6A.5 Demergers · M06A Events, sectors, factors

Motivation

A demerger splits a listed company: shareholders receive shares of the "resulting" company in proportion to their holdings, and the parent continues without that business. Prices around it test whether the market values parts better than wholes, and the tax rules decide what your cost basis becomes.

6A.5.1Value conservation and cost basis#

Setup

A scheme of arrangement sets a share entitlement ratio $q$ (resulting-company shares per parent share), approved by shareholders, creditors, the NCLT (National Company Law Tribunal) and, where needed, the CCI. On the record date the parent goes ex-entitlement. NSE and BSE run a special pre-open session on the ex-date in which the parent's price is discovered without the business; the resulting company lists weeks later.

Proposition 6A.7value conservation and cost apportionment

(a) If the demerger carries no new information and no frictions, the cum and ex prices satisfy

P_{\text{cum}} = P_{\text{ex}} + q\,P_{\text{child}}, \tag{6A.8}

so the special session implies a value for the child of $(P_{\text{cum}} - P_{\text{ex}})/q$ . (b) Under Indian tax law (s.49(2C)–(2D) of the 1961 Act), the cost of acquisition of the resulting-company shares is

\text{Cost}_{\text{child}} = \text{Cost}_{\text{original}} \times \frac{\text{net book value of assets transferred}}{\text{net worth of the parent before the demerger}}, \tag{6A.9}

the parent keeps the rest, and the holding period of the child shares runs from the date the parent shares were acquired.

Proof ofa

A holder of one parent share before the record date owns, afterwards, one ex-parent share and $q$ child shares, with the same claims on the same assets. If two portfolios have identical payoffs in every state, their prices must agree, otherwise a riskless profit exists (buy the cheaper, sell the dearer; M07). ∎ Part (b) is a statutory rule, not a theorem; the company announces the ratio after the demerger.

The cost split uses book values while the market splits market values. They can differ by a factor of two or more, which changes the taxable gain on a later sale of either piece.

6A.5.2The ITC Hotels demerger#

Worked example: ITC Hotels (January 2025) [S unless noted]

Ratio 1 ITC Hotels share for every 10 ITC shares; record date 6 January 2025; ITC retained about 40% of ITC Hotels and the other 60% went to ITC's shareholders. In the special session on 6 January, ITC's price was reduced by about ₹27 to ₹455 on BSE (₹455.60 on NSE), so by (6A.8) the discovered value of one ITC Hotels share was about ₹270 on BSE (NSE ₹260). ITC Hotels listed on 29 January 2025 at ₹188 on BSE and ₹180 on NSE, about 30% below the discovered price, and hit its 5% lower circuit. ITC's filing of 28 January 2025 apportioned cost 86.49% to ITC and 13.51% to ITC Hotels¹. A holder of 1,000 ITC shares bought at ₹400 therefore carries ₹3,45,960 on the ITC shares and ₹54,040 (₹540.40 a share) on the 100 ITC Hotels shares. At the ₹188 listing price, selling the hotel shares would realise a capital loss of ₹352.40 a share, although the economic loss from the demerger was nil. The market-value share of the hotels business on 6 January was about $27/482 \approx 5.6\%$ , against a cost share of 13.51%.

6A.5.3Selling pressure after listing#

Why newly listed demerged companies often fall Index funds hold the parent. When the child lists, index providers typically include it temporarily and then remove it; passive holders who cannot or do not want to hold it sell, while active buyers need time to do research. This is a supply shock unrelated to value, and it is a recurring reason demerged stocks list below their discovered price. Whether it is a reliable opportunity is an empirical question: the sample of Indian demergers is small and each has its own news.

Practitioner notes

Read the scheme document for the ratio, the treatment of employee options, the debt allocation and the parent's retained stake (here 40%: the parent's ex price still contains its share of the child).
Sum-of-the-parts (SOTP) values each segment at a peer multiple and subtracts a holding-company discount for listed stakes. Demergers often aim to close the discount; whether they do is visible in (6A.8) on the day.
Reliance's 2023 demerger of Jio Financial Services had a 1:1 ratio, a special-session discovered value of ₹261.85, and a cost split of 95.32% RIL / 4.68% JFS²: market share about 9%, cost share 4.7%, the opposite direction from ITC.