Case 086Capital allocation and corporate actionsHard

A group is demerging its consumer arm, which peers value at 30x EBITDA, from its chemicals arm, valued at 12x. The group trades at 14x. How much value could the split unlock?

The situation

Tulvara Industries has two businesses. Its consumer arm, home care and personal care brands, earns EBITDA of Rs 500 crore; listed consumer peers trade near 30x EBITDA. Its chemicals arm earns EBITDA of Rs 800 crore; chemicals peers trade near 12x. The group trades at 14x its combined EBITDA of Rs 1,300 crore, has net debt of Rs 1,200 crore and 100 crore shares.

The board announces a demerger: shareholders will receive one share of the new consumer company for each Tulvara share. The consumer arm is smaller and grows more slowly than the listed leaders, and each company will need its own board, finance team and listing costs, about Rs 20 crore a year each.

Your task

What value could the demerger unlock, what does it depend on, and how much would you actually count?

Quick check

Below what consumer multiple does the demerger unlock nothing, with chemicals at 12x?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

At peer multiples the split is worth Rs 6,400 crore, 35% more than today, but a realistic figure is nearer Rs 3,160 crore. The parts, consumer at 30x and chemicals at 12x, add to Rs 24,600 crore against Rs 18,200 crore for the group at 14x. A smaller consumer arm rated at 25x, and Rs 40 crore of new standalone costs, cut the gain to Rs 3,160 crore. The consumer arm must earn at least 17.2x for any gain at all.

Step 1Why can the parts be worth more than the whole?

Because a mixed group gets one blended multiple, and buyers of each part would pay more on their own. A box of mangoes sold with a few tired bananas on top fetches a mango-and-banana price; sold separately, the mangoes fetch a mango price. Tulvara's parts are worth 18.9x the combined EBITDA at peer multiples, and the market pays 14x for the combination. That difference, the conglomerate discountThe gap between what a diversified group trades at and the sum of what its businesses would fetch as separate listed companies., is what the demerger is meant to close.

One group at 14x against two parts at their peers' multiples, Rs crore18,2001,300 x 14xGroup todayChemicals 9,600Consumer 15,00024,600Parts at peer multiples500 x 30x + 800 x 12xChemicals 9,360Consumer 12,00021,360Parts, haircut and costs480 x 25x + 780 x 12x+6,400+3,160
Tulvara at 14x is worth Rs 18,200 crore, its parts at peer multiples Rs 24,600 crore, a gap of Rs 6,400 crore, and after rating the consumer arm at 25x and adding standalone costs the parts are worth Rs 21,360 crore, a gap of Rs 3,160 crore.
Step 2What does the unlock depend on?

On the consumer arm actually being rated like its peers. A demerger unlocks value only if the parts can be rated like their peers; the break-even multiple tells you how much room there is. With chemicals at 12x, the consumer arm needs 17.2x just to leave shareholders where they are. If chemicals, now without a consumer arm to steady it, slips to 10x, the consumer arm needs 20.4x. The listed consumer leaders are larger and faster growing, so 30x is the ceiling for Tulvara's arm, not the expectation.

The split unlocks value only if the parts are rated like their peers-4,000+4,000+8,000012x16x20x24x28x32xValue unlocked, Rs crorechemicals at 12xbreak-even 17.2xchemicals at 10xbreak-even 20.4x30x: +6,400Multiple the consumer arm earns after the split
The value Tulvara's split unlocks rises by Rs 500 crore for every turn of multiple the consumer arm earns, from zero at 17.2x to Rs 6,400 crore at 30x with chemicals at 12x, and the break-even rises to 20.4x if chemicals is rated at 10x.
Step 3How much would you actually count?

Haircut both parts for what changes. Rate the consumer arm at 25x for its smaller size and slower growth, and take Rs 20 crore a year of new costs out of each company's EBITDA. The parts are then worth Rs 21,360 crore, a realistic gain of Rs 3,160 crore, about half the headline. Per share, after Rs 1,200 crore of net debt, that is Rs 202 against Rs 170 today, not the Rs 234 the headline implies.

Rs croreGroup at 14xParts at peer multiplesParts, haircut and costs
Consumer15,00012,000
Chemicals9,6009,360
Enterprise value18,20024,60021,360
Gain against the group6,4003,160
Equity per share, Rs170234201.6
Tulvara's equity is worth Rs 170 a share as a group, Rs 234 if both parts earned full peer multiples, and about Rs 202 once the consumer arm is rated at 25x and each company carries Rs 20 crore of standalone costs.

Close with the conditions to check. The demerger needs to be tax-neutral for shareholders, and Indian law sets conditions for that; state the framework and confirm the current rules rather than assume them. Ask how the Rs 1,200 crore of debt will be split, because loading it onto chemicals changes each company's equity value. And watch the price after the announcement: if Tulvara has already moved towards the parts value, much of the gain is already in the shares.

Where candidates lose it

The weak answer adds 30x and 12x, calls the Rs 6,400 crore gap free money and stops. It assumes a small, slower consumer arm will be priced like the sector leaders and ignores the costs of running two listed companies.

The other miss is forgetting that chemicals may be rated lower on its own. Without the steadier consumer earnings, a cyclical chemicals company can trade below 12x, which raises the break-even for the whole exercise.

What the interviewer asks next

  • All Rs 1,200 crore of net debt goes to the chemicals company. What happens to each equity value?
  • Why might a long-only fund sell the new consumer shares in the first weeks after listing?
  • What would you want to see in the consumer arm's first two quarters as a standalone company?

Company names and figures are illustrative.