Investment Advisory Service

Monday, 17 December 2012

Wipro Limited- Scheme of Demerger

The Demerger Scheme

Wipro Limited has announced the plan to demerge its non-IT business into a separate company ; Wipro Enterprises Limited. The non-IT business consists of :

A)  Consumer Care, Lighting and Furniture Business
B)  Infrastructure Business (Hydraulics and Water)
C)  Medical Diagnostic and Service Business

The new company will be an unlisted entity and the shareholders have been provided with 3 options to choose from in lieu of the non-IT business which will get hived off.

  1. Receive 1 equity share of Wipro Enterprises for every 5 equity shares of Wipro Limited
  2. Receive one 7% Redeemable Preference share (Face Value Rs 50) in Wipro Enterprises for every 5 equity shares held in Wipro Limited. The preference share shall have a maturity of 12 months and shall be redeemed at a value of Rs 235.20
  3. Exchange the shares of Wipro Enterprises with shares of Wipro Limited (pure IT company post the scheme of arrangement) held by the promoter. 1 share of Wipro Limited can be opted for every 1.65 shares of Wipro Enterprises.
NRI shareholders can either choose for option 1 or option 3. However, the ADR holders will compulsorily be given option 3.

The demerger will make Wipro Limited a pure IT company and will also assist Wipro Limited in increasing the public float for the purpose of meeting the minimum public shareholding requirements. The promoter owns 78.31% stake in the company as of Sep 30,2012. Since ADR holders hold 1.73% stake in the company as on Sep 30, 2012 ; the stake of the promoter will definitely come down by this much and more from the action of Resident Indian and NRI shareholders who opt for option 3.

SEBI has approved the proposal to reduce the promoters’ holding by way of the demerger and subsequent exchange of shares in order to comply with the minimum public shareholding norms.

In March 2012, in an attempt to bring down the promoters’ shareholding in the company; Azim Premji Trust had done an “offer for sale” and offered to sell 3.5 crs which was around 1.5% of the outstanding equity. The issue remained partially subscribed and the trust was able to sell only 1.78 cr shares which was 51% of the quantity offered. The sale happened at a price of 421 while the current price is 375.

How good and large is the non-IT Business ?
  
For the year ended March 31,2012 Wipro Limited had a consolidated top line of  about 37,000 crs. The IT Business contributed about 32,000 crs which was 86% of the turnover. The non-IT business contributed 14% or roughly 5,000 crs which looks small when compared to the IT revenues but is large enough in its own right.

In consumer care space, Wipro has brands like Santoor soap, Chandrika soap, Aramusk, Yardley, Safe wash etc. In indoor lighting, Wipro shares No 1 position with Philips; in commercial lighting Wipro is No 3 and in the furniture business, it is No 2 after Godrej. Wipro Infrastructure Engineering is world’s largest independent hydraulics cylinder manufacturer in the world with a 70% market share in India.

The management has been very active in growing the consumer care business inorganically. In the last few years, host of acquisitions have been done like Glucovita (2003), Chandrika (2004), North West Switches (2006), Unza Holdings (2007) and Yardley in 2009. The latest one being the acquisition of LD Waxsons (2012).

Of the non-IT business, the consumer care and lighting business is the largest piece which generated a turnover of around 3300 crs and generated ROCE of 18-20% in FY 12. In the current half year, this division has notched sales of about 2000 crs. Annualising the revenues to 4000 crs and going by the peer valuations, this piece could easily sell for 2-3 times its revenues if it were to list separately. Thus the consumer care division can be valued between 8000-12000 crs.

Other businesses like infrastructure and medical diagnostic businesses are relatively small and currently earn far lower margins and ROCE than the consumer care business. In the current half year, this division has notched sales of about 750 crs. The annualised revenues would be about 1500 crs. Difficult to value this piece in light of the poor margins right now. However, just to put a range of values to it, if it were to sell between 0.5-1 times revenues, this piece could be valued between 750-1500 crs.

