Mumbai: In a move that was not unexpected, Reliance Industries Ltd, or RIL, India’s most valuable company, is considering merging its biggest subsidiary, Reliance Petroleum Ltd, or RPL, with itself as it becomes clearer that US energy firm Chevron Corp. is unlikely to increase its stake in the stand-alone refiner.
A quick poll of three analysts tracked by Mint on the proposed swap ratio threw up two numbers. The first ratio was derived on the basis of the share prices of the two companies, with one RIL share for about 17 shares of RPL. On the basis of the book value, the ratio was put at one RIL share for every 24 shares of RPL. The book value of RIL shares is Rs700 and for RPL, Rs30.
The boards of both companies will meet on 2 March to consider the move, the firms said in separate statements to the stock exchanges on Friday after market hours.
Also See Joining Hands? ( Graphic )
Analysts say a merger was on the cards but the timing has come as a surprise. “It is on expected lines, when it became clear that Chevron would not exercise its option to subscribe to more shares in RPL,” said an analyst from a domestic brokerage, who asked not to be named. “The merger move makes it certain that Chevron will not increase its stake in RPL.”
RPL, in which RIL has a 70% stake, started trial production in January at its 580,000 barrels-per-day (bpd) refinery in Jamnagar, next to its parent’s 660,000bpd refinery. With a combined capacity of 1.24 million bpd, they form the world’s largest refinery complex.
Chevron has a 5% stake in RPL. It has till 27 July, or three months from commissioning of the refinery, to exercise an option to increase its stake.
Mint had reported earlier in February that Chevron’s spending programme for 2009 had not factored in plans to exercise an option to raise its stake in RPL by 24 percentage points, an investment seen as crucial by many experts.
Another analyst, who also expressed surprise at the timing, said a likely reason for the merger would be that Chevron has decided against increasing its stake in RPL. The US firm had an agreement with RIL to sell crude to RPL and, in turn, find buyers for its refined petroleum products in international markets, he said.
P.M.S. Prasad, RPL executive director and a senior executive in RIL, declined to comment on Chevron’s plans for RPL. However, at the KG basin site on Friday, he told reporters RPL had not signed any supply and offtake deal with Chevron.
The proposed agreement had envisaged Chevron supplying 35% of RPL’s crude requirement for its new refinery and procuring 45% of the final product from the refinery.
This is the second time RIL is merging a refinery business with itself. In 2002, under the chairmanship of Dhirubhai Ambani, the company had merged its earlier refinery subsidiary, also called Reliance Petroleum Ltd, with itself. The treasury shares accruing from the merger amounting to 11% of the merged company are still lying unsold with RIL. The latest merger, if approved by the board, will create a further tranche of treasury shares.
Officials at RIL declined to comment on the proposed merger. However, persons close to RIL said the merger would enhance its position as an integrated energy company and the new entity would gain from significantly higher financial strength and flexibility. The merger is also likely to add to RIL’s earnings from the first year itself, they said.
One reason, they said, is that the markets ascribe higher valuation for integrated energy companies vis-à-vis standalone refiners due to better competitive positioning and reduced earnings volatility. Further, the deal would put RIL among the world’s 50 most profitable companies and among the top 10 non-state owned refining firms globally.
The merger will also give the combined entity enhanced weightage in domestic indices.
In a 10 February report, Sanjeev Prasad and Gundeep Singh of Kotak Institutional Equities Research wrote while benchmark refining margins are bouncing back, led by expansion in gasoline and naphtha cracks, the impact would be muted for Indian public sector units as well as for RIL and RPL due to high proportion of diesel in product sales. Further, large capacity additions plus demand weakness would keep margins under pressure, they added.
Analysts Pradeep Mirchandani and Adarsh Parasrampuria of JPMorgan wrote in a report on RIL and RPL, Testing Times, that the outlook for these companies was still cloudy even as refining margins and petrochem spreads rebounded in the fourth quarter of fiscal 2009.
“However, the cyclical business outlook continues to depend on the sustainability of demand and supply discipline, clarity on this could take two quarters,” they wrote.
“It (gains from the merger) is not obvious to me. Prima facie, I don’t see huge benefits accruing from this merger,” the analyst from a domestic brokerage mentioned earlier said. “In bank mergers, there are benefits like branch and employee rationalization. In this case, we don’t see such benefits accruing via a merger.”
As another likely reason for the merger, the analyst said RIL would get tax benefits from its plant in a special economic zone, which provides for a complete tax holiday to SEZ units for a period of five years from commissioning.
On 31 December, Standard and Poor’s Ratings Services downgraded its credit outlook on Reliance Industries to negative from stable, but reaffirmed its long-term corporate credit rating of “BBB”.
The agency said the negative outlook reflected RIL’s increased debt to add pressure on profitability due to the downturn in the commodities and oil refining stemming from the economic slowdown.
Graphics by Ahmed Raza Khan / Mint