What is Demergers and its impact on shareholders?

Disclaimer:-Investments in the securities market are subject to market risks. This content is for Educational purposes only and does not constitute financial advice.

A demerger occurs when a company splits into two or more separate entities. This corporate action is often undertaken to unlock value, streamline operations, or allow the company to focus on its core businesses. In a demerger, shareholders of the parent company are allotted shares in the newly formed entities in proportion to their holdings in the original company.

Demerger transactions can have significant implications for a company’s structure, shareholders, and the broader stock market. For investors and traders, it is crucial to understand how these transactions work and their potential impact on investments.

Impact on Shareholding Pattern

During a demerger, shareholders retain their stake in both the parent company and the newly demerged entity. The number of shares and their value is determined by the share swap ratio or the demerger scheme, which specifies the cost of acquisition.

For example, if Company C decides to demerge its IT services division into a separate entity, the shareholders of Company C will receive shares in the newly formed IT Company proportional to their holdings in Company C. This allows shareholders to diversify their holdings without taking any specific action.

Cost of Acquisition and Ratios in Demergers

The cost of acquisition is an important concept for shareholders during demergers. This is used to calculate the average price of shares in the demerged entities. It is derived based on the cost allocation percentage decided by the company as part of the demerger scheme.

Example: Deriving the Average Price of Shares in a Demerged Firm

When a company undergoes a demerger, shareholders receive shares in the newly formed entity while retaining shares in the original company. Here’s how the cost of acquisition can be apportioned:

1. Original Holding:
   Suppose you hold 100 shares of ABC Ltd. at an original value of ₹500 per share. The total value of your holdings in ABC Ltd. is:
   100 shares × ₹500 = ₹50,000

1. Shares in Demerged Entity:
   ABC Ltd. undergoes a demerger and creates a new company called XYZ Ltd., allotting 1 share of XYZ Ltd. for every 1 share of ABC Ltd. You now have:
   • 100 shares of ABC Ltd.
   • 100 shares of XYZ Ltd.

1. Apportioning the Cost:
   The total value of ₹50,000 needs to be divided between ABC Ltd. and XYZ Ltd. based on the post-demerger market value of their shares.

Let’s assume:

• Market value of ABC Ltd. is 80% of the original value.
• Market value of XYZ Ltd. is 20% of the original value.

The total value of your holdings remains ₹50,000, which is apportioned as follows:

• ABC Ltd.: ₹40,000 (80% of ₹50,000)
• XYZ Ltd.: ₹10,000 (20% of ₹50,000)

The cost of acquisition for your holdings is apportioned in the same ratio:

• ABC Ltd.: ₹400 per share (₹40,000 ÷ 100 shares)
• XYZ Ltd.: ₹100 per share (₹10,000 ÷ 100 shares)

1. Fractional Shares:
   If the calculation results in fractional shares, these are typically rounded down, and the value of the fraction is credited directly to your linked bank account by the Registrar and Transfer Agent (RTA) appointed by the respective companies.

Demerger transactions can unlock significant value for shareholders, allowing them to participate in the growth of multiple entities while diversifying their investments. By understanding the cost allocation and shareholding impact, investors can better evaluate the potential benefits of such corporate actions.

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