Home / Opinion / Views /  Opinion | The Reliance game plan – Part II

I had often wondered why Reliance is converting its debt to equity? In an invitation column for Business Standard soon after the Facebook investment, I had argued that is an anti thesis to its DNA which, from 1977, has followed a path of growth predominantly through high debt and financial engineering. Why? Because it was confident of free cash flows to sustain debt repayments on a sustainable basis, and in the process created enormous wealth for its shareholders through a leveraged play on the oil value chain.

Now, with its cash cow of the oil business threatened, its proposal to raise equity is an indication of its lack of confidence in the existing businesses to consistently generate free cash flows to service debt. Given oil’s structural decline as a commodity, excess global capacity and lower demand for oil-based products imply erosion of refining margins from GRMs of $11 per barrel. Hence, Reliance’s thinking would seem reasonable.

But apart from the dilution impact on existing shareholders, the cost of servicing equity is far more expensive than debt. So why do it if it is so confident of the future business as everyone seems to be? It would make more sense to continue with its DNA of raising fresh debt in an era of ample liquidity, near negative interest rates and high ratings for Reliance paper – and much cheaper too service too! In my career, at least in India, I have found promoter-driven companies very rarely change their DNA during intergenerational transitions. So why? Is Reliance itself not sure of a definitive outcome of this mega transformation it has unleashed, and thus prefers partners in risk rather than risk-free investors which much lower return expectations?

From a technology management perspective too this would seem to be the only plausible explanation. The larger picture of the formidable strategic investments made by the likes of Facebook (FB), Google, Qualcomm reflects the fact that what Jio is attempting is simply more than audacious.

They are planning to play in all six technology stacks that encompass the complete telecom consumer play. Core technology layer through Qualcomm and the 5G switch; the telco layer through Jio the service provider; the handset and OS layer through Google (Pixel equivalent and Android), Apple (distribution); the consumer layer through super apps riding on FB, Google, and finally the infrastructure layer through cloud offerings of Microsoft’s Azure and Google’s cloud.

No technology leader in any one of the these layers worldwide has succeeded a migration to even 2 or 3 other stacks till date. Amazon ( consumer product/services layer) failed with its Fire Phone (device layer), and the Fire OS (OS layer) ; Verizon (telco layer) failed with Yahoo (consumer app layer); Nokia (device layer) with its switch (core technology layer) etc. The closest to owning more than one layer is Apple (device - iphone, OS - IoS, consumer apps – iTunes, etc. ) and Amazon (consumer apps, device - Kindle, and Firestick). Hence, if this works, it will create a competitive moat which will be unsurpassable though questions will remain on creation of anti competitive market structures.

Additionally, it has recently been announced that FB has given up its plans for Libra - its ambitious global crypto currency project. This was a project by which FB would have potentially created the basis for an alternate non USD global financial system leveraging its captive 2.5 billion global user base. It is now, therefore, logical for it to develop instead a classical digital payment network like a Paypal.

India could well be the playground for it in partnership with a telecom operator with both political and financial muscle to navigate the system and regulatory hurdles which ultimately derailed FB’s ambitions. Incidentally, India has no super apps too primarily because these were not operator backed but created by small internet service providers. This time it will be different. Interestingly, a small footnote reported in one of the pink papers suggests Reliance’s interest in obtaining a license to operate a national payments network in competition to NPCI which runs the UPI platform, NFS, IMPS, etc.

China’s pioneering effort to introduce a sovereign digital crypto-currency pegged to the Yuan could well provide a blueprint. The two largest platforms in China Alipay and WeChat Pay, with a combined user base of 2 billion users, have helped create a massive digital currency infrastructure, consumer culture and the technology backbone to enable People's Bank of China to embark on its ambitious journey to launch the world’s first sovereign digital currency.

It is this pie which I believe is the ultimate objective. Reliance would be eager to rival NPCI in building its own proprietory payment systems. And once it reaches the stage to rival NPCI in the future, India could well be on its way to launching its own sovereign digital currency system for which RBI has recently shown preliminary interest. NPCI and Reliance would be the only two large platforms - our own WeChat Pay and Alipay equivalents - and will propel RBI to cross the chasm. Though from an user’s perspective not much will change, the central bank will move to a new paradigm in terms of supervision, future modes of financing, business and social governance apart from transparency.

Hence, these astronomical investments in Reliance. But so are the risks of failure. And, of course, long pay back periods for generating old fashioned operating cash flows. And hence the equity raise instead of debt.

For the ordinary investor, treat this as a PE play in the publicly traded markets - not as a risk-free investment it is being made out to be.

The author is a Sloan Fellow from the London Business School, Director and Advisor to Chairmen of corporate boards, the author has formerly been a Group CFO in various companies. The views are his own.

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