what is the Impact of Demerger on Shareholders?

7 Nov 2019  Read 4002 Views

There are often times when a diversified company opts for focusing on its core businesses and transferring its other business operations to a different company. This is the simple idea behind a popular corporate restructuring activity i.e., Demerger.

In the article,  How is your Purchase Price Divided after a Demerger, we have discussed the advantages of Demerger and what does demerger mean for a shareholder.  Let us now focus on how the stock prices change after the demerger.

On a fundamental note, Demerger refers to the transfer of a company's one or more of its business operations into another company(s). The entity that transfers its business operations is known as "demerged company," and the entity created as a result of the demerger is known as the "resulting company."

What are the different kinds of demergers?

Before moving ahead and demystifying as to what happens to the stock price after a demerger, we must know the types of a demerger. They are:

Let us understand how the stock prices are impacted in Splits and Spin-offs..

Spin-Off

In a spin-off, a company retains a portion of the spun-off identity. Consider ABC, with a market capitalization of Rs 10,00,000 with 10,000 outstanding shares, which means a share price of Rs 100. Let's say that the company is willing to spin off 50% of its business divisions, which is valued at Rs 3,00,000 at an initial share price of Rs 30.

Let us now calculate the post spun off the price.

In this scenario

 Heads Value Per Share Price Market Capitalisation 10,00,000 100 less: Business Required for a spin-off 3,00,000 30 Remaining Value of Business 7,00,000 70 Add The retained 50% stake in the spun-off division. 1,50,000 15 Value after spin-off 8,50,000 85
Split

In a split, the shareholders are given an option to own shares of either parent company or the subsidiary company. In this scenario, the stock price of the company after is calculated as:

Price before the split (original share price) less the initial stock price of the split company.

Suppose ABC traded at Rs 100 before the split. However, the initial stock price right after the split is Rs 50.  Let us now calculate the post-split price.

 Heads Price per share (in Rs) Original Market Price 100 less: Stock Price after a split 50 Post-Split Price 50
How does a Demerger impact shareholders?

The stock price of a company immediately drops after a demerger. This is because assets which once belonged to the parent company are removed from the parent company's books, which lowers its book value. However, investors should keep in mind that the subsidiary company has enormous potential for growth. However, it is subject to high risks as well.

Demergers help the company to focus on its core business operations fully and confidently.

In any way, demergers create a win-win situation for both investors and the companies