Mumbai: Saudi Aramco is in serious discussions to buy as much as 25% in the refining and petrochemicals businesses of Reliance Industries Ltd (RIL), The Times of India reported on Wednesday. That the two companies are considering a deal isn’t entirely surprising. Earlier this year, Saudi Aramco CEO Amin Al Nasser said: “We are looking at additional investments in India. We are in discussions with other companies as well, including Reliance Industries."

But what’s surprising is the reported Aramco-Reliance deal valuation. The TOI report suggests RIL will carve out its refining and petrochemicals divisions into a separate entity, which will be valued at $55-60 billion. This values the downstream businesses at about seven times estimated Ebitda for the year ended 31 March. This will be attractive from Aramco’s perspective, but far from lucrative as far as RIL is concerned.

Ebitda stands for earnings before interest, taxes, depreciation and amortization.

Note that a number of broking houses have valued the downstream businesses at much higher levels already. The median across the Street is upwards of $70 billion. It’s not like Reliance is a distress seller either. While its indebtedness has increased considerably in recent years after its aggressive foray into the telecom sector with Reliance Jio, leverage ratios haven’t gone out of whack. Net debt to Ebitda is around 3.7 times based on the current year’s debt and earnings estimates.

“RIL’s oil businesses generate high cash flows, which will take care of its debt. There is no pressing need to sell a stake in its refining and petrochemical assets," said an analyst at a domestic broking house. The only motivation to sell is if the deal includes a condition to procure crude from Aramco at discounted rates, the analyst added.

But this might not be the bait that attracts RIL either. After all, it is better placed than many other refiners, both in terms of its ability to process heavy/low quality crude and long-established trading relationships that help it procure crude at competitive rates.

According to the head of research at a multinational brokerage, the only reason RIL is likely to part with a stake to Saudi Aramco would be if it gets what it deems is a “full valuation" for the asset. The Saudi state-owned oil company has been aggressively increasing its footprint in downstream businesses, buying stakes and entering into joint ventures with large companies in countries such as South Korea, Malaysia and China. Its eagerness to diversify beyond the upstream oil production business may well result in handsome valuations for RIL.

As far as Reliance in concerned, it has already demonstrated that it isn’t averse to selling stakes in its businesses. Incidentally, the company reported on Wednesday that it had sold a stake in a unit that owns six very large ethane carriers to Mitsui OSK Lines Ltd. Earlier, it announced the sale of its shale units and there is talk of an initial public offering (IPO) of Reliance Retail.

A large stake sale in the downstream business would stand apart from these above-mentioned deals. But if Aramco agrees to higher valuations, with the view to pursue its downstream expansion plans, a stake sale in the core business may well be a smart move for RIL. It will free up resources for the group’s consumer businesses, Reliance Jio and Reliance Retail, which enjoy far higher valuation multiples.

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