A demerger is a corporate action where business operations are separated, and a separate entity is formed and listed on the stock exchange. In this article we discuss the definitions of a demerger, why companies participate in these corporate actions, and the implications for shareholders.

Definition

A demerger occurs when a large organisation decides to restructure its business and splits into different companies and list them as separate entities on the stock exchange. The parent company then issues shares of the new entity to their shareholders and they keep a substantial holding in the spun off entity.

Why do companies demerge?

The board of directors may undertake a demerger when they feel the two companies are heading in different directions as they have formed different objectives. Once the companies separate, each entity can focus on their core objectives. Companies may also decide on demergers to separate the parent company from entities which are not performing.

What is the implication for shareholders?

Shareholders will receive as part of the demerger, shares in the new spun off entity. Demergers have historically been good for shareholders as both the parent and the spun-off company have performed after the demerger.

Examples of demergers

Coles (ASX:COL) and Wesfarmers (ASX:WES) : Wesfarmers decided to demerge with Coles as they wanted to focus on growth opportunities which attracted higher future earnings growth and Coles wanted to focus on earnings growth with defensive characteristics.

Woolworths (ASX: WOW) and Endeavour (ASX:EDV): Endeavour wanted to be more aggressive with their growth and expansion whereas Woolworths wanted to focus on growing their shareholder value and expanding their supermarket network. Superannuation funds in the past have been hesitant to invest in Woolworths because of their exposure to alcohol and gaming assets.

Lauren Hua is a private client adviser at Fairmont Equities.

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