Mumbai: In a move that will create the world’s largest complex to convert crude oil into petroleum products at a single location, Reliance Industries Ltd, or RIL, on Monday said it would offer one share for every 16 shares held by investors in Reliance Petroleum Ltd, or RPL, its refining subsidiary. The two companies had informed the stock exchanges on Friday that their respective boards would meet on Monday to decide whether they should merge.
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RIL’s board unanimously approved the 16:1 merger ratio. RIL will issue 69.2 million new shares to RPL shareholders, increasing its equity capital by 4% to Rs1,643 crore. RIL’s own 70% shareholding in RPL will be extinguished. The company says the merger will increase the earnings per share in the combined entity.
“I can’t think of a better time for the merger. RIL shareholders will benefit from bringing in an asset that is complete now and has minimal project risk (the RPL refinery) and RPL shareholders, by being part of the parent company, can gain from (the) latter’s gas and oil E&P (exploration and production) portfolio, and get all the benefits from KG D6 (Krishna-Godavari gas fields) which is so close to production,” Alok Agarwal, chief financial officer of RIL, told reporters after announcing the merger deal.
He counted synergies in crude procurement, product placement, supply chain optimization and greater operational flexibility as the big merger gains, besides “efficient utilization of combined cash flows” and a higher valuation for the merged entity.
Though a few analysts were surprised by the timing of what they said was an expected move, most said the merger made strategic and financial sense for RIL. Goldman Sachs analysts Nilesh Banerjee, Durga Dath and Karthik Bhat wrote in a Monday report that the deal will be strategically positive for RIL as it would give the company “access to about $1.5 -1.8 billion (Rs7,770-9,324 crore) of RPL’s annual cash flows (on full ramp-up) for its various planned projects” and “Chevron’s concomitant exit from RPL (at Rs60/share) adds marginally to RIL’s valuation and also gives RIL’s promoters full control of the future direction of the company”.
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US energy firm Chevron Corp. decided on Friday to sell its 5% stake in RPL for $260 million at current exchange rates.
RPL commissioned a 580,000 barrels per day (bpd) sophisticated refinery at Jamnagar in Gujarat in late December. This new refinery is adjacent to the 660,000bpd one built by RIL earlier.
The merger ratio, however, seems to have surprised many analysts tracking the oil refiner, who were expecting the share-swap ratio to be something between 17 and 24 RPL shares for one RIL shares. A 16:1 ratio tips the deal against RIL shareholders, they believe. “We were expecting a swap ratio upwards of 20 (RPL) shares (for every RIL share). This was not expected at all because we expected a ratio in favour of the older, parent company,” said Deepak Sawhney, head - research in Mumbai-based brokerage Networth Stock Broking Ltd, who believes there’s more than meets the eye. Sawhney said that while merger was a short-term move, he was expecting RIL to eventually hive off its E&P assets into a separate company that will command much higher valuations than a refinery.
RIL shares fell more sharply that RPL shares on Monday, reflecting investor perceptions that the merger ratio is in favour of RPL shareholders.
RIL shares declined 3.15% to close the day at Rs1,225.15. RPL shares declined 1.38% to Rs75.15 a share. The bellwether Sensex dropped 3.20%, in tandem with stock indices in most other Asian markets.
Most sector analysts Mint spoke to over the weekend said they saw no tax or depreciation benefit from the merger that was largely to boost RIL’s revenues—a fact that Agarwal confirmed in the press briefing. “This merger is not for tax saving. The merged entity will be tax-neutral and we do not see any impact on account of additional depreciation. This merger is about size, about creating an integrated energy major.”
The rating agencies, on their part, reaffirmed their ratings for RIL debt after the merger was announced. Standard and Poor’s Ratings Services said in a statement that “there is no immediate impact on its corporate credit ratings” on RIL of BBB/negative but the company “continues to remain exposed to higher debt levels, pressure on profitability due to downturn in commodities and oil refining, and uncertainties on the size of cash flow from upstream gas operations”.
Moody’s and Crisil Ltd reiterated their ratings for RIL as “Baa2” and “AAA/stable/P1+”, respectively.
The merger has also emerged as interesting transaction that involved the who’s who from the merchant banker and management consulting fraternities.
According to RIL’s statement, Ernst and Young Pvt. Ltd and Morgan Stanley India Co. Pvt. Ltd acted as valuation adviser, JM Financial Services Pvt. Ltd and Kotak Mahindra Capital Co. Ltd as transaction advisers, and DSP Merrill Lynch Ltd “fairness opinion adviser” for RIL.
Citigroup Global Markets India Pvt. Ltd looked into the fairness of the deal for RPL. Amarchand Mangaldas and Suresh A Shroff and Co. was legal adviser while PriceWaterhouse Coopers Pvt. Ltd was the tax adviser.
Explaining to Mint the basis on which they arrived at the swap ratio, E&Y partner-transaction advisory services Sanjiv Agarwal said it had taken into account market capitalization, longer-term averaged out share prices, historical earnings and the assets of the two companies.
RPL adviser Citi’s Sameer Nath, head of mergers and acquisitions in India, and Rahul Saraf, head of the energy vertical in India, said in a telephone interview that this was “the first fairness opinion delivered” in a merger of two listed entities in India, a concept that is not legally required but has become part of corporate M&A best practices, largely in the US.
“Fairness opinions can provide additional comfort to shareholders in the non-promoter category,” said Nath, explaining how their opinion was based on an independent valuation of the recommended exchange ratio.
RIL CFO Agarwal declined to comment when asked if the timing of the merger was influenced by Chevron’s reluctance to invest more in RPL and sign an agreement guaranteeing supplying a potion of crude oil requirement and taking finished refinery product.
“It was a mutual decision not to go ahead with the investment,” said Agarwal, who was sure RIL would be able to sell the products from its new RPL refinery even in a sluggish global economy.
Clearing the air on treasury losses that RIL is rumoured to have incurred in its futures contracts, Agarwal said, “We have bought oil at $10 a barrel in 1999 and at $125/barrel in 2008 and still consistently maintained higher gross refining margins than industry benchmarks. We wouldn’t have got there if we didn’t know how to manage the volatility in risks”. He did not share any details or numbers on this.
Graphics by Sandeep Bhatnagar / Mint