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MF 0011Mergers & AcquisitionsUnit 6 - Demergers

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Program : MBA

Semester : III

Subject Code : MF 0011

Subject Name : Mergers & Acquisitions

Unit number : 6

Unit Title : Demergers

Lecture Number :

Lecture Title : Demergers

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Objectives:

After studying this unit, you should be able to:

Explain the meaning of demerger

Identify the characteristics of demerger

Describe the structure of demerger

Explain the tax implications of demerger

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Demergers

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Introduction

Demerger: Meaning Demerger: Characteristics

Demerger: Structure

Forms of Demerger

Spin-Off

Split-Off

Split-Up Demerger: Income Tax Act

Demerger: Tax Implications

Summary

Glossary

Check Your Learning

Answers

Case Study

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Lecture Outline

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Problems with large business entities:

Hinders entrepreneurial initiatives

Side-lines core activities

Reduces accountability, and

Promotes investment in non-core activities.

Introduction

Possible reasons for demerger:

Demerger may allow them to strengthen their core competence andrealise the true value of their business.

Demerger is often used to divide or separate some undertakings of abusiness, functioning till then under a common umbrella.

Is a way to get rid of underperforming or non-core business divisionsthat can drag down profits.

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The term Demerger has not been defined in the Companies Act, 1956.

However, according to Sub-section (19AA) of Section 2 of the Income Tax Act:

Demerger in relation to companies means transfer, pursuant to a scheme of

arrangement under Sections 391 to 394 of the Companies Act, 1956, by a

demerged companyof its one or more undertakingsto any resulting

companyin such a manner that all theproperty and liabilities of the

undertaking being transferred by the demerged company, immediatelybefore the demerger, become the property and liabilities of the resulting

companyby virtue of the demerger.

Example: Possible Reasons for Demerger: Conglomerate

Rationalisation or embarking on specialisation in the manufacturingprocess

Less successful part of the undertaking could be transferred to a newlyformed company

Demerger: Meaning

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Demerger is basically a scheme of arrangement under Sections 391 to 394of the Companies Act which requires:

Approval by majority of shareholders holding shares that representthree-fourths value in a meeting convened for the purpose

Sanction of the High Court.

Demerger results in transfer of one or more undertakings.

The transfer of undertakings is done by the demerged company, otherwiseknown as transferor company. The company to which the undertaking isbeing transferred is known as resulting company, otherwise known astransferee company.

Demerger: Characteristics

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Demerger: Structure

Distribution of the shares of a firms subsidiary to theshareholders of the firm on a pro rata basis

Neither the dilution of equity nor the transfer of ownership fromthe current shareholders is involved

After the distribution, the operations and management of thesubsidiary are separated from those of the parent.

No cash transactions are involved in a demerger, it is a uniquemode of divesting assets. Hence, it cannot be motivated by adesire to generate cash to pay off debt, as is often the case withother modes of divestitures

Demerger

Click here to see an example ofthe structure before and after

demerger for Bajaj Auto.

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Spin-OffAn individual or an

organizational unit

leaving an existingfirm to start as anew firm on thebasis of his/herknowledge andcompetences.

Split-Off Restructuring of a

company where

the parentcompany will offerinvestors shares ofa subsidiary inreturn for sharesof the parentcompany.

Split-

UpA company splits

up into two or

more independentcompanies

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Forms of Demerger

Some Examples:

1. Larsen and Toubro was considered more of a cement business than a constructioncompany. The company spun off its cement division. Due to this, the stock went uptenfold. (Spin-Off)

2. In 2003 United Breweries de-merged itself into two companies United Breweries (thebeer company) and UB Holdings (the property and investment play). In about 3 years,the collective value of investment went up 8 times. (Spin-Off)

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Companytakes

decision tospin-off adivision

Parentcompany

does thepaper workwith SEBI

Unit

Registeredand filedwith SEBI

Shares ofnew

company

distributed toshareholdersof previouscompany

Companygoes public

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PROCESS OF SPIN-OFF

Forms of Demerger: Spin-Off

No cash exchange (money is not received by the original parent).

Subsidiarys assets are not re-valued.

The transactions are basically a stock dividend and a tax-freeexchange.

Spin-Off

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Forms of Demerger: Spin-Off (Contd.)

Reason why spin-off entitys shares are distributed among the parent company

shareholders: Parent company shareholders who are not interested in holding shares of the

spun off unit are free to sell the shares once the new company goes public. Large institutional stock holders in the parent company are not allowed to keep

shares in spin-offs due to smaller market capitalisation and increased risk andthey look to sell their shares soon.

Proportion of Ownership

The existing stockholders have the same proportion of ownership in the newentity as in the original firm.

