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RIL-RPL merger: Who benefits?

RIL-RPL merger: Who benefits?
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First Published: Mon, Mar 02 2009. 04 02 PM IST

Updated: Mon, Mar 02 2009. 04 02 PM IST
India’s most valuable company (by market capitalization) – Mukesh Ambani-controlled Reliance Industries Limited (RIL) has decided to absorb its Reliance Petroleum Limited (RPL) unit through a share swap arrangement.
RIL said it would issue one share for every 16 held in the unit, giving it direct control of the world’s largest refinery complex.
Below is the analysis from top brokerage houses across the country on the deal and who stands to benefit in the scheme of arrangement.
Angel Broking
RIL currently holds 70.4% stake in RPL, which is likely to increase to 75.4% on account of Chevron selling its stake back to RIL.
The merger is likely to strengthen RILs’s cash flow and balance sheet. RPL has incurred huge capex towards commissioning its refinery and is likely to generate positive free cash flow (FCF) going forward.
Thus, the proposed merger would help RIL utilise this Cash flows in its other business verticals in a fruitful manner.
Alternatively, if RPL would have been maintained as a separate entity and had paid dividend to RIL, it would have attracted dividend distribution tax of 17.99%. Thus, the merger allows RIL flexibility in using RPL’s Cash flows.
The proposed merger could benefit RIL in taking advantage of RPL’s depreciation.
While calculating book profit, RIL would be entitled to take SEZ benefit for RPL’s refinery unit and while calculating taxable income for the year, RIL could avail the benefit of depreciation tax shield.
However, things are still unclear whether RIL would actually benefit from the same.
Who benefits from the merger?
The beneficiary of the merger would depend on the swap ratio. In mergers the swap ratio is determined based on the intrinsic value of the respective companies, which is in turn decided based on various parameters, ie. market value based swap ratio, book value based swap ratio, etc.
As per the 27 February 2009 closing price of RIL and RPL, the swap ratio works out to 1 share of RIL for every share 16.6 share of RPL.
However, on book value basis, the ratio works out to be adverse for the RPL shareholders.
We believe given that RPL is yet to commence production from its new refinery the book value based swap ratio would not be an ideal indicator for fixing a swap ratio.
The case also strengthens from the fact that RPL’s IPO price was fixed at Rs60/share much above the book value of Rs29/share of the company. Thus, a book value based swap ratio does not serve any purpose in this case.
We believe swap ratio in the range of 16-17x will be Neutral for both companies. Since RPL’s listing, the hypothetical swap ratio between RIL and RPL has been in the range of 21 - 10x, giving an average of 15.7x and median of 15.3x.
However, if the ratio is more than around 18x, it would be adverse for RPL shareholders. While any swap ratio of more than 20x would be beneficial for RIL shareholders.
At Rs1,265, the stock is trading at 12.3x FY2009E and 9.7x FY2010E earnings. We maintain a BUY on the stock, with a Target Price of Rs1,440.
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First Published: Mon, Mar 02 2009. 04 02 PM IST
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