ITC: Hotels business demerger

28 Jul 2023 , 11:15 AM

Recommendation: Buy;  Target price: Rs 500

ITC has announced a proposal to demerge its Hotels business into a separate entity under a scheme of arrangement in which ITC would hold ~40% stake in that entity and the balance ~60% stake would be held directly by ITC’s shareholders proportionate to their shareholding in ITC. The transaction would help in unlocking value for ITC’s shareholders (direct stake in the hotels business). Hotels business comprises 20% of ITC’s invested capital but only ~3% of Ebit. Excluding hotels, FY23 pre-tax ROIC would increase by 17%. The transaction is subject to regulatory approvals. Maintain BUY with a TP of Rs500. 

ITC Hotels demerger: 

ITC hotels with 120+ hotels and more than 11,600 rooms would be demerged from ITC through a scheme of arrangement where ~60% stake of the new entity would be held directly by the shareholders of ITC proportionate to their shareholding in ITC and the rest ~40% stake to be held through their shareholding in ITC. The assets, liabilities, contracts and employees forming part of the Hotel business are intended to be transferred to the Hotels Company. The demerger would be a tax neutral one. 

Value unlocking for Hotels: 

The demerged hotel entity would be a pure-play hotels entity and would operate with an optimal capital structure with ability to attract the right set of investors whose risk profiles would be more closely aligned with the Hospitality industry. The new entity would have ~Rs60bn of assets with no debt and can leverage its own balance sheet to raise capital-via debt or equity (if required). At Indian Hotel’s EV / Ebitda (22.5x), the market cap of the Hotels company could be ~Rs.240bn. 

ITC ratios to improve: 

The hotel division contributes to 3% of ITC’s Ebit but 20% of the capital employed for ITC. Hence, the pre-tax ROIC would increase by 17% with the demerger going through. Secondly, the demerged hotel entity won’t depend up on the balance sheet of ITC to fund its future growth endeavours which would increase FCF conversion for ITC. Maintain BUY with a TP of Rs500.