Reliance shifting gears again

A possible spin-off of the oil and gas exploration business, separate entity for overseas oil exploration, possible mega overseas acquisitions and the biggest ever preferential issue to the promoters all mean that Reliance Industries may be gearing up to build a global footprint, says Rex Mathew.

Ever since the Ambani brothers split the monolith to carve out their individual groups last year, Reliance Industries (RIL) has made significant progress in many of its mega business ventures. Retail operations, which would see investments of up to Rs25,000 crore, were kicked off towards the end of last year. The company's subsidiary Reliance Petroleum has already started work on the 580,000-barrels per day refinery in Jamnagar. Land acquisition for the mega SEZ project near Mumbai is progressing well.

RIL recently announced yet another expansion plan and like all other Reliance projects, this one is also big. The company is due to set up a 2- million tonnes per annum integrated cracker and petrochemicals complex at the SEZ being set up at Jamnagar. This would be one of the largest integrated cracker complexes and would produce ethylene, propylene and other products. The project would go on stream by 2010-11 and would see a capital investment of $3 billion.

Apart from these, there are other significant initiatives which suggest that the company may be readying for a much bigger global expansion in the years to come. Though many of these initiatives have not been formally announced, and company officials have been denying some of them, most industry analysts believe that these moves are very likely.

Oil & gas assets to be de-merged?
Though RIL officials have repeatedly denied such a move, there has been considerable speculation in the market and the media about a spin-off of the upstream oil and gas business into a separate company. Most industry analysts back such a move, as it would create an entity focussed on exploration and production which would help RIL to rope in a strategic partner — if required.

RIL has been the most successful in domestic oil and gas exploration in recent years and has made some very significant natural gas discoveries in the Krishna-Godavari basin. RIL owns 80 per cent of these fields and has received government approval for the development plan for the Dirubhai-1 and Dirubhai-3 gas discoveries.

RIL has hiked its targeted production plateau from an earlier indicated 40- million cubic metres of gas per day to 80-million cubic meters. Some analysts believe this is a conservative plan and actual production plateau may be over 100-million cubic metres. Production is expected to start early next year.

Developing the existing discoveries and setting up production facilities would require capital investments of around $5 billion and the company has already spent part of it over the last couple of years. Besides, the company also holds more than 30 exploration blocks in the country, which would require additional investments in the near future.

Spinning of the upstream exploration and production business into a separate company would help in funding these projects without straining the parent company's balance sheet. Some investment banks have valued the upstream business of RIL at a staggering $35 billion and selling even a small stake can net it sufficient funds.

Roping in a strategic partner would also provide access to advanced exploration technology, though company officials have stated that the company already has access to the required technology.

Overseas oil exploration plans
RIL is readying to set up a dedicated entity in Dubai for international oil and gas exploration, if media reports are to be believed. This entity would be on the lines of ONGC Videsh, the overseas arm of ONGC, which holds operating interests in all overseas assets of the public sector company. RIL has not so far officially commented on these reports.

RIL's international exploration interests are very small at present, limited to a few blocks in Oman, Yemen and Timor Leste. Most of these fields are in the early stages of exploration, involving evaluation of seismic data. Though there were reports about the company setting up a refinery in Yemen, no announcements have been made so far.

If true, creation of such a separate company would mean that RIL is looking to expand its overseas exploration portfolio in future. The success in domestic exploration would have made the company confident enough to take up overseas projects. A separate entity would also reduce the financial risks to RIL as most of the existing and potential overseas exploration interests are located in politically sensitive regions. Formation of a distinct entity would also make it easier to form strategic partnerships for such overseas forays.

On the prowl for overseas acquisitions
Reliance Industries has so far focussed more on the domestic market as all the segments it operates offered tremendous growth opportunities. Now that the company has achieved global scale in its manufacturing capacities and has enough financial resources, Mukesh Ambani may gradually unfurl a global strategy for his group. Being amongst the most globally cost-competitive in each of the business segments it operates in, Reliance has developed the required competencies to widen its geographical presence.

Reliance's biggest overseas acquisition till date was its approximately $100-million buyout of the German polyester yarn and fibre manufacturer Trevira in 2004. That is small compared to some of the overseas businesses Reliance is said to be eyeing.

The first of the possible targets being speculated is the petrochemicals and plastics division of General Electric, which is generally known as GE Plastics. The division had revenues of over $6.5 billion last year and may cost up to $10 billion. Though not officially announced, GE is said to be keen to get out of the plastics businesses as margins may come under further pressure in future. Other potential bidders for the division include BASF, Dupont and Dow Chemicals.

But Dow Chemicals itself is rumoured to be on the block. Over the last couple of months, there have been persistent rumours about some large private equity investors making a large bid for the legendary US corporation. Some state-run oil companies from the Middle East and Reliance Industries are also speculated to be interested.

