From an investment point of view, the bulk of the gains in stock price from a de-merger situation appear to be captured in the immediate aftermath of the announcement.

Investors who buy into the parent company's stock in the hope of a windfall on listing of the de-merged company, may have a long wait before the product of the spin-off is actually listed. And if the de-merger comes with patchy disclosures, there may be a loss of value on listing.

Those that clicked

When it comes to spin-offs, simplicity pays. Spin-offs that try to separate one high-potential business from a clutch of less promising ones pay off for the staying shareholders.

The de-mergers of Godrej Consumer Products from Godrej Industries and that of Wockhardt from Wockhardt Life Sciences are good cases in point.

Wheat from chaff

Godrej Industries, which housed the soaps and hair care businesses of the Godrej group, suffered from an anaemic price-earnings multiple (PEM) of around six times its earnings in 1999, at a time when the market was willing to value a rupee of earnings for focussed FMCG companies at over 25 times.

From an investment perspective, any benefits from Godrej's clutch of FMCG brands were more than offset by the lacklustre prospects for its remaining businesses — a motley mix of industrial chemicals, medical diagnostics, edible oil trading and financial services. But a de-merger of Godrej's Consumer Products business, announced in October 2000, helped secure a much higher valuation for the consumer products business and put this business on a growth trajectory. The spin-off was transparently structured to favour Godrej Consumer Products. The distribution of assets and liabilities between the two companies left Godrej Consumer with a lower equity base and a higher share of profits after the de-merger.

Between financial year 2000-01 and 2002-03, despite a sluggish FMCG market, Godrej Consumer Products managed to grow FMCG sales by 23 per cent and per share earnings from Rs 6.7 to Rs 9.2. While Godrej Industries still hovers at a PEM of four times the earnings, Godrej Consumer listed at a PEM of seven times and went on to secure a PEM of 12 times within a year.

Similar is the case with Wockhardt's decision in 2000 to separate its pharma business from others such as agri-sciences, IV fluids, and hospitals. While the former was retained with Wockhardt, the latter were hived off as Wockhardt Life Sciences.

The de-merger came at a time when the stock market was just waking up to the potential of research-driven pharma companies, with strengths in the generic market. The de-merger delivered almost instant results.

Wockhardt, which traded at Rs 300 levels at the time of the announcement in July 1999, doubled to over Rs 600 within three months of the de-merger proposal being cleared.

By the time Wockhardt Life Sciences was listed, at a surprisingly high price of Rs 260, Wockhardt itself had risen to over Rs 900.

As a result, a shareholder who invested Rs 1,000 in the Wockhardt stock on the eve of the de-merger announcement, would have made a cool Rs 4,030 on the day of the listing, on his combined holdings of the Wockhardt and the Life Sciences stocks.

The initial ardour did cool off over the next year, but shareholders in the company would have still made a 60 per cent return on their holdings over a one-year holding period. In Wockhardt's case, again, it was clear at the outset that the de-merger was structured to create a favourable balance sheet for the pharma company.

While the pharma business accounted for 73 per cent of sales and 80 per cent of the profits before the de-merger, it inherited only 68 per cent of the net worth.

Complexities, patchy disclosures knock value

On the other hand, the move to separate computer major, Aptech's education business from its software services business, appeared to be jinxed from the beginning due to changes in the initial de-merger proposal and the decision to combine it with a merger.

Aptech's proposal, first mooted in 2000, was to separate its software services business from the computer education business. For some reason the proposal dragged on without any decisive result, until June 2001, when it was finally cleared by the Apetch board. The new proposal also meant merging another group company, Hexaware Technologies, with the software services division.

The absence of information about Hexaware's financials and apprehensions about the motive for the de-merger exercise, combined to dent shareholder value for Aptech shareholders. That the proposal came at a time when IT stocks were already being put through the wringer, did not help matters.

So, Rs 1,000 invested in the parent on the day of the announcement, would have been worth just Rs 457 (assuming shareholders held on to both Aptech and Hexaware) on the day the demerged company — Aptech — was listed on the bourses. It is only recently that the Hexaware Technologies stock has perked up on improving prospects.

Sold on expectations

The de-merger of a highly promising business from others may help focus stock market attention on the business. But it can also make the individual stocks more vulnerable to swings in fortune in their chosen area of business.

Put through at a time when the telecom business was on a high, the Sterlite Opticals de-merger separated the much-sought after cables business from the non-ferrous metals business of Sterlite Industries.

The game-plan was to garner high valuations for the former, based on its growth prospects.

When the proposal was cleared, Sterlite projected a 50 per cent return on capital and a 50 per cent annual profit growth for the Optical Fibre arm. This de-merger generated high returns on listing, with the Sterlite Opticals stock listing at over Rs 900 (Sterlite traded at Rs 907 before the de-merger took effect).

But the returns fizzled out along with the dimming prospects for optical fibre cable offtake. An investment of Rs 1,000 in the Sterlite Industries stock on the eve of the de-merger announcement would have appreciated to Rs 1,698 on listing of Sterlite Opticals, for those who held both stocks. But the collapse of the IT and telecom boom trimmed the value of the holding to Rs 692, barely a year later.

Parts better than the whole

Despite the Sterlite experience, the de-mergers that split a diversified company into two distinct, focused, businesses may pay off over the long term, just by making the individual stocks more attractive investment candidates.

Investors who put Rs 1,000 in the ABB stock just after it announced its intention to hive off its power generation business to the newly-formed ABB Alstom Power would have been poorer for the decision, even a year after the listing date.

But the de-merger has helped secure a better valuation for ABB, especially in the recent times, given its strong presence in the power transmission business.

With power equipment stocks hogging attention in the recent rally, an investment made just after the de-merger announcement, would be now worth Rs 1,540 for investors who have held both stocks to date.

No guarantee of better valuations

Many spin-offs appear to be motivated by the prospect of better valuations for the individual businesses. But stock valuations are influenced by too many extraneous factors.

So, a de-merger does not immediately lead to better stock market valuations once the de-merger takes effect. Novartis' decision to spin off its agrochemicals business into a separate company, Syngenta, in line with a similar move at the global level, proved to be value-eroding for its shareholders.

The de-merger hoped to ring-fence the high-potential pharma business from the cyclical agrochemicals business by hiving off the latter into a separate listed company. But the timing of the de-merger proved to be its undoing.

Coming at a time when valuations for MNC pharma stocks were just being marked down from their peaks, both the Novartis and the Syngenta stocks were left with much lower valuation levels after the de-merger — a case of the individual parts of a business being valued at less than the whole, despite better business focus.

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