labels: industry - general, reliance industries, investment - general
Reliance after the splitnews
10 August 2005

The Reliance group has formally announced the much awaited de-merger plans. What does the future hold for the more focused Reliance Industries and does the current stock price reflect its future potential ? Rex Mathew analyses.

After more than six months of market speculation and media hype, the details of the de-merger from the parent Reliance Industries (RIL) group of companies that now constitute the Anil Dirubhai Ambani Enterprises (ADAE) was formally approved by the RIL board last Friday. Though the details of the de-merger were public knowledge even prior to the formal announcement, courtesy the media-savvy Anil Ambani, the formal announcement has finally laid to rest most of the uncertainties surrounding the Reliance group.

The de-merger plan involves formation of four holding companies and transfer of RIL's holdings in the energy, financial services and telecom businesses to these companies. The fourth company would hold contracts with RIL for supply of natural gas to the power generation ventures of ADAE.

The Reliance de-merger plan

Company

Nature

No of shares*

Reliance Communication Ventures (RCV)

Holding company for telecom businesses

100

Reliance Energy Ventures (REV)

Holding company for power business

100

Reliance Capital Ventures (RCapV)

Holding company for financial services businesses

100

Global Fuel Management

Natural gas supply contracts from Reliance Industries

100

* For every 100 shares of Reliance Industries Limited

The current holdings of RIL in all its telecom ventures is being transferred to Reliance Communication Ventures. RCV would be the holding company for Reliance Infocomm, Reliance Telecom and Reliance Communication Infrastructure Limited (RCIL).

Reliance Energy Ventures would receive, by way of transfer, RIL's holdings in Reliance Energy Limited, the group's power generation and transmission company. Based on the current RIL holding in Reliance Energy Limited, the residual holding would be seven shares of Reliance Energy Limited for every 100 shares in RIL.

Similarly, Reliance Capital Ventures would receive RIL's holdings in various financial services businesses. These include Reliance Capital, Reliance General Insurance and Reliance Life Insurance. Based on the current RIL holding in Reliance Capital Limited, the residual holding would be five shares of Reliance Capital Limited for every 100 shares in RIL.

Global Fuel Management would hold contracts for supply of natural gas by RIL for the power generation ventures being planned by Reliance Energy Limited. The requirement of a holding company to handle these contracts is not clear, though Anil Ambani has stated that this company may also look at opportunities in the energy management business.

Valuation of de-merged businesses

As the ADAE group has already stated that Reliance Energy Ventures and Reliance Capital Ventures would eventually be merged into Reliance Energy Limited and Reliance Capital Limited respectively, their valuations are equal to their holdings in the two operating companies. The holdings in the two insurance businesses are not relevant, as they would also eventually be consolidated under Reliance Capital Limited.

The value of Global Fuel Management can only be taken as the paid up value of equity at this stage, as the value of contracts this company would hold in future is not known.

That leaves the telecom business, which is the most prominent and visible in the ADAE group.

The telecom businesses include Reliance Infocomm, which is the largest CDMA telecom operator, with a nationwide presence. Reliance Communications Infrastructure is a large shareholder in Reliance Infocomm. Eventually, this company may be merged with Reliance Infocomm in the process of reducing the multiple layers of ownership.

Reliance Infocomm was valued at around Rs25,000 crore at the time of conversion of preference shares held by RIL. Though there can be significant upsides in future depending on the company's ability to improve profitability and expand into new businesses like broadband, this valuation seems fair at present.

Reliance Telecom operates in the GSM space and is present in seven telecom circles, mostly in the eastern states. It has a subscriber base of over 1.1 million and is profitable. The GSM business of BPL with over two million subscribers was sold at an enterprise value of $ 1.1 billion recently. This valuation reflects the strong presence of BPL in Mumbai. Since Reliance Telecom operates in the less lucrative eastern circles, the company may get a valuation of $400 million or around Rs1,740 crore.