There is separation of control. The new entity exists as a separate decision-making unit. It may develop policies and strategies different from those of the parent.

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Transaction in which some, but not all, shareholders of the

parent company receive shares in a subsidiary, in return forrelinquishing their parent companys shares.

Some shareholders of the parent company get the subsidiarysshares in return for which they must give up their parentcompany shares.

Split-Off

Forms of Demerger: Split-Off

Example:

Viacom announced a split off of its interest in Blockbuster in 2004 wherebyViacom offered its shareholders stock in Blockbuster in exchange for an

appropriate amount of Viacom stock. (Split-Off)

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Restructuring where the firm strategically breaks up the entirecorporate body.

Firm is broken up into a number of spin-offs, after which the parentcompany does not exist any longer, and only the newly formedcompanies exist.

The stockholders in the companies may not be the same, as thestockholders trade their shares in the parent company with shares inone or more of the units that are spun-off.

Split-

Up

Forms of Demerger: Split-Up

Features:

The entire firm is split up into a series of spin-offs.

The parent company no longer exists.

Only the new companies survive.

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Demerger: Income Tax Act

IncomeTaxAct

All the assets and the liabilities of the undertaking are transferredfrom the demerged company to the resulting company.

The transfer is on a going concern basis and at book value.

Shareholders holding not less than 75 per cent in value of the sharesin the demerged company become shareholders of the resultingcompany or companies by virtue of the demerger.

In consideration of the demerger, the resulting company issues itsshares to the shareholders of the demerged company on aproportionate basis.

The Income Tax Act stipulates the following conditions for a transaction to berecognised as a demerger:

Click here to know the taxbenefits and concessions

available for demerger under ITAct

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Demerger: Tax Implications

Amendments to Income Tax Act were introduced by the Finance Act, 1999(effective from 01-04-2000) to enable corporate enterprises to be assuredthat:

Click here to read about thecontrols to misuse of taximplications and benefits

extended to authorities fordemergers

Amendm

entsto

ITAct Demergers will be tax-neutral and not attract any additional liability to

tax.

Tax benefits and concessions available to the demerged undertakingwill be available to the resulting company after demerger.

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Summary

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Demerger is often used to separate different undertakings of a business

functioning under a common umbrella. A demerger is distribution of the shares of a firms subsidiary to the

shareholders of the firm on a pro rata basis. Neither the dilution of equity northe transfer of ownership from the current shareholders is involved.

Demerger can be by spin-off, split-off and split-up.

Spin-off is often used to get rid of unprofitable business divisions. In a split-up, a company is split up into two or more independent companies.

Split-off provides shares in the subsidiary company to certain shareholders.

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Glossary

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Spin-off: When a division of a company or organisation becomes an

independent business and the resulting company takes assets,property, technology, and/or products from the parent organisation.

Split-off: When the stock of a subsidiary is exchanged for shares in aparent company.

Split-up: When a single company splits into two or more companiesand loses its original identity.

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Check Your Learning

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1. A ____________ results in the transfer by a company of one or more of itsundertakings to another company.

2. Demerger is often used to describe ________ of different undertakings of abusiness, functioning till then under a common umbrella.

3. ____________ is not defined under the Companies Act.

4. The company whose undertaking is transferred is called the resulting

company. (True/False)

5. A demerger is distribution of the shares of a firms subsidiary to theshareholders of the firm on a pro rata basis. (True/False)

6. There is no cash exchange in a spin-off. (True/False)

7. In split-off all the shareholders of the parent company get shares in thesubsidiary. (True/False)

8. In a split-up, a company is split up into two or more dependent companies.(True/False)

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MF 0011 Mergers & Acquisitions

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Check Your Learning

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9. Demerger constitutes a unique mode of divesting assets since they do notinvolve any cash transaction. (True/False)

10.The resulting company in demerger can get the tax relief if the resultingcompany is an ________________.

11.Demergers should be ________________ and should not attract anyadditional liability to tax.

12.Accumulated losses and ________________ can be carried forward from thedemerged company to the resulting company.

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Answers

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1. Demerger.2. Division or separation.

3. Demerger.

4. False.

5. True.

6. True.7. False.

8. False.

9. True.

10. Indian company.

11. Tax neutral.12. Unabsorbed depreciation.

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MF 0011Mergers & Acquisitions

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Case Study

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Answer the following questions, based on thegiven case:

QuestionDiscuss the impact of demerger decision on thecompany value.

Hint answer:Decisions like merger and demerger create big impact onthe share value of the firm. Kalyani Steels share valueincreased by 20% before the demerger of its investmentarm.

Click on the icon besides, toanalyse the case on Demerger

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