Behind ITC's hotels demerger

Why ITC threw down the gauntlet with the demerger of its hotels business

Last month, the board of directors at ITC cleared the demerger of its hotels division, kicking off an important — and long-awaited — transition for the cigarette-to-FMCG diversified conglomerate, and one of the country’s most valuable firms.

On the face of it, the strategic rationale for carving out the hotels division and separating it from the mothership is clear. However, the manner in which the proposed structure has been designed for the new entity — ITC Hotels — and ITC’s decision to retain a sizeable 40 per cent stake in the new entity, has invited critical commentary, with ITC’s share price dropping 2.6 per cent between July 24, the date of the announcement, and August 9.

The moot issue is whether ITC is wary of completely cutting off the umbilical cord with its hotels business. Is there really a perceptible threat of a takeover, as speculated by some analysts, that influenced ITC’s decision to retain a controlling stake in its hotels business?

Before we dive in, let’s quickly understand the implications — and also the key trends driving the hospitality sector. ITC hotels is second in size only to the Tata group-owned Indian Hotels in the organised hotel industry. When ITC Hotels eventually lists on the stock exchanges in about 15 months, the demerger could possibly impact the industry structure. How? In the early 2000s, ITC, under its then chairman Y C Deveshwar, began accumulating shares in East India Hotels (better known as the Oberoi Group), the third player, albeit much smaller than Indian Hotels and ITC. It stopped short of the 15 per cent stake to avoid an open offer. Devashwar had maintained that ITC did not have any intention to mount a takeover, but that this was a financial investment. Yet that assurance didn’t placate the patriarch PRS “Biki” Oberoi from inviting a white knight in Mukesh Ambani to pick up a 14.1 per cent stake to ward off the prospect of a hostile takeover. Nita Ambani and Manoj Modi joined the EIH board. Reliance currently owns 18.83 per cent in EIH, while ITC holds 13.69 per cent. There has been intense speculation about the Ambanis waiting in the wings to take control, but perhaps only after Biki Oberoi, the 94-year-old chairman emeritus, is no more.

To signal its intent, Reliance spent $100 million last year on acquiring a controlling stake in Mandarin Oriental, a top-of-the-line property in New York, not far from the Taj Group’s Pierre. Last month, Reliance Industries announced a tie-up with Oberoi Hotels and Resorts to co-manage three property projects spread across India and the United Kingdom, signalling a deeper foray into the hospitality industry. Oberoi-run Anant Vilas in Mumbai and an unnamed planned project in India’s western state of Gujarat, and Reliance-owned Stoke Park in Buckinghamshire in the UK, will now be managed jointly by the two companies.

Reading the tea leaves, Reliance’s impending entry into the hospitality industry through the Oberoi Group and its own M&A plans, could significantly alter the landscape — and the outcome of the three-horse-race among Tatas, ITC and now, Reliance. Until now, the Oberoi Group had remained a distant third. Biki was known to be selective in expanding the luxury chain, and had studiously avoided the mid-market and budget hotel space, unlike the Tatas and ITC. What’s more, their decision to own and manage many of their properties — compared to the asset-light management contract model pursued by the Tatas — had left them susceptible, whenever the business was hit by a down cycle.

On the other hand, hotels enjoyed a special place in Y C Deveshwar’s heart, ever since he took over as chairman in 1996. On the back of its huge cash flow from its dominant cigarette business, he significantly expanded its presence to over 100 (120 now) properties. As recently as 2019, he built palatial, iconic properties like the Royal Bengal in Kolkata, and the Grand Chola in Chennai in 2012. But analysts tracking the company were never happy with its single-digit return on capital employed or its contribution to the overall top line, compared to the more robust performance of other businesses — tobacco, paper and paperboards, agri, and FMCG. Furthermore, the former parent BAT (British American Tobacco), which still held a 29.1 per cent stake in ITC, was never happy with Deveshwar’s diversification strategy, but couldn’t do much to influence him.

ITC’s demerger plan was proposed in its annual report of FY20. Deveshwar succumbed to cancer on May 11, 2019. The following year, the pandemic and the lockdown wreaked havoc on the entire hospitality industry. The post-pandemic rebound in the hotel industry is now palpable. Sensing the uptick, the new Chairman and Managing Director, Sanjiv Puri, put the demerger plan back on track.

The demerger kills at least three birds with one stone. It offers ITC shareholders, including BAT, an option, to either stay invested in ITC Hotels or exit. ITC Hotels now has a strong book of assets, branded properties at different price points and zero debt. It will be able to raise resources, have the agility to operate through its own independent board and yet have access to the goodwill, ITC brand, and capabilities. ITC, on its part, stands to gain higher returns, based on reduced capital expenditure needs. If BAT chooses to exit ITC Hotels down the line by selling its 17.4 per cent stake, ITC, with a 40 per cent stake, will be able to guard against any hostile takeover and provide a measure of stability to its own employees. The die is cast for a transformative period.

The writer is co-founder at Founding Fuel