MARCH 31, 2002
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RIL-RPL Merger
The Inside Story
More reasons went into the birth of the RIL behemoth than the pure logic of vertical integration. Size, yes; but more urgent seemed the need to work on the changing dynamics of the global energy industry.
The Ambanis: Dhirubhai (seated) with Mukesh (left) and Anil

Every weekday afternoon, Mukesh and Anil Ambani drop everything and walk across from their fourth floor offices to a big rectangular room that serves as Chairman Dhirubhai Ambani's sanctum during the three hours that the Ambani patriarch spends each day at Maker Chambers iv, Reliance's headquarters in Mumbai's Nariman Point. The two sons have lunch with ''Papa''-a practice that has become a ritual. This is when the two brothers get to listen to India's foremost entrepreneur, a man who has achieved in his lifetime what few are bold enough to dream. It was at one of these lunches, nearly four months back, that the 69-year-old senior Ambani first talked to his sons about his latest dream, one that he has just seen come true. It was a proposal to merge Reliance Petroleum Ltd (RPL), the biggest grassroots oil refinery company that the Ambanis have built, with parent Reliance Industries Ltd (RIL). The merger would catapult RIL, already the largest company in India's private sector, into the Fortune 500 list, a dream that Dhirubhai had cherished for years.

In minutes, the atmosphere of the usually low-key lunch meeting was electrified. Within days, a core team was formed: the two brothers, of course, plus Anand Jain, Reliance Capital's Managing Director; Amitabh Jhunjhunwala, CEO, Reliance Capital; Alok Agarwal, Treasurer, RIL; and Satish Seth, Director, Reliance Power, RIHL, Reliance Telecom, and BSEs Telecom. Swiftly the numbers were crunched, the details thrashed out and the final proposal drafted in a secret operation code-named Project Aden, an allusion to the African port where Dhirubhai, then in his teens, cut his teeth as a petrol station attendant. It was only in mid-February, four weeks before the official announcement that the financial institutions, which hold 13 per cent in RIL, and JM Morgan Stanley, the financial advisors in the deal, were informed about what was to happen.

PETROCHEMICALS: The merger helps to insulate the petrochem business against price volatility of naphtha, a feedstock for its cracker.
OIL: In the post-APM scenario, the merger will help leverage a larger balance sheet to raise funds that can be invested in setting up a distribution and marketing network.
DISINVESTMENT: Reliance is a strong contender in the race to acquire HPCL, BPCL, and IPCL. The merger will help it make more aggressive bids against global oil giants.
INFOCOM: Fund-raising for the Rs 25,000-crore plan to build a nationwide network could be easier.

What happened will surely become a landmark in corporate India's history: the birth of a behemoth. The merged company will have a turnover of Rs 58,000 crore. That's 23 Infosyses if you like your units in new economy companies. Or two A.V. Birla groups, if you're still a dyed-in-the-wool old economy aficionado. The merged company's annualised net profits will be Rs 4,000 crore. Or nearly 30 per cent of the total profits of all private sector companies in India. And if that's not stunning enough, deal with this: the RIL-RPL combine's total sales will be a tidy 3 per cent of India's GDP; the tax it will pay the government will represent 10 per cent of total indirect tax revenues of the Central government; its exports will form 5 per cent of India's total exports and its stock will command a 15 per cent weightage in the BSE Sensex.

But the fundamental reasons for the merger are not about size alone. The RIL-RPL merger has not come as a surprise: it was logical. In the global energy business, standalone refineries don't make business sense. Refining margins are wafer thin and any business model that relies on oil refining alone cannot be profitable in the long run. Average profit margins on refining have fallen from $4.69 per barrel in third quarter of 2000-01 to around $1.45 per barrel in the third quarter of 2001-02. Only when the entire chain of the oil business is integrated-from exploration to refining to marketing and distribution-does it make economic sense. So a merger with RIL, which consumes a quarter of RPL's output, helps. Says Miten Lathia, Analyst, SSKI: ''With the merger, RIL has become a totally integrated energy company. The diverse streams of earnings would reduce earnings volatility.''

Figures in Rs crore
JULY 1975
mergerd with MYNYLON*, a company manufacturing synthetic blend yarns & fabrics, and polyester filament yarn.
MARCH 1992

into itself
SALES: Rs 3,005 crore
PAT: Rs 163 crore
MARKET CAP: Rs 9,783 crore
JUNE 1995

into itself
SALES: Rs 8,085 crore
PAT: Rs 1,305 crore
MARKET CAP: Rs 5,566 crore
MARCH 2002

into itself
SALES: Rs 58,000 crore
PAT: Rs 4,000 crore
MARKET CAP: Rs 49,000 crore

Merging For Acquisition

It helps RIL too. Although RIL is a market leader in petrochemicals, with marketshares of 50 to 80 per cent in polymers, polyester, and fibre intermediates, the merger with RPL would help insulate it against the volatility in naphtha prices, the feedstock for its cracker. That will help, especially since in future, growth and profitability in petrochemicals will be increasingly governed by international price fluctuations of various end products. Also, since RIL buys 25 per cent of RPL's output, there are big savings in sales tax. Plus there are yet-to-be-calculated benefits like the depreciation of the Rs 14,404-crore refinery at Jamnagar and other indirect tax savings.

