Behind ITC’s hotels demerger

[ITC Royal Bengal, Kolkata. Photo from ITC Hotels]

Last month, the board of directors at ITC cleared the demerger of its hotels division, kicking off an important—and long awaited—transition for the cigarette-to-FMCG diversified conglomerate and one of the country’s most valuable firms.

On the face of it, the strategic rationale for carving out the hotels division and separating it out from the mothership is amply clear. However, the manner in which the proposed structure has been designed for the new entity—ITC Hotels—and ITC’s decision to retain a sizable 40% stake in the new entity, has invited critical comment, with ITC’s share price dropping from Rs 471.35 on July 24, the date of the announcement, to Rs 442.60 on September 25.

The moot issue is whether ITC is wary of completely cutting off the umbilical cord with its hotels business. Is there really a perceptible threat of a takeover, as has been speculated by some analysts, that influenced ITC’s decision to retain a controlling stake of its hotels business?

Before we dive in, let’s quickly understand the implications—and also the key trends driving the hospitality sector. ITC hotels is second only to the Tata group-owned Indian Hotels by size. When ITC Hotels eventually lists on the stock exchanges in about 15 months, the demerger could possibly impact the industry structure. How? In the early 2000s, ITC, under its then chairman YC Deveshwar, began accumulating shares in East India Hotels (part of the Oberoi Group), the third player, albeit much smaller than Indian Hotels and ITC. It stopped short of the 15% stake (now at 13.69%) to avoid an open offer (the trigger has since been raised to 25). Deveshwar had maintained that ITC did not have any intention to mount a takeover, but that this was a financial investment. Yet that assurance didn’t placate the patriarch PRS ‘Biki’ Oberoi from inviting a white knight in Mukesh Ambani to pick up a 14.1% stake (now 18.83%) to ward off the prospect of a hostile takeover. Nita Ambani and Manoj Modi joined the EIH board. Since then, there has been intense speculation about the Ambanis waiting in the wings to take control, but perhaps only after Biki Oberoi, the 94-year-old chairman emeritus, is no more.

ITC had also acquired around 13% stake in the distressed Hotel Leelaventure (Hotel Leela) between 2008 to 2013. In 2019, ITC attempted to increase its stake when the bankrupt hotel group tried to sell its assets to Brookfield Asset Management. In June 2019, ITC sought a stay on the sale from Sebi, but the Securities Appellate Tribunal rejected its appeal in September 2019; the case is pending before the National Company Law Tribunal (NCLT).

To signal its intent, last year Reliance spent $100 million on acquiring a controlling stake in Mandarin Oriental, a top of the line property in New York, not far from the Tata group’s Pierre. Last month, Reliance Industries announced a tie-up with Oberoi Hotels and Resorts to co-manage three property projects spread across India and the United Kingdom, signalling a deeper foray into the hospitality industry. Oberoi-run Anant Vilas in Mumbai and an unnamed planned project in India's western state of Gujarat, and Mukesh Ambani's Reliance-owned Stoke Park in Buckinghamshire in the UK, will now be managed jointly by the two companies.

Reading the tea leaves, Reliance’s impending entry into the hospitality industry through the Oberoi group and its own M&A plans, could significantly alter the landscape—and the outcome of the three-horse race among Tatas, ITC and now, the Reliance-Oberoi combine. Till now, the Oberoi group had remained a distant third. Biki was known to be selective in expanding the luxury chain, and had studiously avoided a presence in the mid-market and budget hotel space, unlike the Tatas and ITC. What’s more, their decision to own and manage many of their properties—compared to the asset light model management contract model pursued by the Tatas—had left them susceptible, whenever the business was hit by a down cycle, like after the terror strike in Mumbai and of course, the devastating pandemic. With its enormous war chest, Reliance could emerge as a formidable rival to both Taj Hotels and ITC Hotels. There’s every chance that it will also aim to be a full-line player—and not stay ensconced in the top-end luxury segment.

On the other hand, hotels always enjoyed a special place in YC Deveshwar’s heart, ever since he took over as chairman in 1996. On the back of its huge cash flow from its dominant cigarette business, he significantly expanded its presence to nearly 100 (120 now) properties. Till as recently as 2019, he built palatial, iconic properties like the Royal Bengal in Kolkata and the Grand Chola in Chennai in 2012. ITC’s management team justified investments in such marquee properties to pump up the brand value—and signal to property owners that it was a skilled hotel operator. It believed these landmark properties would allow ITC to bag management contracts in partnership with property owners to run these hotels.

But analysts tracking the company were never happy with the performance of its hotels division. While it accounted for 20% of the total capital employed, it generated single digit return on capital employed and its contribution to the overall topline was insignificant, compared to the more than healthy performance of other businesses—tobacco, paper and paperboards, agri, and the FMCG business. What’s more, the erstwhile parent BAT (British American Tobacco), which still held a 29.1% stake in ITC, was never happy with Deveshwar’s diversification strategy; it couldn’t do much to influence him.

ITC’s demerger plan was mooted in its annual report of FY 2019-2020. Sadly, Deveshwar succumbed to cancer on May 11, 2019. And next year, the ensuing pandemic and the lockdown wrecked havoc with the entire hospitality industry. 

The post pandemic bounceback in the hotel industry is now palpable, with all the leading hotel brands reporting exceptional Q1 performance in 2023. Much of the growth has been led though by domestic travel. Sensing the uptick, the new chairman and MD, Sanjiv Puri, put the demerger plan back on track.

The demerger kills at least three birds with one stone. It offers ITC shareholders, including BAT, an option to either stay invested in ITC Hotels or exit. ITC Hotels now has a strong book of assets, branded properties at different price points (ITC Luxury Collection, Welcomgroup, WelcomHeritage, Fortune, Mementos, Storii). Its zero debt status will allow it to raise resources, have the agility to operate through its own independent board and yet have access to the goodwill, ITC brand and group capabilities. ITC, on its part, is likely to see the upsides of higher returns, based on reduced capex needs.

If it so chooses, BAT has the option to exit ITC Hotels down the line, by selling its 17.4% stake in the new entity. There’s every chance that BAT could explore a list of potential buyers in tandem with ITC to maximise the value it could unlock. The need for any strategic convergence is high, since BAT’s decision could impact the economic interests of both ITC and BAT in the parent company.

ITC has already clarified that it will not acquire, in case BAT decides to opt for a strategic sale. ITC, with a 40% stake, will be able to guard against any hostile takeover and provide a measure of stability to its own employees.

When the foray into the hotel business was taken by the then chairman AN Haksar in 1975, the Oberoi group was shortlisted as a possible partner. So ITC would own the properties, while the Oberoi group would manage them. 

Eventually, ITC decided, and perhaps rightly so, that it needed to build its own capabilities to own and manage a chain of hotels. Nearly 48 years later, the die is now cast for ITC Hotels to chart its own destiny.

(A shorter version of this column was first published in Business Standard)