The management of Wipro has indicated in the latest concall that the non-IT business would have debt of 200 crs and cash of around 1500 crs. So net cash of 1300 crs is going to come along with the non-IT business.

The sum of the parts for the 2 pieces plus the cash thus ranges between 10000 crs-14800 crs. Wipro Limited has 246 cr shares outstanding. Since for  every 5 shares of Wipro Limited, 1 share of Wipro Enterprises would be issued; Wipro Enterprises would have 49.2 cr shares. Thus, according to my workings, the per share intrinsic value of the non-IT piece of Wipro Limited ranges between 203 and 300 bucks. The average of the 2 figures is around 250.

Is the demerger fair to the shareholders ?

Point 1. The shareholders of Wipro have not been given an option to remain invested in the non-IT business. The option to retain shares of Wipro Enterprises is a dead option with no sight of listing. -1 to Scheme.

Point 2. But are the shareholders of Wipro actually invested in Wipro for the non-IT part ? People might come up with all sorts of arguments but the fact is that with 86% of the turnover and 95% of the profits coming from the IT division, the weight of evidence is heavily tilted in favour that for the current shareholders, Wipro is an IT company. Period.

Point 3. What is the scheme offering in lieu of the non-IT business ? Option 1 is a dead option and Option 3 is in the realm of speculation because Wipro shares price is a moving target and we don’t know what price one would get for the Wipro Limited (pure IT company) shares when they are sold. Option 2 of taking the preference share is a more concrete benchmark to find out what the shareholders are receiving for the non-IT business. The present value of the preference share at 10% discount is Rs 217 which is close to my average intrinsic value working of 250 of the non-IT piece. Thus, in my view the shareholders are being offered a fair price for the non-IT business. +1 to the Scheme.

Point 4. The promoters had tried to reduce their shareholding through an offer for sale but it didn’t succeed. With the deadline for complying with the public listing norms approaching, the promoters had the option to either opt for delisting or to try again and sell shares through offer for sale. Reverse book building for a 92,000 cr market cap company is not a joke and the promoters might not have the liquidity of 20,000 crs plus required to buy out the minority shareholders. Offer for sale might have proved disastrous as the stock price might have slided massively thus hurting the very shareholders of Wipro. +1 to the Scheme.

Overall to me it seems that the promoters have been pragmatic and have hit 2 birds with a single stone by offering this demerger and the exchange of shares scheme. In spirit of the Wipro’s concept of “Applying Thought” ; a lot of thought seems to have gone behind this demerger scheme too.

What option should the current shareholders of Wipro Limited choose ?

If a current shareholder of Wipro has a much better understanding of the non-IT business and has a much higher intrinsic value figure in his mind, he should definitely choose Option #1 of retaining the shares of Wipro Enterprises. But be prepared for a long ride with no dividends and no quotes on the stock for very many years. I am quite confident that the money is in safe hands and the consumer care business of Wipro would grow handsomely from here but the waiting period might easily stretch into a decade. This option is for people who have a mentality of an art collector. People who can buy a Picasso and sit patiently for decades.

If a shareholder is of the kinds who wishes to update his portfolio on a regular basis and likes the regular stream of dividends, he has to choose from Option #2 or Option #3. With Option 2, one can take his money and if interested buy other consumer care businesses listed in the market. If somebody is interested in only the technology part, he can simply opt for Option #3.

I am currently not a shareholder of Wipro Limited and any shareholder of Wipro reading this post should make his own judgement about the option he wishes to choose.

Is there any opportunity to make money in this deal ?

There is nothing I could think of as of now. But it’s a large company; with an impending demerger; stock is in F&O and the promoter is ethical. It would be interesting to watch and a possibility of making money might come at some later point of time.

-END-

7 comments:

Neeraj Marathe said...

Great post, as usual.
I had a question Ankur. Suppose the ex-date was tomorrow. How much do you think the stock should fall? Since its a widely tracked and held stock, should it fall about 12% (which is roughly the embedded value per share of the business going out)?
Now if it does fall 12 odd percent, the interesting thing is that the business going out is one which contributes only about 6% to the operating profit. After it goes out, Wipro becomes a pure IT company. For this, should the stock of Wipro fall 12%, or should it fall since its so widely held (read efficient market!) and then recover immediately? I am just thinking out loud here. I have been working on this for some time now, but do not have the answers.. :-(
Neeraj

Neeraj Marathe said...

