- Demerger is when a company splits into two or more separate entities. This is often done to unlock value, streamline operations, or focus on core businesses. In a demerger, the shareholders of the original company receive shares in the newly formed companies in proportion to their holdings in the parent company.
- A demerger is a common corporate action with significant implications for a company's structure, shareholders, and the broader stock market. For investors and traders alike, understanding how these transactions work and their potential impact on investments is essential.
Impact on Shareholding Pattern: In a demerger, the shareholders continue to hold shares in both the parent company and the newly demerged entity. The number of shares and their value are determined by the share swap ratio or demerger scheme/cost of acquisition. As the businesses split, shareholders own a stake in each of the resulting companies. This can lead to diversification of holdings without the shareholder taking any specific action.
For example, if Company C decides to demerge its IT services division into a separate entity, shareholders of Company C would receive shares in the newly formed IT company proportional to their holdings in Company C.
Cost of Acquisition & ratios : Demergers
Cost of acquisition is an essential concept for shareholders during demergers. The average price for a particular share is derived from the cost of acquisition percentage of which the company has decided to demerge.
Example: Deriving the Average Price of a Demerged Firm's Shares
When a company undergoes a demerger, the shares of the newly demerged entity are allotted to the shareholders of the original company. The shareholders now own shares in both the parent company and the demerged entity. One common question investors ask is: "How do I allocate the cost of acquisition of my original shares between the two companies?"
Let’s walk through an example to illustrate how you can calculate the average price of shares in the demerged firm.
Step-by-Step Example:
1. Original Holding:
You held 100 shares of ABC Ltd. at an original value of ₹500 per share. Therefore, the total value of your holding in ABC Ltd. is:
100 shares×₹500=₹50,000
2. Demerged Entity:
ABC Ltd. undergoes a demerger and creates a new company called XYZ Ltd., which results in the following shareholding structure:
For every 1 share of ABC Ltd., you are allotted 1 share of XYZ Ltd..
Now, you have:
100 shares of ABC Ltd.
100 shares of XYZ Ltd.
3. Apportioning the Cost:
The total value needs to be divided between ABC Ltd. and XYZ Ltd. based on the cost of acquisition provided by the company.
Let’s assume that after the demerger:
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 immediately after the demerger is:
(100 shares×₹400) + (100 shares×₹100) = ₹40,000+₹10,000=₹50,000
Since the total value of your holdings remains ₹50,000, we can apportion the original value (₹50,000) between the two companies in the same ratio.
The apportionment ratio is:
₹40,000 / 50,000 = 80% (for ABC Ltd.)
And
₹10,000 / 50,000 = 20% (for XYZ Ltd.)
Note: In the event that any fractional shares result from the calculation of a merger or demerger, the usual procedure is to round down the fractional amount. The value of the fraction is then credited directly to your linked bank account by the RTA (Registrar and Transfer Agent) appointed by the respective companies.
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