwards. Simultaneously, the demerged entities will continue to enjoy cross synergies. The shift towards the ‘asset-right’ strategy and higher dividend distribution will also reinforce ITC’s capital allocation strategy, benefiting shareholders.

In my opinion, the demerger aims to propel the next horizon of growth for the hotels business and create sustained shareholder value by providing it with the freedom to develop its unique strategies, operate with an optimal capital structure, and unlock value through a market-driven valuation.

A Breakdown of ITC’s Revenue

Segment	2023 Revenue (in Crore INR)	Percentage of Total Revenue
Cigarettes	31,267	37.26%
FMCG	19,153	22.83%
Hotels	2,689	3.20%
Agri	18,443	21.98%
Paperboards & Packaging	9,081	10.82%
Other	3,263	3.89%
Total	83,896	100%

ITC Hotels contributed 3.20% to the total revenue of ITC Ltd. in FY23, amounting to 2,689 Crore INR. While the percentage may appear small in comparison to other segments, it is essential to pay heed to the impressive Year-over-Year (YoY) growth.

The Hotels segment of ITC Ltd. has demonstrated nearly 100% YoY growth from FY22 to FY23, doubling the revenue from 1,348 Crore INR to 2,689 Crore INR. This robust growth rate indicates the potential the segment holds and how it can significantly contribute to ITC’s total revenue.

Why does a Separate Listing for ITC Hotels Make Sense?

In a business conglomerate like ITC, each entity or business segment has its unique growth rate, profit margin, and capital requirements. They operate in distinct markets, face different competitors, and cater to different customer bases. Combining such diverse businesses under one conglomerate often leads to the undervaluation of some of its parts, especially those with high growth potential but currently smaller in size. This is often due to the overshadowing effect of the larger segments. The ITC Hotels segment, despite its significant growth rate, is likely facing such a situation.

Increased valuation of ITC Hotels

If we see, ITC Hotels in FY 2022 contributed only 1.92% in its revenue, which grew to 3.2% in FY2023. ITC hotels is expected to grow at a faster rate compared to ITC, and with demerger, ITC hotels valuation is expected to rise.

It is fair to say ITC Hotels was not getting the proper valuation under ITC. ITC’s PE ratio as of today is 30.5, whereas Indian hotels P/E ratio is 53.16. Another peer, Lemon Tree Hotels gets a P/E ratio of 62.93. With ITC Hotel demerger, the ITC hotels may get a higher valuation once listed as a separate entity. 

Benefit from Institutional Synergies

According to Sanjiv Puri, Chairman of ITC, both ITC and the new entity will continue to benefit from institutional synergies. The restructuring is aimed to harness the exciting opportunities in the Indian hospitality industry and foster the next horizon of growth. The new company will take the reins of the hotel business, operating as a separate entity in the hospitality industry and focusing on an optimal capital structure to nurture its growth path.

The Implications for Stakeholders

The demerger will have implications for minority shareholders of the hotels company who won’t be entitled to all of its earnings. However, Puri reassures that the future of the shareholding pattern will depend on circumstances, and the strategic move is expected to provide good returns to the new entity.

For employees, the proposed reorganization will continue to support them. The same values and culture will be maintained, and high potential employees will have the opportunity for mobility across divisions in ITC. In addition, the new company will be empowered to decide the terms of the Employee Stock Ownership Plans (ESOPs), ensuring benefits are in no way inferior to those of ITC.

Prospects for the New Entity

The demerged hotel company will have a strong balance sheet with no debt and significant assets, paving the way for robust growth in the Indian hospitality industry. It will also continue to receive strategic support from ITC, providing comfort to its employees and stakeholders.

Tourism industry in India is showing immense growth, enhancing the interest in the new entity. The strategic help from ITC will further propel its growth. Puri believes that an asset-right strategy, focused on management contracts, would benefit the business and provide attractive returns.

Tax Implications and the Way Forward

From the company’s perspective, the demerger is expected to be tax neutral as it adheres to the requisite tax conditions. In the long run, the new entity will have to leverage its own balance sheet, steering towards a more asset-light situation.

The structure of the demerger is designed to reward existing shareholders more than new shareholders. Every ITC shareholder will own some shares in the new entity, thereby ensuring the move benefits those who have trusted ITC to manage the assets.

With a bullish outlook, the demerger of ITC Hotels has sparked positive reactions among investors and stakeholders. It serves as a testament to ITC’s adaptive business strategy and its drive for sustained value creation. As the hospitality industry continues to evolve, this significant restructuring could set the stage for exciting developments in the future.

Hospitality Sector Enormous Growth and ITC Hotels

ITC Hotels’ demerger could position it to fully exploit the rising tide in the hospitality sector. Here’s how.

Growing Per Capita Income: As global incomes rise from $1,360 in 2010 to an expected $5,242 by 2031, people will likely splurge more on experiences like hotel stays. As an independent entity, ITC Hotels can specifically cater to this demand, potentially boosting its revenue.

Urbanization: More urban areas mean more business and tourism opportunities for hotels. Post-demerger, ITC Hotels can focus on tailoring its services to these urban markets, attracting more customers.

Government Initiatives and Digital Trends: With government pushing infrastructure and tourism development and technology changing the way we book hotels, the demerged ITC Hotels could be more agile in responding to such beneficial trends and schemes. This adaptability could give it an edge in the competitive hospitality landscape.

In a nutshell, the demerger could put ITC Hotels in the driver’s seat to capitalize on the booming hospitality sector, creating greater value for shareholders and offering enhanced experiences for customers.

Will the demerger boost ITC’s numbers?

The ITC-ITC hotels demerger could potentially enhance ITC’s financial performance through several pathways:

Valuation Upside: The demerger could allow both ITC and the newly formed ITC Hotels to secure better valuations, as investors could now evaluate each entity independently, potentially leading to an aggregate market value higher than the combined pre-demerger value.

Operational Efficiency: With each entity focusing on its specific business segment, there could be improvements in operational efficiency and profit margins, which would further boost ITC’s financial numbers.

Higher Growth Rates: The demerger could enable each entity to achieve higher growth rates due to enhanced focus and operational efficiency. The impressive past growth of ITC Hotels suggests significant growth potential.

ITC would be retaining 40% of the ITC hotels. Any impact in valuation growth of ITC hotels will indirectly benefit ITC and should boost ITC’s share price.

However, the demerger will involve one-time restructuring costs that could impact short-term financials. The success of the demerger also depends on strategic execution post-demerger and market conditions. ITC Hotels, now an independent entity, will need to manage operational challenges while capitalizing on opportunities. If managed well, the demerger could unlock value for shareholders and improve growth prospects.

Conclusion