Wipro Chairman Azim Premji has presented an interesting choice to shareholders while proposing the demerger of the non-IT businesses of the company into Wipro Enterprises Ltd (WEL): they can get shares in the new company (one for every five shares of Wipro); they can get more shares in Wipro itself by exchanging 1.65 WEL shares for one of Wipro (which will come from the promoter holdings); or they can choose to be compensated with a 7 percent preference share (one of Rs 50 for every five shares held) that will be redeemed one year after the demerger record date.
Some analysts maintain that the three options are really two: there is no point in owning shares in an unlisted non-IT company, unless you expect it to list. So the real choice is: cash after one year, or shares in Wipro, the IT major. Which one is better?
Mobis Philipose, writing in Mint, says investors should take the cash. His reasoning: the net present value of every preference share received for every five shares of Wipro is Rs 213, while the conversion rate of 1.65 WEL shares for one of Wipro share gives investors a value of Rs 194, assuming Wipro shares correct by 12 percent from current prices. (Read his full analysis here).
However, there is another way of looking at the choice: What investors are really getting is two stocks – one in the volatile IT sector, and another in the defensive consumer sector (with some unrelated businesses thrown in). You also get one play based on the global markets, and another based on domestic demand.
In short, you get a chance to balance your exposures – the same one you had in the pre-demerged entity, but now with better business focus.
Given the uncertainty surrounding the tech business due to the slowdown in the US and European markets, it is the domestically-driven soaps and toiletries business that will continue to remain the stable part.
To be sure, WEL still has four businesses under it: Wipro Consumer Care and Lighting (WCCL) has soaps and lighting; and then there is Wipro Infrastructure Engineering and Medical Diagnostic Products and Services, for which there is a GE tieup. Clearly, WEL itself can be demerged further for there is no synergy between soaps, infra engineering and medical diagnostic products. That will probably happen later, when these businesses grow to some scale.
For the present, the real business is about soaps and lighting, which Business Standard says, had a turnover of Rs 3,340 crore and an operating income of Rs 395.6 crore last year.
Philipose, writing in Mint, puts the topline of the non-IT businesses “at Rs 5,208 crore and earnings before interest and tax at Rs 384 crore. The price-earnings (P/E) valuation, therefore, is hefty at around 28 times.”
As against this, the P/E of the main IT business is lower at 19/20, reflecting the greater uncertainty of the export market right now.
However, while it is true that WEL is richly valued at a P/E of 28 times, longer-term investors should consider the possibility that not only will the company be listed (to unlock value, so to say), but be further demerged.
The consumer products-led WEL’s P/E of 28 compares well with other majors in the business, where P/Es are in the range of over 30. For example, Hindustan Unilever Ltd (33), Marico (34) and Dabur (43).
Moreover, Wipro is No 3 in the soaps business, with Santoor being its top brand. Business Standard says: “Overall, in the Rs 10,000-crore soaps market, WCCL (i.e. the consumer part of WEL) as a company stands third after HUL and Godrej Consumer Products Ltd (GCPL) with a share of 8-9 percent. HUL has 45 percent share, while GCPL has a share of 10-11 percent.”
Brand shares for Santoor have been estimated at 8.5 percent, behind Lifebuoy (14 percent) and Lux (13 percent).
After demerger, if WEL begins to focus strongly on growing the Santoor brand (where there is scope for brand extensions), and also goes in for acquisitions in the soaps and toiletries space, there is no reason why its P/E should not correct upwards. Listing would be needed to finance these plans.
Bottomline: there is no need for investors with a medium-term perspective to take their money and run. They could also benefit by waiting.