TCS stake sale and what it means for Tata Chemicals

Speculation on likely listing of Tata Sons has undergone several rounds in the last one month, each time impacting the stock price of Tata Chemicals differently.

The story started with surmises about Tata Sons IPO listing owing to regulation associated with ‘upper layer NBFC’. Tata Chemicals, which owns 3 per cent stake in Tata Sons (potentially valued at ₹7-8 lakh crore), suddenly found an equity holding (worth ₹20,000 crore), which implies a 75 per cent addition to its market capitalisation. The stock soared 40 per cent from February 29 to March 3 on the newfound crown jewels. As news spread that Tata Sons may look to avoid an IPO, the stock gave up 15 per cent of its gains by March 19. Since then, the stock gave up 7.5 per cent, till March 22, as Tata Sons’ recent stake sale in TCS further strengthened the non-IPO route.

As Tata Sons has not commented on the reason for the stake sale (0.6 per cent from its 73 per cent holding), speculation can range from overvaluations in IT sector, Tata Sons’ foray into capital-intensive semiconductor and green energy ventures, or to reduce its debt and avoid an IPO. In most likelihood, it could be a combination of all three. But overall, it strongly deflates the hopes of an IPO. Tata Sons has a net debt of ₹20,642 crore as of March 2023 and the recent transaction has armed it with cash of close to half that amount at ₹9,300 crore.

Over the last month and through its ups and downs, Tata Chemicals stock is still 12 per cent above February 29 levels. Now that the cat is out of the bag, investors, in all likelihood, have to assign a value to the Tata Sons stake whether the parent goes for an IPO or not.

Monetisation plan key to assigning value

But, we recommend that unless a clear path of monetisation of the stake is chalked out, the stake in Tata Sons should not warrant a high valuation and the recent rally should not distract from the valuation of Tata Chemicals’ core business. If the stake in Tata Sons residing with Tata Chemicals can be compared with cash, investors must acknowledge that the cash component generally gets a discount in company valuations. Cash component can rise to as much as 80 per cent of a company’s value in certain cases as investors discount its value significantly and only the core business gets valued despite high cash base. Similarly, stakes held in listed companies are assigned huge holding company discounts, which are sometimes even as high as 80-90 per cent.

Hence, unless management announces a special dividend to investors or spins off stakes in listed companies to investors, the value of cash/assets is generally tied to plans on utilisation of these assets, the return expectations and the allied discount to the operational risk of execution. With IPO plans most likely on the back foot, based on recent speculation, monetisation plans should be even more discounted.

Value of core business

Tata Chemicals has expanded its capacity in the recent past and is facing slowdown in demand currently and may not be likely to propose a new phase of investment. The management, in its recent 3QFY24 results, reported a 10 per cent y-o-y revenue decline and a 54 per cent y-o-y PAT decline. The management indicated a 12-18 month slowdown in demand as the US and Europe are facing a slowdown. The excess Chinese production has also pressured prices, exacerbating the impact. The situation is akin to commentary coming from wider speciality chemical companies and the impact on base chemicals manufacturers such as Tata Chemicals (soda ash manufacturing) will be more pronounced.

Two years back, in our bl.portfolio edition dated February 20, 2022, we had recommended that investors accumulate the stock when it was trading at ₹886 . Considering the sharp rise in valuations currently after the recent rally and the difficult business outlook, investors can book profits from the stock. Compared to the past five-year average of 13 times of one-year forward earnings, the stock is trading at 25 times due to speculation on the value of its stake in Tata Sons.

With a lot of uncertainty on listing of Tata Sons and lack of clarity on how and whether it will be monetised, staying invested in the stock based on speculated value appears risky. With the core business also facing headwinds, we recommend that investors book profits from the stock.

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