The decision to merge Reliance Industries Ltd (RIL) and subsidiary Reliance Petroleum Ltd (RPL) is the latest in a long line of similar inter-group mergers in the Reliance group.
This move was expected by many analysts and investors. India’s largest business group has historically preferred to incorporate new subsidiaries to implement large projects that could strain the cash flows of the parent. Once the project is up and running, the subsidiary is folded back into RIL.
This is a strategy that has worked, though we wonder how long the public investors who buy shares in the new subsidiaries (through initial public offers) will take to see that they are behaving like quasi-venture capitalists that fund a start-up and then exit it by getting RIL shares once the project is ready to spew out cash.
That said, the mega merger between the two Reliance companies makes a lot of operating and financial sense— especially since the final decision by US energy firm Chevron Inc. to exit RPL took away the biggest reason to maintain RPL as a stand-alone entity.
The new merged company will become one of the world’s largest refiners and could have one-fourth of the global complex refining capacity. Such economies of scale in production as well as a larger consolidated balance sheet is bound to help in tough times such as these when cash will be king.
The money generated by the RPL refinery, which will be fully commissioned soon, and the cash from the sale of natural gas pumped out of the Krishna-Godavari basin is likely to strengthen the finances of India’s most valuable company.
In this merger, RIL has had to balance two factors.
The basic trade-off seems as follows, at least to us: RIL owned 70% of RPL and hence would have had access to 70% of its cash flows once the refinery starts running at full capacity. The merger allows RIL to get access to the other 30% of the new refinery’s cash flows, though it has had to buy out Chevron to make this possible. Buying Chevron’s 5% stake in RPL will cost RIL around $270 million, while the extra 30% cash flow could well be around $700 million a year.
It looks like a trade-off worth making.
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