Types, Reasons and Modes of Demerger

Only available on StudyMode
  • Download(s) : 62
  • Published : March 8, 2013
Open Document
Text Preview
Demerger of a company takes place when:
1.Part of its undertaking is transferred to a newly formedcompany or an existing company and the remainder of thefirst company’s division/undertaking continues to bevested in it; and2.Shares are allotted to certain of the first company’sshareholders. 

A demerger is a form of restructure in which owners of interests in the head entity (for example, shareholders or unit-holders) gain direct ownership in an entity that theyformerly owned indirectly (the ‘demerged entity’).Underlying ownership of the companies and/or trusts thatformed part of the group does not change. The company or trust that ceases to own the entity is known as the‘’


This type of demerger involves division of company intowholly owned subsidiary of parent company by distribution of allits shares of subsidiary company on Pro-rata basis. By this way, both the companies i.e. holding as well as subsidiary companyexist and carry on business. For example Kotak, Mahindrafinance Ltd. formed a subsidiary called Kotak Mahindra CapitalCorporation, by spinning off its investment banking division. 

Split ups:
This type of demerger involves the division of parentcompany into two or more separate companieswhere parent company ceases to exist after the demerger. 
Equity carve out:
This is similar to spin offs, except that same partof shareholding of this subsidiary company is offered to publicthrough a public issue and the parent company continues to enjoycontrol over the subsidiary company by holding controllinginterest in it. 

These are sale of segment of a company for cash or for securities to an outside party. Divestitures, involve some kind of contraction

Reasons for DEMERGER

1.Corporate attempt to adjust to changing economic and political environmentof the country; 
2.Strategy to enable others to exploit opportunity effectively to optimize returnswhen the parent company is unable to do so; 

3.To correct the previous investment decisions where the company moved intothe operational field having no expertise or experience to run the show on a profitable basis; 
4.To help finance an acquisition;

5.To realize capital gains from the assets acquired at the time when they wereunder performing and now no better performance, capital gain can berealized. 
6.To make financial and managerial resources available for developing other more profitable opportunities. 
7.Selling unwanted and surplus or unconnected parts in the business as arestructuring strategy to get rid of sick part of the company. 

Focus on core business

Companies which have more than one business and the smaller business is not recognized in valuations of these companies demerger help to separate this investments out of the core business. They canfocus on core business and exploit the benefits of core competenciesand utilize surplus cash in a productive way. 

Demerger allow them increased flexibility in taking advantage of thehuge growth opportunities in their respective business segments. 
If a subsidiary is not doing well and is pulling down the profit of thecompany . 
Example : the two wheeler major BAL ‘s valuation had suffered fromlower returns on capital (ROCE) and net worth (RONW ).
Theautomotive business added sizeable cash to BAL’s kitty but currentvaluation, which was based on returns generated from both themanufacturing and investment business, was affected by lower contribution from investment business. 

Attracts investors:

1)A demerger generates cash for the parent company that can be usedto pay off its debt. This saves the interest on the debt and increasesthe cash flow to equity holders.The prospect of getting a higher dividend pushes up the share price of the parent company. This gives investors a chance to exit at a higher price. 

2) Usually, existing shareholders are allotted the shares of thesubsidiary in proportion to their holding...
tracking img