Are Demergers Good For Value And Growth – A Popular Supermarket Player On The Radar

In the below article, reader will get a brief of demerger, forms of demerger, its benefits to the investors. The reader will also get to know about the reason why companies go for such transactions.

Understanding of “Demerger”

• A Demerger is a part of corporate restructuring activity, which generally means separating a part of the existing business into another company or organisation.
• In the process of demerger, the parent company transfers all rights on the business to be separated to resulting company as well as transfers the shareholding to the new company.
• The company which transfers its undertaking to another company is identified as parent company and the other company, which gets the rights or undertaking is known as the resulting company.

Now, let’s get to know about the forms in which a company can carry out the demerger, which include Spin-off and Split-off.

• Spin-off is a divestment strategy, which leads to creation of an independent company post transfer of division or undertaking of parent company.
• This strategy is primarily being adopted when the parent company believes that the division or undertaking can generate positive outcome, if it runs by an independent management.
• However, following the spin-off strategy, parent company and resulting company start to perform as independent corporate entities.

In a split-off, shareholders must exchange the shares of the parent company in order to subscribe to the shares of the subsidiary. In a spin-off, shares of the subsidiary are distributed to all shareholders just like dividend. This is the crucial difference between a split -off and a spin-off.

What are the reasons for a company to opt for demerger?

In general following can be the reasons for demergers:

• When an organisation is having a major focus on core business, which requires a different level of attention with respect to investments, human resources, etc
• When a specific business becomes an un-healing wound or a regular loss maker. This is done in order that the ailing business may be taken over by some other corporate entity and execute a turnaround.
• Also, for unlocking the true value of a portion of the parent company’s business.

Value and Growth

Value and growth generally depend on the expectation of market participants from the demerger and whether these are in sync with the management’s vision. Some of the companies manage to create value for shareholders and some do not. Let’s understand this by an example:

Demerger of Coles Group and Wesfarmers:

• In 2018, there was a demerger of Coles Group Limited (ASX: COL) from Wesfarmers Limited (ASX: WES) that took place on 28^th November 2018. The shares of the Coles Group Limited begun its trading on 29^th November 2018.
• As per ASX, the shares of COL have provided Year-to date return of 32.38% to its shareholders, which can be taken as decent return.

Demerger announced by Woolworths Group Limited

On the context of demerger, one of well-known Australian Supermarket players, Woolworths Group Limited (ASX:WOW) has previously announced a demerger of its drinks and hospitality business, Endeavour Drinks and ALH Group, into a single entity known as Endeavour Group Limited. On that, the company believes that the demerger will be creating value for its shareholders. Let dig deeper into the same:

• As per the release dated 3^rd July 2019, the company updated the market participants with an announcement, wherein it has entered into an agreement to combine Endeavour Drinks and ALH Group, its drinks and hospitality businesses into a company, which will be referred to known as Endeavour Group Limited.
• It was mentioned in the release, the company is intending to implement a separation of the business via value-accretive alternative or demerger after the combination of Endeavour Drinks and ALH Group.
• The company stated that separation is anticipated to take place in calendar year 2020. The Board of the company believes that the separation is in the best interest of shareholders as well as provides benefits to customers and team members of Woolworths Group Limited and Endeavour Group Limited.
• It was added that the decision has been arrived at after taking into account the future prospects of drinks and hospitality businesses, which demonstrates the focus of the Board on increasing long-term shareholder value.

A Look at Endeavour Group after the combination

• The combination of drinks and hospitality businesses, Endeavour Drinks and ALH Group, would be creating one of Australia’s leading integrated players with the expected sales and EBITDA of around $10 billion and $1 billion, respectively.
• Adding to that, Endeavour Group would be placed in a leading position with strong cash inflows in order to finance the investments for growth as well as to build up a robust revenue and earnings profile.
• The Endeavour Group would consist of store-based and online offerings, with 327 ALH hotels and in excess of 1,500 BWS and Dan Murphy's retail drinks outlets.

An Introduction to the Transaction Steps:

• The first step in the transaction include the Formal transfer of assets and liabilities to create Endeavour Group from Woolworths Group, which is subject to WOW’s shareholders vote at the 2019 Annual General Meeting on 16^th December 2019.
• The acquisition of ALH will take place by Endeavour Group in consideration of scrip.
• BMG exchanges entitlements as per contract as well as 25% stake in ALH for a 14.6% interest in Endeavour Group.

After the demerger, Endeavour Group would be able to realise its full potential by further developing its retail drinks and hospitality networks. It will also capitalize on its store network and digital capabilities to augment online penetration. It would also continue to enrich and differentiate its drinks product portfolio.

On the Stock’s performance front, the stock of Woolworths Group Limited last traded at a price of A$37.270 per share (up 0.431% on 14^th October 2019). In the time frame of three months and six months, it generated returns of 7.94% and 21.91%, respectively. As per ASX, the Annual dividend yield of the company stood at 2.75% and the stock is trading at P/E multiple of 18.00X.

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