Explained: Here's why ITC slipped 4% after announcing hotels business demerger

• ITC kicks off its value unlocking process with the demerger of its hotels business.
• Existing shareholders to get shares in the new entity, which will also get listed.
• Markets give a thumbs down to the proposal as ITC will continue holding 40% in the new entity.

It is a season of value unlocking. After the demerger of Jio Financial Services by Reliance Industries, the board of ITC Limited on Monday informed shareholders that it would demerge the hotels business. The company said that the board had evaluated and discussed various alternative structures for the hotels business towards “crafting the next horizon of growth as also enhancing value creation for all stakeholders.” The stock, however, fell by 4% after the announcement as the structure of the demerger has confused investors.

Under the demerger scheme approved by the board of ITC, the company will hold a stake of about 40% in the new entity and the balance shareholding of about 60% to be held directly by the company’s shareholders proportionate to their shareholding in the parent company. It is this that the market has given a thumbs down to. The Street was expecting all the shares of the demerged entity to be offered to shareholders.

The argument given by the company is interesting. According to the ITC’s statement, the company's proposed reorganisation will ensure continued interest of the company in the hospitality business, provide long term stability and strategic support to the new entity in its pursuit of accelerating growth and sustained value creation as also enable leveraging of cross synergies between the Company and the new entity.

Commenting on the proposed reorganisation, Sanjiv Puri, Chairman of ITC Limited, said: “The proposed demerger of the Hotels Business is testament to the company’s commitment to creating sustained value for stakeholders. Creation of a hospitality focused entity will engender the next horizon of growth and value creation by harnessing the exciting opportunities in the Indian hospitality industry. In the proposed reorganisation, both ITC and the new entity will continue to benefit from institutional synergies.”

ITC added that its hospitality business had matured over the years and was well poised to chart its own growth path as a separate entity. Despite the demerger, the hotel business will continue to leverage ITC’s institutional strengths, brand equity and goodwill. The demerger will help the new entity in attracting appropriate investors and strategic partners/ collaborations whose investment strategies and risk profiles are aligned more sharply with the hospitality industry.

In addition, ITC will unlock value of the hotels business for the company’s shareholders by providing them a direct stake in the new entity along with an independent market driven valuation thereof. This move by the company also reinforces the sharper capital allocation strategy put in place in recent years, manifest in the pivot to ‘asset-right’ strategy in the hotels business.

Analysts believe that this is the beginning of the value unlocking process started by ITC. Says Prashanth Tapse, senior vice president (Research) at Mehta Equities Ltd: “ITC's hotel business demerger approval may unlock shareholder value with a direct stake in the new entity, but it disappoints some street expectations. Clarity on the scheme of arrangement is awaited until the Board meeting on 14 August 2023. The stock faces technical pressure.”

Details of the proposed reorganisation, including the scheme of arrangement, shall be placed for approval of the Board at its meeting to be convened on 14th August, 2023. To progress the proposed reorganisation as aforesaid, the Board has also approved incorporation of a wholly owned subsidiary of the Company, to be named ITC Hotels Limited or such other name as may be approved by the Ministry of Corporate Affairs.

Currently, ITC has 120 hotels and 11,600 keys across 70+ locations. The business today ranks amongst the fastest growing hospitality chains in the country with marquee brands like ‘ITC Hotels’ in the Luxury segment, ‘Welcomhotel’ in the premium segment, ‘Fortune’ in the Mid- market to Upper-upscale segment and ‘WelcomHeritage’ in the Leisure & Heritage segment.

Having achieved considerable scale and market standing, the business in 2017 pivoted to an ‘asset-right’ strategy which envisages a substantial part of incremental room additions to accrue through management contracts. Accordingly, two new brands, ‘Mementos’ in the Luxury Lifestyle segment and ‘Storii’ in the Premium segment, have also been launched recently to offer varied experiences to new age travelers. The market has been critical of this business as it is capex intensive and the return ratios have also been low for this business.

After two years of pandemic-led disruptions, the Indian hospitality industry has bounced back strongly with significant improvement in room rate and occupancy. ITC’s Hotels Business has also emerged stronger and has delivered robust growth and margin expansion in FY 2022-23 and is well poised to sustain the growth momentum.

The Indian hospitality industry is expected to witness rapid growth going forward. The key drivers of growth include the strong macroeconomic fundamentals and growth prospects of the Indian economy, increasing affluence and favourable demographic profile of India’s population.

Along with this, the Government of India’s thrust on the travel and tourism sector, which ranks amongst the highest in industry in terms of economic multiplier impact and employment generation, will be a catalyst for growth. The significant investment in infrastructure including airports and highways, leading to improved connectivity and favourable demand-supply dynamics in the industry, should augur well for the sector too.