What are demergers?
Demerger is a type of corporate action where a company splits a part of its business into a separate entity. In a demerger, the original company transfers a portion of its assets and liabilities to the new entity while allowing each company to operate independently. This is usually done to streamline operations, unlock value, and focus on the core business areas.
For Example: Larsen & Toubro's separation of its technology business into L&T Technology Services, Reliance Industries' demerger of its financial services business into Jio Financial Services, and the demerger of Piramal Enterprises' pharmaceutical business.
The goal of a demerger is to create a separate company that can focus on specific business segments, leading to better management and unlocking value for shareholders through specialization.
Disclosure of demergers
Demerger announcements can significantly affect the companies involved and the public, which is why regulatory bodies enforce disclosure requirements. This ensures transparency and allows investors to access all relevant details for informed decision-making.
Under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, companies must disclose key information about the demerger, such as the size and turnover of the involved businesses, the objective of the demerger, the industries concerned, and details about the split of assets and liabilities. Any related party involvement must also be disclosed.
These details are available on the BSE and NSE websites under announcements or corporate disclosures. The company’s official website and press releases typically provide comprehensive information as well.
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Effect of demergers
Demerger announcements often have a noticeable impact on the share prices of the companies involved. Understanding the purpose behind the demerger helps in estimating the effect on the share prices. For instance, if a business segment is separated to focus on growth opportunities, the new company's shares may experience a boost due to the increased specialization.
Conversely, there can be uncertainty about the impact on the parent company's share price, as it might be seen as losing a valuable asset. If the market perceives the demerger as unfavorable, it could negatively affect the share prices of both entities.
Taxation of Merger:
When shareholders of a demerged company receive new shares in the resulting companies, there are no immediate tax liabilities. Tax implications arise only upon the sale of those shares.
Short-Term Capital Gains (STCG) are applicable if the shares are sold within 12 months of acquisition, taxed at a rate of 15%.
Long-Term Capital Gains (LTCG) apply if the shares are held for more than 12 months. As of now, LTCG exceeding ₹1 lakh in a financial year is taxed at a rate of 20%, with indexation benefits available.
Understanding these tax implications is essential for effective financial planning following a de-merger.
Merger Jargons:
Below are some key terms related to mergers:-
Demerged Company:
The original entity that undergoes the demerger process, separating a portion of its business operations, assets, or divisions to create the resulting company. The demerged company retains its remaining operations and continues to function as a standalone organization after the separation.
Resulting Company:
The new entity created as a result of the demerger. It takes over the specified assets, liabilities, and business operations spun off from the demerged company and operates independently. Shareholders typically receive shares in the resulting company based on the distribution ratio established during the demerger.
Announcement Date:
This is the date when the company publicly declares its intention to demerge, detailing the rationale for the separation and the assets or business units that will be spun off. It serves as the official communication about the demerger to shareholders and the market.
Effective Date:
The day the demerger is officially completed, and the newly created entity, known as the resulting company, starts operating independently. On this date, shareholders of the demerged company receive shares in the resulting company, reflecting their ownership in both entities.
Distribution Ratio:
In a demerger, this ratio determines how many shares of the resulting company each shareholder of the demerged company will receive for every share they own. It is crucial for establishing the ownership structure of the newly created entity and reflects the relative value of the demerged assets.
Mergers vs Demergers
Investors might find it difficult to distinguish between Mergers and Demergers. Here is a table distinguishing the same for better clarity-
| Mergers | Demerger |
| Involves the combination of two companies to form a single new entity. | Involves the separation of a part of a company into a new, independent entity. |
| Typically occurs between companies of similar size aiming to create synergy and increase market share. | Often involves a larger company spinning off a division or business unit to focus on core operations. |
| The resulting company shares a new name or identity that reflects the merged entities. | The resulting company operates under a new name while the demerged company retains its original identity. |
| Seen as a strategic move to achieve mutual benefits and share resources. | Considered a strategic way to unlock value, enhance operational focus, and improve shareholder value. |
| Example: Vodafone India and Idea Cellular merger to form Vodafone Idea Limited (2018). | Example: Hindustan Unilever Limited (HUL) demerging its tea business to form a separate company called Hindustan Unilever Tea (2019). |
Conclusion
Understanding the demerger process is essential for stakeholders looking to optimize their investment strategies. Demergers indicate a company’s intent to unlock value by separating its business units, allowing each entity to focus on its core operations and enhance shareholder value.
By staying informed about demerger activities, investors can strategically position themselves to take advantage of new opportunities and potentially maximize their returns.
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