Why ITC chose not to demerge hotels in Mukesh Ambani's buy 1 get 1 style

In the last few weeks, two big demerger news of RIL-Jio Financial Services and ITC-ITC Hotels have kept investors busy. While Mukesh Ambani triggered a retail frenzy to buy RIL shares ahead of the demerger, shares of Street favourite ITC dropped over 7% in just 2 days following the announcement of the spin-off.

After Ambani's 'buy 1 get 1 offer' for shareholders of Reliance Industries (demerger ratio of 1:1), investors were expecting ITC also to opt for a 100% vertical split. But ITC management chose to keep 40% ownership with itself and give away the remaining 60% to existing shareholders.

This demerger ratio placed the stock under selling pressure as it restricts 100% value unlocking in the hotels business.



ITC is yet to declare the share swap ratio for the hotels subsidiary and has also not declared why it chose to keep 40% stake in it but it did mention that the demerger will help the new entity in attracting appropriate investors and strategic partners whose investment strategies and risk profiles are aligned more sharply with the hospitality industry.

This statement has led to speculations in the market that ITC may be on the look for a new strategic investor in the hotels entity.

Calculations show that the British American Tobacco (BAT) would end up owning about 17.4% stake in ITC Hotels. The world's largest tobacco company, which owns 29% stake in ITC, may have little interest in owning a hospitality stock in its portfolio.

In case BAT chooses to exit at some point post-listing of ITC Hotels, it could create a supply overhang on the new stock and even throw it open to hostile takeover bids. Analysts are not ruling out the possibility of ITC buying BAT’s stake in hotels to take its ownership above 51% mark.

"40% holding by ITC in the new entity can aid in securing management control in case if any large shareholder intends to exit," said Nomura analyst Mihir P Shah.

The new ownership structure will also ensure that synergies between hotels and other ITC businesses (e.g. foods) should largely remain unaffected given that the new entity would remain an associate of ITC, domestic brokerage firm JM Financial said.

Recognising recurring concerns on ITC investing significant sums of money in hotels venture, the management had pivoted to an ‘asset-right’ strategy for the business some years back and focused a lot more on management contracts whilst curtailing capex on owned-hotels to the extent feasible.

Hotels segment capital employed has grown just about 4% (cumulative) over FY19-23 vs 58% during the preceding five-year period. Such a strategy may, however, deprive the hotels business from investments that could be necessary for its own growth and may lead to the business missing out on some opportunities, analysts say.

"The decision taken to alternatively structure the ownership of the business would enable ITC to continue participating in the Indian hospitality growth story whilst limiting use of its own capital to drive growth therein. The demerged unit would take its own decision on (raising, if necessary) and deploying its own capital and ITC as a shareholder, we believe, may or may not participate in such fund-raises thus limiting its own capital-use every time the hotels business is in need of capital," said JM Financial's Richard Liu.




With multiple businesses like hotels, FMCG and agri maturing over the years, investors have been demanding that the Kolkata-based FMCG major should demerge segments to get rid of the shadow of the tobacco business which restricts investments from the big boys on account of ESG concerns.

Although ITC is no more the Indian Tobacco Company, it remains a cigarette stock for investors. Despite the steady growth seen in its non-cigarette businesses over the years, cigarettes contributed a lion's share of 76% to its EBIT and required only 8% of its capex in FY23.

The demerger of the hotels business into a new subsidiary which will be called ITC Hotels addresses this key investor concern. As a cash guzzler, hotels have commanded 20% of ITC's capex in FY23 but contributed only 2% of its EBIT.

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