Analysis of Abbreviations and Technical Terms
BAT stands for British American Tobacco, a global tobacco company. ITC stands for Indian Tobacco Company, India’s largest cigarette maker in which BAT holds a 29.02% ownership stake. This makes BAT the largest shareholder of ITC. BAT’s CEO has indicated they would be open to reducing their stake in ITC from 29.02% down to around 25%. This is still a sizeable stake that would give BAT significant influence and veto rights on ITC’s board. However, divesting/selling part of their stake is complex due to India’s strict foreign direct investment (FDI) rules that limit international ownership in domestic tobacco companies. Specific approvals from India’s central bank, RBI, would be required for BAT to sell any ITC shares. So while BAT is open to lowering its stake, it faces regulatory hurdles to do so easily. ITC is a conglomerate with tobacco, FMCG, hotels, paper, and agri-business divisions. It recently decided to spin off and separately list its hotel properties in a demerger deal that BAT supported. This could make it easier to divest non-tobacco businesses in the future.
Impact on Retail Investors
This news has mixed implications for retail investors in ITC and BAT stock or considering an investment. For ITC investors, sustained strong performance across cigarettes and FMCG coupled with hotels demerger unlocks value. However, regulatory uncertainty introduced by BAT’s stake sale consideration could increase stock price volatility. FMCG, agri, and paper verticals make ITC less dependent on tobacco, which faces regulatory headwinds. Demerger gives investors the option to stay invested in the high-growth hotels business exclusively. For BAT investors, ITC remains a highly profitable investment even at a 25% lower stake. Upside from the Indian tobacco market growth offsets stricter regulations in developed countries. However, the reduced stake caps future upside from ITC share price growth, while Indian regulatory hurdles make exiting not straightforward. Overall, retail investors need to assess risk appetite, time horizon for returns, and extent of diversification into the Indian market before deciding exposure levels to either stock. Active monitoring of regulatory announcements is prudent.
Impact on Industries
This development can impact several industries:
Tobacco
A stake sale by BAT in the lead cigarette maker ITC increases uncertainty for the highly regulated domestic tobacco sector. Stricter FDI norms make foreign participation difficult and could consolidate ITC’s dominance. However, BAT’s continued influential minority stake ensures global expertise/technology transfer to the Indian JV partner.
FMCG
As the FMCG sector sees heightened competitive intensity from new-age digitally native D2C brands, ITC may need to accelerate investment in marketing, delivery infrastructure, and product innovation to protect and gain market share in categories like packaged foods. Funds allocation could change.
Hotels
The demerged listed entity gives potential for higher capital inflow from dedicated hotel sector funds, allowing expedited expansion plans for ITC Hotels. Ownership uncertainty post BAT’s lowered ITC stake may worry some investors wanting stability ahead of public listing.
Paper & Agri
While not highlighted specifically, these businesses critical to ITC’s diversification may also need realigned investment priorities if cash generation or apportioning changes due to lower BAT holding.
Overall, the news signals that the status quo will be disrupted across ITC’s presence. Rivals in respective industries may sense opportunities for grabbing market share.
Long Term Benefits & Negatives
Potential long-term benefits from BAT reducing ITC holding include:
- Greater autonomy for ITC to chart future strategy with lower dependence on the lead shareholder. Agility in decision making could increase.
- Demerged hotels entity benefits from a dedicated investor base, strategic partners for joint ventures, raising growth capital through equity and debt unconstrained by ITC policies.
- Lower investment from foreign tobacco giant provides insulation if India increases regulatory scrutiny of cigarette/tobacco companies under local ownership.
- ITC forced to focus innovation and capital allocation excellence for homegrown FMCG brands to protect market position, providing impetus for the next stage of value creation.
Potential long-term negatives include:
- ITC deprived of global best practices, new product ideas, distribution, and marketing support from British American Tobacco, which has faced similar challenges in developed country markets.
