DEMERGER

Demerger of a company takes place when:



1. Part of its undertaking is transferred to a newly formed

company or an existing company and the remainder of the
first company’s division/undertaking continues to be
vested in it; and
2. Shares are allotted to certain of the first company’s
shareholders.

 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 they
formerly owned indirectly (the ‘demerged entity’).
Underlying ownership of the companies and/or trusts that
formed part of the group does not change. The company or
trust that ceases to own the entity is known as the
 TYPES OF DEMERGER:
 Spinoff: This type of demerger involves division of company into
wholly owned subsidiary of parent company by distribution of all
its shares of subsidiary company on Pro-rata basis. By this way,
both the companies i.e. holding as well as subsidiary company
exist and carry on business. For example Kotak, Mahindra
finance Ltd. formed a subsidiary called Kotak Mahindra Capital
Corporation, by spinning off its investment banking division.
 Split ups:This type of demerger involves the division of parent
company into two or more separate companies
where parent company ceases to exist after the demerger.
 Equity carve out: This is similar to spin offs, except that same part
of shareholding of this subsidiary company is offered to public
through a public issue and the parent company continues to enjoy
control over the subsidiary company by holding controlling
interest in it.
 Divestitures: 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 environment
of the country;
2.Strategy to enable others to exploit opportunity effectively to optimize returns

when the parent company is unable to do so;



3.To correct the previous investment decisions where the company moved into
the 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 were
under performing and now no better performance, capital gain can be
realized.
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 a

restructuring 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 can
focus on core business and exploit the benefits of core competencies
and utilize surplus cash in a productive way.
 Demerger allow them increased flexibility in taking advantage of the
huge growth opportunities in their respective business segments.
 If a subsidiary is not doing well and is pulling down the profit of the
company .
 Example : the two wheeler major BAL ‘s valuation had suffered from

lower returns on capital (ROCE) and net worth (RONW The ).

automotive business added sizeable cash to BAL’s kitty but current
valuation, which was based on returns generated from both the
manufacturing 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 used
to pay off its debt. This saves the interest on the debt and increases
the 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 the

subsidiary in proportion to their holding in the parent company. So if

an investor has a 5 per cent holding in the parent company, he will be
allotted 5 per cent of the shares in the subsidiary too.
3) Demerger a company can attract specific institutional investors

having interest in particular sectors. For example, retail company

Pantaloon was attracting only retail investors. By spinning off a
private equity fund, Kshitij, it attracted a different set of investors.
 Improve valuation:
The benefits of a greater focus to each of the businesses does get reflected
in the market and it is possible to realize the actual value of each
business.
Example: The combined market capitalization of Sun Pharma and its

demerged R&D firm SPARC has been 10 to 15 per cent higher than the
market capitalization of Sun Pharma since SPARC listed in July 2007.
Example : Demerger of Dabur India comprised of the FMCG business
including personal care, healthcare and ayurvedic speciality products.
The pharmaceuticals business which include allopathic, oncology
formulations and bulk drugs.
Demerger was done to create a global presence for Dabur’s pharmaceuticals

business and provide focus to maximise penetration in global markets.

The FMCG business also benefited from this move as it will lead to
better and more efficient management of its resources and facilitate more
accurate benchmarking with industry which lead to improvement in
valuations for both businesses.

 Family settlement: split among family members can be reason for
demerger.
 Example : Reliance splits into five companies
 De-merged entities—Reliance Capital Ventures, Reliance
Communication Ventures, Reliance Energy Ventures and the Global
Fuel Management Services
 
 Taxation of shareholders in demerged company :


1)Dividend : S. 2(22) has been amended by inserting a new clause (v) to

provide that no dividend income shall arise in the hands of shareholders of
demerged company on demerger.
2)Capital gains : A new clause (vid) in S. 47 has been inserted to provide that no

capital gains shall arise to shareholders of the demerged company on account

of receipt of any shares from the resulting company.
Tax benefits to resulting company :

1)Expenses incurred for the purpose of amalgamation or demerger shall be

allowed @20% every year from the year in which the demerger takes place.
2)Depreciation shall be apportioned between the demerged company and the

resulting company in the ratio of number of days for which the assets were
used by them.
3)The accumulated losses and unabsorbed depreciation in a demerger shall be

allowed to be carried forward by the resulting company.

4)Benefits available for demerger are also extended to authorities or boards set