Reliance Communication Ventures - Valuation

Company

Enterprise Value in Rs (crore)

Holding

Value of holding in Rs (crore)

Reliance Infocomm

25,000

65.9%

16,475

Reliance Telecom

1,740

35.2%

612

Enterprise Value of Reliance Communication Ventures

17,087

Total number of RCV shares in crores

122

Value per share of Reliance Communication Ventures in Rs

140

The value of the shares to be received by RIL shareholders in the de-merged entities for can be summarised as follows:

Value of the de-merged entities

Company

Residual no of shares per share of RIL

Current Value in Rs

Value in Rs

Reliance Energy+

0.07

629

44

Reliance Capital+

0.05

470

24

Reliance Communication Ventures#

1

140

140

Global Fuel*

1

5

5

+ Closing price on 09th Aug 2005 on the NSE
# Value as estimated
* Value of Global Fuel taken at face value

Valuation of core businesses of RIL

The contribution of the de-merged businesses by way of dividends, etc, to RIL's revenues and profits are insignificant. Hence, the de-merger would not have any impact on the operations of RIL.

The residual value of the core businesses of RIL along with its holdings in petrochemicals company IPCL after the de-merger is given below:

Reliance Industries - Valuing the core

In Rs per share

Current market price of RIL*

711

Less: Value of de-merged entities per share of RIL

Reliance Communication Ventures

140

Reliance Energy Ventures

44

Reliance Capital Ventures

24

Global Fuel Management

5

213

Residual value of core businesses of RIL

498

* Closing price on 09th Aug 2005 on the NSE

After the de-merger, RIL would become a well integrated and more focused entity concentrating on oil and gas exploration, crude refining, and petrochemicals. While this would convert the company into a pure play on the petroleum and petrochemicals sector from a more diversified entity, better focus would help the company in achieving the ambitious growth targets announced recently.

The company is planning to expand the capacity of its refinery to 60-million tonnes per annum. The refinery is capable of processing the cheaper heavy crude, which has helped the company earn better refining margins. The company is also a significant exporter of refined products. Even if refining margins were to come down in future, an unlikely scenario given the global shortfall in refining capacity, the significant economies of scale after the expansion would help the company to maintain its profits.

The company has plans to expand its petroleum retail network significantly over the next few years. It has a network of 500 fuel stations at present. This is expected to increase to over 5,000 in future. Though the company has refuted the news many times, the company is believed to have large plans for development of retail shopping and entertainment complexes.

On the petrochemicals side, the company is already the largest player in the polyester fibre and yarn in the world. The company is expanding its polyester capacity to
2-million tonnes this year and PTA capacity to 1.9-million tonnes by next year.

Petrochemical prices have been on an up trend for the last few years. Though prices have come down from last year's peak, the downside from here on is limited as long as the economy grows at a steady clip. Besides, the dominant position of RIL in the domestic petrochemicals market would protect the company's margins to some extent.

The company has already stated that it is on the lookout for inorganic growth through overseas acquisitions. There was considerable market speculation last week about RIL picking up a large stake in German petrochemicals giant Basel. A large overseas acquisition over the next few years is very much on the cards.

The exploration business could become the most significant value creator in future. The company holds 90-per cent stake in the Krishna-Godavari basin besides minority stakes in Panna-Mukta and Tapti oil fields. It has also acquired minority stakes in one exploration block each in Yemen and Oman. RIL has won five exploration blocks under the most recent round of NELP and has plans for coal bed methane exploration as well.

The core businesses of RIL is expected to report a net profit of over Rs10,000 crore this year or a year-end EPS is of around Rs72. For 2005-06, RIL's EBITDA is expected at around Rs15,000 crore or Rs108 per share.

The residual value of Rs498 per share translates to a forward price-earnings multiple of under 7 and EV / EBITDA of 4.6. These valuations are reasonable going by the current performance of the company and offer some upside in the short to medium term provided the market retains its momentum. Besides, the stock may see a mild re-rating if governance standards and transparency improves.

The potential upside over the long term, three years and above, could be significantly higher. By then, the petrochemical expansions would go on stream and a significant overseas acquisition might also happen. The refinery expansion would also be completed by then and the fuel-retailing network would attain the planned size. The company would also start pumping out gas from the KG basin by 2008-09, which could add significantly to revenues and profits.

The company is in a position to finance this large-scale expansion from internal accruals. RIL could generate free cash flows of at least Rs45,000 crore over the next three years, which would be sufficient to finance most of the investments. Hence, there would be no equity dilution unless the company comes across a significantly large overseas acquisition opportunity.

RIL would double its revenues in four years and profits should grow at a faster rate unless there is a significant downturn in petrochemical prices, which is unlikely. Therefore, at a residual value of Rs498 per share, the stock is significantly undervalued from a long-term perspective.


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Reliance after the split