- Reduced cashflow hits expansion plans for hotels, squeezes investment for promising FMCG products. Speed of diversification into future engines of growth slows.
- Spin-off entities are sub-scale compared to the enterprise leverage of ITC until maturity phase is attained.
- Loss of EVEN a single board seat by BAT nominee risks key veto powers on critical issues like Chairman appointment, dividends, voting rights dilution, etc., hampering the interest of minority shareholders.
Short Term Benefits & Negatives
In the near term, potential benefits include:
- ITC share price gets re-rated, narrowing the valuation gap vis-a-vis consumer peers as the cigarettes business dominance reduces further.
- Clarity of demerged structure for hotels, affirmation of support from BAT despite lowered stake, spurs investor interest. Credit rating uplift possible.
- Raise in foreign holding limits for tobacco unlikely; hence, status quo reduces policy uncertainty that threatened operations continuity.
Short term negatives encompass:
- Distraction of leadership managing complex restructuring around hotels separation, potential buyback from BAT stake sale draining bandwidth.
- Reduced stake transfer subject to RBI approval causes delays; the process could take up to 12 months, hampering nimble decision making.
- Cigarettes volume, sales disruption in transition phase if BAT leverages India portfolio churn to drive own brands in developing markets.
- Capex allocation, supply contracts for hotels expansion stranded in interim phase pre and post demerger during the separation of assets, employee transfers, etc.
Overall, short-term price volatility cannot be ruled out until clarity on the revised structure emerges.
Companies that Will Gain
Several public-traded companies can benefit from this situation:
- ITC Hotels: Demerged entity gets a dedicated investor base, sector-specific funds to drive expansion unconstrained by parent company policies. Gain long-term autonomy.
- EIH (Oberoi Hotels): Competition disrupted during ITC Hotels restructuring. Chance to capture market share in the domestic hospitality sector.
- Hindustan Unilever (HUL): Opportunity to accelerate FMCG market share gains as market leader ITC faces internal realignment over the next 1-2 years across categories like soaps, detergents, etc.
- Dabur India: Similar FMCG sector upside as HUL to fuel above-market growth capitalizing on flux at ITC.
- Emami Ltd: Mid-sized FMCG firm housing strong brands in underpenetrated categories. Outside shot to leapfrog into the top tier if ITC drops the ball.
- Varun Beverages: With stellar past share price returns, the firm could consider hospitality sector diversification via strategic acquisition of ITC Hotels properties to open a new revenue stream for growth.
- Godfrey Philips India, VST Industries: Cigarette firms with single product concentration must gain share from any ITC disruption over the 2023-2025 timeframe.
Companies that Will Lose
Several public-traded companies may face challenges due to this development:
- ITC Ltd: Clear near-term uncertainty overhangs share price, longer-term growth trajectory ambiguity with reduced ownership of strategic investor BAT who provides global expertise, distribution muscle, and credibility. Core cigarettes and promising FMCG, hotels businesses equally impacted. Demerged structure adds complexity. Loss of a board nominee risks key veto powers on Chairman appointment, M&A decisions, etc., hampering the interests of non-anchor minority shareholders.
- Zee Entertainment: As the largest media firm in hotels & travel space via Goibibo and at risk of losing ad budget from demerged ITC Hotels entity, which must cut costs and leverage partnerships in the interim phase. Risk of downward forecast revisions.
- Asian Hotels North: Competitor to ITC Hotels risks accelerated loss of market share as the latter turns aggressive backed by hunger for growth ahead of demerger milestones and eventual listing gaining stature of a pure-play entity.
- Page Industries, Trent: Apparel retailers with strong hospitality sector exposure via branded stores likely to endure volatility. Expansion plans face uncertainty amidst flux in hotel industry occupancies, average room rentals, etc.
Source: Sagar Malviya and Writankar Mukherjee, “Diluting Stake in ITC Complex, Says its Largest Shareholder”, 16 December 2023, Economic Times Bureau