What Happens if ITC Hives off ITC Infotech?

The share trading volume for ITC spiked this week as there were rumors of yet another demerger plan.

Following this news, ITC share price added 4% intra-day on Wednesday and closed 1.7% higher.

Earlier this year, there were rumors that ITC would demerge its lucrative FMCG business and hotel business. This time, it's ITC Infotech, the company's IT service business that is being talked about.

The cigarette to hotel conglomerate is reportedly mulling demerger of its software business at a valuation of around Rs 250 bn.

According to several media reports, the company's board will soon meet to discuss the demerger plans and also appoint investment bankers.

Now, we cannot verify these media reports. But what we can definitely do is hypothesise its impact if it were to happen.

So, here goes...

About ITC Infotech

ITC Infotech provides technology solutions and services to enterprises across industries such as banking and financial services, healthcare, manufacturing, consumer goods, and travel & hospitality, through a combination of traditional and newer business models.

It's basically a company like Tata Consultancy Services (TCS) or Infosys, only much smaller.

In the last three years, especially in fiscal 2021, ITC Infotech's profitability and revenues have improved.

The company had posted revenues of Rs 24.5 bn in financial year 2021. It's eyeing Rs 30 bn revenue this financial year.

Financial year 2021 was the second straight year where ITC Infotech delivered double digit revenue growth and doubled its bottomline.

After a 4X growth in net profit in two years, ITC is now giving special attention to ITC Infotech.

ITC Infotech's Revenue and Profit over the Years

(Rs bn)	Mar-19	Mar-20	Mar-21	H1FY22
Revenues	20.1	22.5	24.5	14.5
Net Profit	1.0	2.1	4.5	3.1

Data Source: Company Reports

What's interesting is that ITC Infotech's fiscal 2021 revenues are higher than other mid-tier IT firms including Tata Elxsi, Mastek, eClerx Services, KPIT Technologies, and Happiest Minds Technologies.

How will a demerger unlock value? Hear out this valuation guru...

In June 2021, Professor Sanjay Bakshi, who is well known in the field of value investing and behavioral finance, explained how ITC's demerger can unlock value in a series of tweets.

He pointed out three scenarios in which the unlocking can happen.

Another scenario in which this can happen is that if ITC tobacco is separated from other businesses, then non tobacco assets would have no recourse to funding from tobacco. Some of those assets may have to be sold off and their asset value may be more than earning power value.

— Fundoo Professor (@Sanjay__Bakshi) June 5, 2021

That's because lower the P/E, higher the cost of capital and higher the discount rate used to bring back future cash flows to present value And vice versa.

— Fundoo Professor (@Sanjay__Bakshi) June 5, 2021

Equitymaster on ITC

In August 2021, co-head of Research at Equitymaster, Rahul Shah, wrote an editorial on why this is the best time in years to buy ITC.

Here's an excerpt:

• I have a strong feeling that unless something goes drastically wrong with the fundamentals, the stock may have reached a nadir.
  
  Put differently, the stock may not fall much from the current levels. On the contrary, this could perhaps be the best time in a long time to buy the stock.
  
  Why?
  
  My optimism stems from the low interest rates on offer across a spectrum of asset classes.
  
  Take fixed deposits for example. I recently renewed my FD with a leading private sector bank at an interest rate of just 5% per annum.
  
  Well, this is exactly the dividend yield that ITC is currently trading at.

You can read the entire piece here: This Could be the Best Time in Years to Buy ITC

What if ITC's demerger rumor is actually true?

In the past, there were rumors revolving around ITC's demerger. But those were speculative in nature.

But what if the demerger actually take place this time? Will it be the biggest event of the year? Even bigger than Vedanta's complete overhaul of its corporate structure?

One thing is for sure.

The demerger rumor comes as a big positive for ITC shareholders. They have long demanded for spinning off profit-making entities such as FMCG and software.

ITC has been facing the heat for a long time now and for good reason given the stock's underperformance for the past 10 years.

Despite being the largest cigarette manufacturer and seller in the country, and operating in various segments (some average, some extremely good), it has failed to unlock shareholder value.

This is not surprising since tobacco is not an industry that can attract huge ESG focused investors.

Although ITC has in the past stated that the demerger is just speculation, if this time around the reports are true, and if ITC Infotech does get a valuation of around Rs 250 bn, a vertical that's less than 1% of revenues right now may see sharp uptick in valuation.

If an actual demerger does take place, ITC Infotech as a standalone company will get better valuations, which it may not get if perceived to be a unit of a very large conglomerate.

Often, the sum of the parts is much more valuable than the whole.

Though such a demerger would still take several months, or even a year given that ITC is a big company, concentrating on profitable segments will ultimately create more value.

ITC shareholders have realised by now that they are in for the long haul. They are still keeping firm hopes on the company.

Here's something good they can ponder over...

Larsen & Toubro (L&T) also had different segments and over time, the company unlocked value for shareholders by listing its business separately - L&T Finance, L&T Infotech, L&T Technology Services.

L&T's marketcap was around Rs 1.5 tn when it carved off L&T Infotech and L&T Technology Services. Today, it has a marketcap of Rs 2.7 tn.

If we consider its holding in subsidiaries the two software subsidiaries, the value goes up to Rs 4 tn.

The marketcap of Larsen & Toubro Infotech has risen over 9 times since listing while L&T Technology Services has multiplied its marketcap by more than 5 times.

So, will ITC be able to unlock value like L&T did and prove the critics wrong?

There's a good chance of that happening.

About ITC

Established in 1910, ITC is India's biggest cigarettes & second largest fast-moving consumer goods (FMCG) company with 78% market share in cigarettes and presence in staples, biscuits, noodles, snacks, chocolate, dairy, and personal care products.

The company is also present in paperboard, printing & packaging business with revenue of Rs 45.5 bn and agri-business with Rs 80 bn as of fiscal 2021.

The company completed 100 years in 2010 and it employs over 36,500 people at more than 60 locations across India and is part of the Forbes 2000 list.

To know more, check out ITC company fact sheet and quarterly results.

For a sector overview, read our FMCG sector report.

You can also compare ITC with its peers:

ITC vs VST Industries

ITC vs Godfrey Philips

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...