Great post, as usual.
I had a question Ankur. Suppose the ex-date was tomorrow. How much do you think the stock should fall? Since its a widely tracked and held stock, should it fall about 12% (which is roughly the embedded value per share of the business going out)?
Now if it does fall 12 odd percent, the interesting thing is that the business going out is one which contributes only about 6% to the operating profit. After it goes out, Wipro becomes a pure IT company. For this, should the stock of Wipro fall 12%, or should it fall since its so widely held (read efficient market!) and then recover immediately? I am just thinking out loud here. I have been working on this for some time now, but do not have the answers.. :-(
Neeraj

Ninad Kunder said...

Couple of more questions in addition to Neeraj's question

1) What is the timeline that you expect for the closure of this deal?

2) Subsequent to the announcement the consumer business has gone ahead and done a new acquisition. Will the cost of the acquisition come out of the cash that is earmarked for the consumer business or is additonal value being transmitted to the consumer business? Any clarity on this.

Cheers

Ninad

Ankur Jain said...

Thanks Neeraj.

It's true that the scheme would provide 12% extra shares of Wipro (pure IT) in lieu of the non-IT business, but whether the stock would go down by 12% or more or less would depend on a lot of factors like the run up in the stock till the record date, market sentiment towards the consumer care business and the IT business around the time of record date, overall market scenario etc.

Let's say the market is down 40% by the time the record date is announced, what will happen to Wipro demerger? Market might completely ignore the demerger and there might not be any substantial decline in the price of Wipro pre and post demerger. Different iterations might play out depending on the combination of factors.

Too early to comment on the possible decline in Wipro's stock price on the ex-date.


Regards

Ankur

Ankur Jain said...

Ninad,

I think it could easily take 8-12 months from here for the deal to consummate.

In the concall, the management had indicated that the net cash moving to the non-IT business would be around 1300 crs as on March 31, 2012. We still need to verify that figure by going through the actual scheme of arrangement. Any acquisition in the non-IT division post that date should ideally be funded by that cash in that division or internal accruals for that division or debt taken in that division alone.

I don't think any additional value is being transmitted to the non-IT division. But we need to add the internal accruals of the non-IT division for the last 9 months to the net cash figure of March 2012 , deduct the cash spent on acquisitions post March 2012 and also add the cash generated from divestments from the non-IT division to arrive at the net cash figure as of now.


Regards

Ankur

Rayhaan said...

hi,
truly a post to get excited about ,especially in sentiment heavy(and substance less ) times like these.

in my (expectation heavy) opinion i'm pretty sure mr. market will be cooperative in this situation,not sure to what extent of course

primo,the fact wipro is widely held has a greater chance of contributing to inefficiency. After all a sell off by not one but two or three different indices(nifty,cnx it and sensex) is bound to , to quote duke nukem'gotta leave a mark"

secondo,obviously some(read much of the retail) people are going to opt for the second and third options if not blindly selling

terto,you might be right about the decade long wait part,but i sincerely doubt(and am truly unaware how) a billion dollar company with an apparently honest and well incentivized management to remain undervalued for that long.
obviously the potential for catalysts like a further spinoff or two and maybe even an eventual share buyback is NOT something we can count on(but certainly can hope for).

Moral of the story:as u said really gotta keep the eyes peeled(and google alerts on) for this one,indeed a lot will depend on the eventual scheme of demerger .
thank you for the wonderful wonderful post.Any and every opinion is heavily influenced by the werm fuzzy feeling the portfolio is giving me these days

Ankur Jain said...

finalo ,let me thank you for your comment Rayhaan :-)

10 year period is just an anchor for people who believe in the consumer care business to fasten their belts and sit tight. As you pointed out, it can be less than that or even more.