The demerger of ITC's hotel business, effective January 1, 2025, represents a pivotal moment in the corporate and investment landscapes. The demerger of ITC Hotels allows shareholders direct exposure to the hospitality sector, while ITC can focus on its high-margin businesses. ITC Hotels, now an independent entity, can optimize its capital structure and attract investments that were previously limited by ITC's tobacco focus. The separation of ITC Hotels Ltd. from ITC Ltd. is set to have far-reaching implications for stakeholders, including shareholders, institutional investors, mutual funds, and foreign investors. This report provides an analysis of the demerger’s mechanics, ownership structure, and its anticipated impact on various investor groups, particularly focusing on mutual funds, passive investors, and foreign investors.
The Demerger Mechanics and Immediate Effects ITC Ltd. is a leading blue-chip stock in India and holds a significant position in the NSE Nifty 50 index, with a weight of 4.1% as of January 6, 2025. Under the demerger scheme, shareholders of ITC Ltd. will receive one share of ITC Hotels Ltd. for every 10 shares of ITC Ltd. held as of the ex-date on January 6, 2025. This move aims to unlock value in the hotel business, but it also raises several questions regarding its impact on stock prices and market dynamics.
In the short term, the composite weight of ITC and ITC Hotels will remain unchanged in indices such as the Nifty 50 and the BSE Sensex, as ITC Hotels will continue to trade as part of these indices until it is formally listed. This temporary inclusion gives passive funds, such as ETFs, a grace period of three days to adjust their portfolios. This is similar to the demerger of Jio Financial from Reliance Industries in 2023, where the change in index composition was managed with minimal disruption.
Ownership Structure and Stakeholder Composition
As of September 30, 2024, ITC Hotels had a diversified ownership base, with both domestic and foreign institutional investors holding significant stakes.
Institutional Ownership: Domestic and foreign institutional investors held 24.56% of ITC Hotels, with mutual funds owning 7.66%. The SBI Nifty 50 ETF held around 0.80% of the shares. Prominent domestic investors like Life Insurance Corporation (LIC) owned 9.1%, while the Government of India, through the Special Undertaking of the Unit Trust of India, held 4.69%.
Foreign Investors: Foreign portfolio investors (FPIs) held 9.06% of ITC Hotels. Notably, the Government of Singapore and GQG Partners had stakes of 0.6% and 1.8%, respectively. The demerger presents a unique opportunity for foreign investors, especially as the foreign ownership cap in ITC Hotels will initially be 34%, potentially allowing for increased foreign investments in the future.
However, a key development in the post-demerger phase is the expected exit of British American Tobacco (BAT), which owns 15.3% of ITC Hotels. BAT’s decision to divest its stake could create a significant supply overhang in the market, potentially leading to increased volatility and influencing the stock price in the initial period after the listing.
Impact on Mutual Funds and Passive Investors
The demerger is likely to have multiple consequences for mutual funds and passive investors, especially those holding ITC shares through index funds and ETFs.
Passive Fund Adjustments: Passive funds tracking the Nifty 50 and Sensex indices will need to adjust their portfolios after ITC Hotels is removed from the indices. The stock's temporary retention in the index for three days after its listing will provide passive funds with a window to divest their holdings in ITC Hotels without causing major disruption. However, this could lead to initial volatility, especially if ITC Hotels’ shares experience significant price fluctuations. The 2023 demerger of Jio Financial serves as a cautionary example, where the stock hit lower circuit limits due to a sharp drop in price.
Mutual Funds Holding ITC Shares: Mutual funds holding ITC shares will receive ITC Hotels shares in the 1:10 ratio. This could lead to substantial portfolio rebalancing, particularly for funds with a significant exposure to ITC Ltd. Depending on the fund's investment strategy, this could require adjustments in both equity and sector allocations. The weight of ITC Hotels in their portfolios could necessitate strategic changes in fund composition as it begins trading independently.
Impact on Foreign Investors: Foreign investors, including FPIs and global funds, will also need to adjust their portfolios. With the initial foreign ownership cap of 34%, there is a potential for more foreign capital to flow into ITC Hotels in the future. However, the short-term volatility caused by BAT’s stake exit and the regulatory process surrounding foreign ownership could influence investor sentiment. Foreign investors in the hospitality sector may find the demerger aligning better with their sector-specific investment strategies.
Valuation of ITC Hotels: Analyzing the Impact
A key focus for investors and analysts will be the valuation of ITC Hotels following the demerger. Preliminary estimates suggest that ITC Hotels’ stock could debut at a price range of Rs 150 to Rs 175 per share. ITC Ltd. will retain a 40% stake in ITC Hotels post-demerger, and the market will closely monitor how the hotel business is valued as an independent entity. The market’s perception of ITC Hotels’ growth prospects and profitability will be central to determining its long-term success. The demerger allows for a more focused assessment of the hotel business, which could result in more tailored investments in the hospitality and real estate sectors.
Global Market Indices and the Long-Term Outlook
ITC Ltd. is a prominent constituent of global market indices, including the MSCI Standard Index and the FTSE Global Index. However, the future inclusion of ITC Hotels in these indices remains uncertain.
MSCI Indices: ITC Hotels may be included in the MSCI Global Small Cap Indexes post-listing, while ITC Ltd. will remain part of the MSCI Standard Index. This could offer more targeted exposure for investors in the hospitality sector.
FTSE Indices: There is some uncertainty about whether ITC Hotels will be included in the FTSE Global Index, as the company’s listing is subject to meeting certain criteria within 20 working days of the record date.
For global investors, the demerger could provide more focused exposure to the hospitality sector through ITC Hotels, while still maintaining exposure to ITC Ltd. in other indices.
Conclusion:
The demerger of ITC Hotels marks a transformative event for both the hospitality and investment sectors. For mutual funds, foreign investors, and passive funds, the separation introduces both opportunities and challenges. While the short-term impact on stock prices, market volatility, and index adjustments remains uncertain, the long-term value creation potential of ITC Hotels will be a crucial factor in its success. Investors will need to navigate the transitional period carefully, adjusting their portfolios to reflect the changes brought about by this major corporate restructuring.
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