Recently Iluka Resources spun-off their Deterra Royalties business. Deterra earns a royalty on iron ore mining in Mining Area C, located in the Pilbara of Western Australia, as well as some other royalties. To the surprise of few, Iluka Resources and Deterra Royalties now have a combined value far higher than when the two businesses were whole.
This is a story that has been repeated before, with Coles splitting from Wesfarmers, or South32 splitting from BHP, or BlueScope (formerly BHP Steel) splitting from BHP. Even when there are presumedly great synergies between two businesses, the market has attributed greater value to the separate parts.
It is no surprise then, that the go to move for companies that have suffered from a loss of shareholder value is to demerge businesses to hopefully benefit those shareholders.
Indeed, just today AGL announced plans to separate the energy generation business from the retailing business. This is surprising given that you’d assume the two businesses complement each other operationally. However, AGL is undoubtedly hoping that they too can benefit from a greater value in separation than they presently do as one whole.
Treasury wines and Telstra have also been considered as potentials for a demerger recently, with a view of rescuing declining shareholder values. Although both of these appear to on hold for the time being as other restructuring plans go ahead.
However, the company does not need to be struggling to consider a demerger. We have seen Woolworths announce plans to demerge their drinks businesses in June, even though Woolworths is trading at highs and performing well operationally. The spin-off will be named Endeavor Drinks and will include the Dan Murphy’s, BWS, and other brands.
One would assume that there would be strong operational synergies between grocery and liquor retailing, with shared logistics, real estate, and negotiating power. However, once again, the separate entities will likely hold more value than Woolworths does at present.
Plenty of academic literature agrees that demergers create abnormal shareholder value, particularly during periods of bullish movement in markets. Different reasoning has been attributed for the strong value gains, including increased management focus, market perception, removal of negative synergies, reduced complexities, and an increased likelihood of getting a proper valuation.
However, during periods of economic or market weakness, demerging has shown less abnormal returns, with a weaker ability to borrow money on beneficial terms, and less diversification against loss making divisions.
We anticipate that the demerger trend that is being seen on the Australian market will continue and that in the present market environment, it will benefit Australian shareholders. If you’d like to discuss the Australian market or any ASX listed stock further, please contact an Emerald Advisor on 03 8080 5788.
Sam Green is the Portfolio Manager at Emerald Financial, whilst also being an Equities and Derivatives expert for his clients at TradersCircle.
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