Sanjiv Puri Explains Why ITC Chose To Retain 40% Stake In Hotels Business

The proposed restructuring of ITC Ltd. that would demerge its hotel business as a separate entity is a win-win for both entities and existing shareholders, according to Chairman and Managing Director Sanjiv Puri.

The demerger will improve financial ratios for ITC, while the new entity will start with a strong balance sheet with no debt and net assets worth just Rs 6,000 crore, said Puri during an analysts' call. This assurance came after the conglomerate's stock crashed nearly 7% since the demerger was announced on July 24.

Under the proposed scheme of arrangement, ITC will directly own 40% of the equity in the hotel company, with the existing shareholders of the company holding the remaining 60% in proportion to their ownership of ITC. Any further stake dilution will be the decision of the board and contingent on the situation at that point in time, Puri said.

"This arrangement will give flexibility to the new entity to chart its own growth path and raise its own resources and funds based on an asset rights strategy while leveraging the goodwill, brand equity, and synergies of ITC, providing stability to the hotel business and comfort to employees and stakeholders," he said.

It will also sharpen ITC's capital allocation strategy.

The hotel division had been a capital guzzler, accounting for over 20% of ITC's capex. However, it contributed less than 5% to ITC's revenue and EBIT over the last decade. After the demerger, ITC’s return ratios and valuations will improve. "But not to the extent if this had been a clean spin-off," he said.

A clean demerger is one where the business is spun off to a new company, with all shareholders getting shares in the new entity. But there’s a catch: A shareholder can either continue holding shares in the parent company or exchange some (or all) of their holdings for shares in the new company.

The new entity would be determined as an associate company on ITC's balance sheet. The segment may give ITC a return on capital employed that’s higher by 18–20 percentage points. The return on invested capital should improve by 10%, said Supratim Dutta, executive director and chief financial officer. These were ballpark figures based on FY23 numbers.

The structure is not designed in a manner to save stamp duty, said Dutta. The registered office of ITC and the new entity will be in West Bengal, and thus stamp duty on the issue of shares will be paid in that state. The stamp duty rate is 0.5% on the fair value of new shares, and hence the 60% stake share issued multiplied by its fair value and 0.5% would have to be paid. "From an overall cost perspective, it is not going to be significant."

For ITC as well as for the shareholders that receive the shares of the new entity, it will be a tax-neutral transaction.

Besides, there will be no GST impact, the management said.

The proposed structure for ITC has been designed to reward existing shareholders more than new shareholders, Puri said. In the proposed restructuring, the management said that both ITC and the new entity will continue to benefit from institutional synergies.

The hotel entity will get the backing of ITC's institutional strength and brand, which in turn will provide comfort to employees, Puri said. ITC will also draw synergies for its food vertical from the demerged entity.

The benefits that accrue to employees moving to hotels will be in no way inferior to those of ITC, Puri said. "Once the employees move to the new company, it (the new company) would determine the terms of the scheme in that respect if they wish to ... nobody is going to suffer."

Raising debt would not be a problem for the new entity. Puri said that ITC Hotels would have the capacity to raise its own capital through investors or debt markets because it would have a very strong balance sheet.

After the demerger, it is going to be a situation where it will be asset-light with less capital.

For the use of ITC and its brand assets, Puri said that there would be an arrangement for royalty with the new entity based on industry standards. However, the numbers need to be arrived at, which, at this juncture, are not expected to be very high.

ITC shall have no arrangements with any of its existing shareholders to buy shares if they wish to offload their holdings in the new entity.

"Each shareholder of the new entity will make an independent decision with regards to their stake," the management said.

ITC, though, would stay invested in the hotels business. The intention was "never to completely move out of" the hotel business", said Puri.

"The tourism industry is in good shape, and the (investor) interest in this (new company) will be equal (to that in ITC) if not more … anybody who does not wish to be with it (ITC Hotels), market dynamics will give an exit," he said.

A board meeting is slated for August 14 to approve the details of the proposed reorganisation, including the scheme of arrangement. ITC will list on exchanges after approvals. The process is likely to take 12–18 months.

"This is the best arrangement at this point in time," Puri concluded.