But the strongest benefit of the merger is in how it could help in marketing of RPL's products. With the dismantling of the administered price mechanism from April 1, 2002, Reliance will have to market and distribute the refinery's output on its own. That means building a network of retail outlets across the country. Setting up a pan-Indian retail network could cost Rs 5,000 crore at the minimum. Besides, it is crucial for it to get a headstart in marketing by acquiring the government's stake in either of the two public sector oil majors-Bharat Petroleum Corp. Ltd (BPCL) or Hindustan Petroleum Corp. Ltd (HPCL). The price tag for either of these could be upwards of Rs 5,500 crore (for the government's stake in one company, plus a 20 per cent open offer).

A merged RIL-RPL would probably find it easier to raise that kind of money than an RPL alone. If RPL were to invest Rs 5,000 crore, its debt:equity ratio in fiscal 2003 would have been strained at over 1:1.5. For the record, Anil Ambani says the company can now raise around Rs 11,000 crore (on a debt equity ratio of 1:1). Plus, because RIL commands a better credit rating, the terms at which fresh debt can be raised could be better. Says John Band, CEO, Ask Raymond James: ''A better treasury management is possible for capital investments.'' Reliance will have to be more aggressive in its bidding for HPCL or BPCL, plainly because it lost the chance to bag IBP. According to sources, Reliance's bid for IBP was the fifth highest. This time, pitted against global oil giants like Shell, Exxon-Mobil, BP, and Petronax, all of which have refineries that are in the neighbourhood of India, Reliance will have to do better.

Not A Slick Future

Although the Ambanis say the merger is good for RIL's shareholders because the company gets assets worth Rs 21,000 crore by issuing shares worth Rs 11,000 crore, the merger ratio of 1:11 hasn't excited the stockmarkets, which believe that the stock price of RPL (pre-merger value: Rs 28) was undervalued. Moreover, since the merger represents the folding of subsidiary (RPL) into the parent company, all the benefits of integration in the refining/chemicals chain were captured by the earlier parent-subsidiary structure. To quote a DSP MerRILl Lynch report: ''We do not see any visible near term synergies from the merger and would be cautious of any sharp price rally on this news.'' Post-merger, the RIL stock has moved from Rs 322.12 (March 1, 2002) to Rs 306.85 (March 8, 2002), reflecting the market's 'limited positive' reaction, at least in the short term.

RPL's assets have been revalued at Rs 21,000 crore as against the value of Rs 14,830 crore as on March 2001. Arun Kejriwal, an investment analyst, is critical of the structure for merger: ''If 64 per cent of the shares held by RIL in RPL had been extinguished and the remaining 36 per cent converted into RIL shares at the current ratio of 1:11, they would have unlocked greater value for RIL shareholders.'' Instead, 36 per cent of the RIL shareholding in RPL, held through Reliance Industrial Investments and Holdings (RIIHL) and RIL associate companies, will not be extinguished but converted into 12 per cent equity stake in RIL held by RIIHL and RIL associates. While the company says that these shares are for sale in the future to create resources, it could weigh on RIL stock performance.

While stock pundits keep watching its scrip, the future for RIL isn't going to be a cakewalk. With lower tariffs in the offing and a general softening of global petrochemical prices, its inward-looking strategy of catering to the domestic market could need revisiting. Globally, according to crisil, the profit margins for global petrochemical producers have been under pressure over the past two-three years, primarily on account of high and volatile oil prices in 2000 and early 2001. Profitability has also been affected by weak demand and prevailing overcapacity situation in many commodity chemicals. True, after hitting lows in the third quarter of 2001-02, polymer prices have picked up in the fourth quarter and are now ruling at $480-500 (Rs 2,300-2,400) per tonne. Still, margins continue to be under pressure. RIL will find the going tough if the government is committed to reducing the import duty on polymers to 20 per cent (Budget 2002 reduced it to 30 per cent from 35 per cent).

Then there are the new businesses that the Ambanis have ventured into. Reliance Infocom, a 45 per cent subsidiary of RIL, which is setting up nationwide broadband network to provide fixed line, wireless, national long distance and international long distance telephony as well as a range of data and value-added services, is expected to require investments of nearly Rs 25,000 crore over the next few years. Although the Ambanis say that the merger will have no impact on Reliance Infocom, the market will be watching to see whether Reliance will dilute its stake, perhaps through an IPO, and go public with the company.

It will also wait to see what it does with the 12 per cent of the RIL equity capital that is currently reposed in a special purpose vehicle (trustee for RIHL and RIL associates). This shareholding was an outcome of the fact that RIL held 64 per cent in RPL and because under Indian laws, a company cannot hold its own shares, therefore the ensuing 12 per cent will have to be liquidated. Valued at Rs 5,400 crore, this stake may be monetised in international markets, through sale to strategic and financial investors. And the proceeds used to fuel the investments that are on the cards.

Reliance has the ability to sometimes shock and sometimes surprise. Less than a month back it was in the news for the wrong reasons-with the Securities & Exchange Board of India investigating whether its purchases of L&T stock (before selling its stake to the A.V. Birla group) broke the law. Now, its merger has taken Corporate India's breath away. What's going to be next from India's second most valuable company with highest turnover, the largest profits, and the most assets? Says a company wag, half-joking: ''Now that we have such an impressive balance sheet, perhaps we'll go out and raise a billion dollars from the global markets.'' Maybe he's not joking.

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