Tata Motors Demerger: Value Positive or Value Neutral?

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Let me start by eating the proverbial humble pie.

You see, I have been pessimistic about Tata Motors for quite some time now.

Don't get me wrong. It is not the business model I am pessimistic about but the share price. To be more specific, I am not too enthused by its valuations.

For a conservative value investor like me, the risk reward looked unfavourable at a stock price of Rs 500 per share.

In other words, I found the stock to be expensive even at Rs 500 per share. And guess what? The stock has doubled since then. To make matters worse, it looks unstoppable even at the current share price.

My argument was simple. The current profits or the current earnings per share cannot be the basis of determining the company's fair value.

If you go by the past performance, Tata Motors' earnings have been highly cyclical. Therefore, it is the average earnings per share that is a better representation of the company's earnings power than the most recent earnings.

Alternatively, one can also value the company through the book value route. Even here, a share price of Rs 500 per share looked well above par.

Thus, to see the stock price climb to more than Rs 1,000 per share, has certainly come as a shocker to me.

So, am I ready to throw in the towel and accept defeat? Was I completely blind to the fabulous turnaround that the stock has scripted?

Well, not so fast.

I am a believer in the adage that the markets are a voting machine in the short term and a weighing machine in the long term.

Thus, it is quite possible that investors are getting carried away and are taking too optimistic a view of the stock. The true test of the company's fundamentals would be its performance over the next couple of years.

If it can keep growing consistently then the current re-rating is indeed well justified. But if it struggles and profits take a big hit, then the stock price can also come crashing down.

Having said that, the latest development in Tata Motors can make things really interesting going forward.

In an attempt to unlock value and create more shareholder wealth, Tata Motors announced day before yesterday that it will split into two listed businesses, comprising the commercial vehicle and the passenger vehicle businesses that includes luxury car maker Jaguar Land Rover (JLR).

Besides unlocking value, separation of the two businesses will help them capitalise on the opportunities and enhance focus and agility.

Now, demergers are usually done when the promoters feel that the sum of the parts is greater than the whole.

In other words, when they believe that individual entities within a business are worth more when valued on a standalone basis than when their profits are combined.

Is this the case with Tata Motors? Is the sum of the valuation of its passenger vehicles business and its commercial vehicles business, significantly higher than the valuation of the combined entity i.e. the current Tata Motors?

Well, let's find out.

Our calculations suggest that the CV business of Tata Motors has generated a topline of close to Rs 80,000 crores over the trailing twelve months whereas the passenger vehicle business that also includes JLR, generated close to 3.5 lakh crores during the same period.

Now, Tata Motors' rival in CV i.e. Ashok Leyland, has traded at a market cap to sales ratio of close to 1.3x on an average over the last decade or so.

Applying a similar multiple to the revenues of the CV business of Tata Motors gives a valuation of around Rs 1 lakh crore to this business.

Coming to the valuation of the PV business, this is where it gets tricky. Tata Motors is currently trading at a market cap to sales ratio of around 0.8x and its 10-year median has been a poor 0.5x.

Yes, that's right. Historically, investors have paid only Rs 50 per share for every Rs 100 earned by Tata Motors in revenues on account of the poor profitability of JLR, which accounts for 65-70% of the sales of the consolidated entity.

So, should we use a price to sales multiple of 0.5x to value the passenger vehicles division of Tata Motors or use the current multiple of 0.8x? Well, let's take a number in between i.e. 0.65x so as to make it look neither too aggressive nor too conservative.

Hence, using 0.65x multiple on the trailing twelve-month revenues of the PV division of Tata Motors, gives us a valuation of 2.2 lakh crores for the PV business.

Thus, as per our broad estimates, if the two divisions were valued separately, the CV division can fetch a valuation of Rs 1 lakh crore whereas the PV division valuation can come in the region of Rs 2.2 lakh crores.

Both put together result into an overall valuation of Rs 3.2 lakh cores which when divided by the total number of shares outstanding, give a value of around Rs 850 per share for Tata Motors.

Interestingly, the stock currently trades at Rs 1,020 per share, which means that the benefit from the value unlocking seems to be already priced in if one goes by our revenue and valuation multiple assumption.

In fact, even if you add another Rs 50-60 to the valuation of Tata Motors to account for stakes in subsidiaries like Tata Technologies, it will still be less than the current share price.

This means that if Tata Motors splits at this very moment and both the entities get listed, the value unlocking would be next to zero. In fact, the values may fall a bit if our calculations are any indication.

Please note that I have considered the latest revenues to arrive at the fair value of both the entities. If I consider the average revenues of the past few years to account for the cyclicality of the business, the value will go even lower.

Of course, this is not a recommendation to buy or sell Tata Motors. It is just a framework to show you how you can do your own basic calculations and arrive at a broad estimate.

Talking of broad estimates, the split does not look like a great news for Tata Motors especially at the valuations it is currently trading at.

Happy Investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)