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Will the Kaya spin-off revitalize Marico? - Views on News from Equitymaster

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Will the Kaya spin-off revitalize Marico?
Jan 11, 2013

After operating for a decade under its umbrage, Marico has finally separated its specialized skincare business Kaya into a distinct company Marico Kaya Enterprise Ltd (MaKE) effective 1st April, 2013. With this, Marico aims to streamline into a pure FMCG products company consisting of domestic operations and international business. We will evaluate the likely long-term impact of this re-structuring exercise on the company financials? Also we will try to answer whether existing shareholders will really benefit by holding shares in the companies' separate business entities.

To begin with, Kaya business is a relatively small business contributing a miniscule 7% to Marico's consolidated operations as per FY12 figures. Therefore its separation will not result in a significant fall in Marico's turnover. The Kaya business segment has been incurring losses since its inception in FY03. Hence the demerger is likely to favourably impact Marico's profit margins by at least 50 basis points. Even from the business point of view, both the entities are expected to benefit from the resulting sharper focus. While synergies across the value chain and product portfolio are expected to aid the integrated FMCG business, the Kaya business is expected to gain from independent leadership.

How will the restructured Marico look like?

Marico has been funding its Kaya's business venture that is to yet to break even. By FY13, the total capital employed in the Kaya business is estimated to be Rs 3.5 bn out of which Rs 1.5 bn are the accumulated losses alone. A major part of Rs 2.6 bn of the Kaya's business capital has been funded by Marico with the balance through bank borrowings. Marico has proposed to set off its investments in Kaya against the Securities Premium Account post the demerger. Thus apart from a small drop in revenues, there will be no impact on the company's earnings. But the resulting operating leverage arising from the spin-off is expected to plug the downfall in Marico's shareholder's returns. The company's inorganic expansion had resulted in the shareholder's return (ROE) falling from 59% in FY07 to 27% in FY12. From FY14 onwards, the returns are expected to improve slightly.


Valuation of MaKE business

Existing shareholders of Marico will also receive proportionate shareholding in the demerged entity MAKE which will be listed on the bourses. One fully paid-up equity share of Rs 10 each of MaKE shall be issued and allotted at a premium of Rs 200 per share for every 50 fully paid-up equity shares of Re 1 each held in Marico. Therefore as per the computation given below, Marico is valuing its Kaya business at a slight discount to the revenues generated by it.

Valuation snapshot
No. of shares of Marico (nos in m) 614.9
Make Share allotment ratio 1:50
No. of shares of Make post demerger (nos in m) 12.3
Market value per share of MaKe post demerger ( in Rs m) 210
Total market capitalisation (in Rs m) 2,582.6
MaKE's sales for FY12 (in Rs m) 2,790
Marico's valuation of MaKE (as a multiple of its latest turnover) 0.9

Conclusion

While the de-merger will favourably impact Marico's financials but the impact is too small to accrue significant benefits in the immediate future. Moreover, Marico stock is currently fairly priced. Even the Kaya business, which continues to remain in losses, is being valued at a discount to its present turnover.

Kaya's business in Southeast Asia is profitable whereas its business in Middle-East and India continue to remain in red. Kaya has recently launched low cost skin clinics 'Kaya Skin Bars' that have a strong product presence. With this the company is slowly re-positioning from a skin care business to a much wider beauty care or salon business model. In this business segment, Kaya is likely to face competition from the likes of Hindustan Unilever's Lakme Salons and Cavinkare's Green Trends & Limelite label. Many branded regional salons such as Javed Habib Hair & Beauty, Natural and Enrich salons have also established their presence and caught the attention of Private Equity (PE) players on account of their profitable operations. Salons such as Enrich and VLCC are scaling up rapidly after the PE capital infusion. The Kaya business has been paring losses and turned profitable at the EBIT level in September 2012 quarter. Marico expects the business to turn around over 1-2 years time-frame.

Therefore, with shares in both Marico and MaKe, post demerger, not offering significant upsides to shareholders, we continue to maintain a SELL view on the Marico stock.

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