MOSL: CESC (Buy)-Driving value through simplification

​CESC: Driving value through simplification

(CESC IN, Mkt Cap USD1.6b, CMP INR830, TP INR1040, 25% Upside, Buy)

• In a major development, the board of directors of CESC has approved a scheme for demerger of the company into four separate entities, which would be listed individually. Economic interest of shareholders in each of the companies would remain the same as their current holding in CESC. The four entities are carved out such that they specialize in a particular line of business – distribution (CESC), generation (Haldia Energy), retail (RP-SP Retail) and others (RP-SP Business Process Services). For every 10 shares of CESC, shareholders will receive five (of INR10 each) shares of distribution, five (of INR10 each) of generation, three (of INR5 each) of retail and two (of INR10 each) of others. The demerger would require approval of the Company Law Board and the West Bengal Electricity Regulatory Commission. Management expects the merger process to be completed by 1 October 2017.
  
• We see significant benefits of the demerger:
  
• Exposure to the only pure-play distribution business: It would be the only pure-play distribution business in India. A regulated distribution business is one of the best regulated businesses to own, given low gestation period (high IRRs), steady growth and negative working capital. The Kolkata business is high-RoE and growing at a steady rate (5-6%). Noida is growing rapidly, with regulated equity having increased 3x over past five years. Growth will also be driven by the entry into new circles through the distribution franchise model, which is low capex and would leverage on CESC's 100+ years of experience in the distribution business. The closest comparable peer is Power Grid.