Of two ‘G’s & two ‘R’s?

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The RIL-RPL merger would lead to the making of one of world’s largest refineries; but is long term growth guaranteed sans shareholders’ smiles?

There’s one ‘G’ that defines short-term prosperity – Gain, but there’s another that pronounces long-term sustainability – Growth! And what’s most critical in the whole kaleidoscope of strategy is the co-existence of the two, a company can’t survive or even trivially dare to make it to the big league! For a change, even in these painfully obstreperous times, where one only hears of bailouts and bankruptcies, Mukesh-led Reliance Industries Ltd. (RIL), India’s largest company with an Mcap of Rs.1.9 trillion, and Reliance Petroleum Ltd. with Rs.333 billion in Mcap are together forecasted to report net profit figures of Rs.161 billion – that’s laudable considering many negative estimates that have flown into the market of late. And if that was not enough good news, both entities have announced a merger (effective April 1, 2009) that is in total alignment with the business strategy that RIL has been implementing for the past three decades. Operationally, this move makes sense as even in the past, the company has done well to allow new entities (that were used to initiate new petrochemical projects) of the Reliance Group to merge with RIL, post the initial gestation period. This gives space to the parent to hedge itself against many risks involved with ‘new’ projects.

“This merger is a significant step in our goal to be among the largest global corporations,” optimistically declared Mukesh Ambani, CMD, RIL. This move, besides serving its financials well, would enable RIL to get counted amongst the world’s top 10 refining non-PSUs, with a total capacity of 1.24 million barrels per day. RIL which has 70% stake in RPL, would buy Chevron’s 5% holding in RPL for Rs.13.50 billion, as a part of the deal. The merger is a tax neutral one, thereby enabling both companies to retain their tax benefits. The merged-entity aims to derive various operational & financial synergies from various joint operations like crude sourcing, product placement, supply chain optimisation et al. “RIL expects the merger to provide synergies in crude procurement and product placement,” says Deepak Pareek, Analyst, Angel Broking. At the same time, he warns, “We believe that synergies are likely to be lower as the companies would be sharing facilities.” The deal involves a RIL & RPL share-swap agreement at a ratio 1:16. In order to buy back RPL, Ambani will be issuing 69.2 million new shares of RIL to RPL shareholders. The merged entity would thus have a large pool of 3.7 million shareholders; and this would lead to the rise in RIL’s equity capital to Rs.16.43 billion. But the situation doesn’t seem to pleasing for ordinary shareholders as the current move has resulted in a heartrending evaporation of Rs.68 billion of shareholder equity. Also, not much could be done to avoid the whopping erosion of Rs.67.52 billion in combined Mcap! “The merger definitely leads to RIL becoming a larger player in the global refinery market, but the small investors in the group are being made the scapegoat in the process with their money being turn to dust,” avers N. Wadhwa, MD, SKI Capital.

Yes, cash flow will get stronger post-merger (by $1.5-$1.8 billion), but does prosperity mean paying no heed to petty shareholders? Considering how deep has the principle of shareholder wealth maximisation been embedded in the group, one question gets raised at the end of the day. The merger looks good, in terms of balance sheet affairs, but is big brother trying to redefine the very foundation on which Reliance grew (i.e. Growth@shareholders)? (Ah! That’s a new G there!)

Ratan Lal Bhagat

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Source : IIPM Editorial, 2009

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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