Shares: Partitions that give investors a break: Two UK conglomerates look ripe for profitable demerger

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The Independent Online
DEMERGER potential is becoming another argument for holding shares. This is particularly true of the larger, more diversified companies most likely to benefit from a more focused approach. Demerger deserves to be even more popular with investors than scrip issues, because the new shares are in a freshly quoted company and there are usually real gains to be had. Demerged companies often grow faster and are rated more highly, giving a double boost to investor fortunes.

I have looked at the FT-SE 100 to select shares in companies that look potential candidates for demerger. The scope is indicated by a recent academic study, which calculated that if all quoted companies demerged or disposed of unrelated activities, the stock market would rise by 30 per cent higher.

Past demergers have done well. The last time I looked at the case for buying shares in demerged companies was when ICI was under pressure from the stake acquired by Hanson. At that time, there was scepticism about claims that the break-up value might be nearer pounds 16 a share than the pounds 6 net asset value shown in the balance sheet. Yet the combined value of shares in ICI and the spun-off pharmaceutical business, Zeneca, are worth pounds 14.94 1/2 at current prices and peaked at pounds 16.79. Other demergers have produced superbly performing offspring, such as Racal's demerger of Vodafone and later Chubb Security and Alexon's flotation of the hugely successful Marks & Spencer supplier, Claremont Garments.

A prime candidate for demerging is Thorn EMI at pounds 10.59 1/2. There is little synergy between the two main businesses - music and rental - and the possibility that a stand- alone music business would be better placed for deals and joint ventures to exploit opportunities in the emerging multimedia market. As with the pre-demerger ICI, analysts' calculations suggest that a broken-up Thorn EMI could be worth up to pounds 19. It may not happen, but the company has said it is an option once the small loss-making security and defence electronics businesses have been sold.

The shares look attractive without demerger because of dramatic changes taking place at the group. Thorn used to be synonymous with lighting. That business was sold last year. Since 1986, operating profits from the music business, now known as EMI Music and headquartered in New York, have grown from almost nothing to pounds 246.1m of total profits of pounds 382.4m for the principal businesses. The 1992 purchase of Virgin for pounds 560m - regarded at the time as too high a price - contributed pounds 90m to that figure, justifying the new line that it was 'bought for a song'.

Margins have almost trebled over that period and may not rise much further. But scope for turnover growth remains considerable, as demand for new, 'golden oldie' and local music continues to surge worldwide, fuelled by new outlets and with the CD-ROM revolution just beginning.

The other great success has been the turnaround of the rental business. Traditional rent-for-rent is in decline, but is rapidly being replaced by a highly successful rent-to-own business. The product range has also been extended from televisions and videos to white goods, mobile phones, computers and even furniture. In effect, renting-to-own makes buying on credit available to many who don't have bank accounts and cannot obtain credits. Bad debts should not be a problem because of reference checking.

Meanwhile, the whole division, now known as the Thorn Group, increased profits last year to pounds 130.2m from sales up 8.9 per cent to pounds 1.5bn Many new initiatives are at an early stage, suggesting growth to come. Group-wide earnings this year should reach 60p for a price-earnings ratio of 18, which looks solid value.

My other demerger candidate is Granada at 533 1/2 p. The company has said nothing to encourage such notions, and its acquisition programme suggests it is quite happy with a broad spread of disparate activities, from rental to catering to running television stations.

There certainly seems no reason why it should rush down the demerger route, since Gerry Robinson, the chief executive, seems to have a remarkable ability to take almost any business and make it more profitable. As with Thorn EMI, even if he does not demerge, the business is changing dramatically.

There may be another parallel if, like EMI's Virgin purchase, the acquisition of LWT turns out to be a huge success, having initially looked expensive. My guess is that that will happen, and the shares are cheap on a prospective p/e of perhaps 15. There is also the wild card of a 13.5 per cent stake in BSkyB, which could end up being worth between pounds 500m and pounds 1bn against a total group market capitalisation of little over pounds 3bn.

(Photograph omitted)

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