The size of the deal is said to be a staggering $40 billion, which makes it unlikely that RIL would go in for an outright acquisition bid. There is speculation that RIL is discussing a broad business alliance with Dow including the transfer of some manufacturing facilities Dow to RIL, leaving the US company free to focus on high-end and high-margin products by sourcing the intermediates from RIL, which would be able to manufacture them very competitively in India.

IPCL merger
The move to merge IPCL with Reliance Industries is no surprise as the market had been speculating it for quite some time now. IPCL is a focussed petrochemicals company and there is no reason why it should be kept separate from the parent company, which is the largest in the domestic petrochemicals business.

The merger ratio between IPCL and RIL is now a matter of considerable speculation. The final ratio would be announced only later after an independent evaluation but most analysts expect a ratio of between 5 and 6 shares of IPCL for a share of RIL.

The merger would lead to an increase of around 10 per cent each in the revenue and assets base of RIL. The consolidated net profit of RIL would increase by over Rs800 crore for the current financial year as the company has been including only 46 per cent of IPCL's profits in its consolidated accounts. However, the equity dilution for the merger would mean that there would be no material improvement in EPS of RIL.

Immediate synergies from the merger would not be materially very significant, though some savings can be expected by streamlining the manufacturing and marketing operations. There would also be some savings on sales tax or VAT on feedstock sourced from RIL by IPCL. Going forward, the petrochemicals business of the combined entity would benefit considerably by using natural gas supplied from RIL's KG basin fields as feedstock.

RIL had acquired a 26-per cent stake in IPCL through the government's disinvestment process in 2002 and then hiked it to 46 per cent through an open offer. Last year, IPCL had merged some privately held small polyester manufacturing companies with itself.

Funding the mega projects
Thanks to steady cash flows from its mature refining and petrochemicals businesses, financing such heavy capital expenditure plans is not that difficult for RIL. The company generated surplus cash of around Rs12,000 crore from its operations during the last financial year and has already clocked Rs11,000 crore during the first 9 months of the current financial year. The cash generated by IPCL would make these figures even bigger.

To meet additional capital expenditure requirements in retail, petrochemicals and oil and gas businesses, RIL is issuing convertible warrants to promoters on a preferential basis. The company would also raise $2 billion through external commercial borrowings. RIL can easily raise additional debt as the debt-equity was below 0.4 as of December 2006.

Direct holdings of chairman Mukesh Ambani and his family members are very low. Mukesh Ambani holds just 0.13 per cent while his wife and two children hold 0.12 per cent each. Kokilaben Ambani, Mukesh Ambani's mother and wife of RIL founder Dirubhai Ambani, holds a 0.26 per cent stake and is the largest individual shareholder of RIL.

As many as 43 privately held companies and trusts controlled by Mukesh Ambani hold the remaining 49.87-per cent stake listed under the promoter and promoter-group category. Once such a promoter-group company holds just 10 shares of RIL while a few others hold 100 shares each. The Petroleum Trust, an entity formed to hold RIL shares at the time of the merger between the earlier Reliance Petroleum and RIL, has the largest holding among the promoter group entities with a 7.51-per cent stake.

RIL is issuing 12 crore convertible warrants to promoters and associates which would be convertible within a period of 18 months from the date of allotment. On allotment, 10 per cent of the conversion price would become payable and the balance would be payable at the time of conversion to equity shares.

At the conversion price of Rs1,402 per share, the promoter group would pump in Rs16,800 crore within the next 18 months. Add to that the external borrowings and total funds available would be close to Rs26,000. Including cash generated from operations, funds available for investments would move closer to Rs50,000 crore over the next 18 months.

On conversion of the warrants, the total paid up capital of the company would increase to Rs1,513 crore from the current Rs1,393 crore. The promoter's holdings would have risen to 54.53 per cent of the expanded capital base after the conversion of warrants. Because of the IPCL merger, the promoter's stake would only rise to around 53 per cent.

If the internal accruals and inflows from the preferential issue and overseas debt do not suffice, RIL has the option to raise additional funds by liquidating a part of the treasury stock held by the company.

The 7.5-per cent stake with the Petroleum Trust is held on behalf of RIL shareholders and hence the company has full beneficial interest in it. The treasury stocks would go up if RIL chooses not to extinguish its own shares that it would receive for the 46-per cent stake held in IPCL. A part of the total treasury holdings can be offloaded while retaining the total promoter's stake above 51 per cent.

A giant by any standards
RIL is likely to end the current financial year with revenues of close of Rs1.2 lakh crore, including IPCL. It would be the first private sector Indian company to cross the Rs1 lakh crore revenue mark in a financial year. The company's market capitalisation crossed Rs2 lakh crore last month, which was again a first for a private Indian company. But these numbers can go up substantially as the new initiatives fully go on stream.

RIL is targeting annual revenues of Rs1 lakh crore from the retail business after five years. By then Reliance Petroleum, in which RIL would continue to hold a majority, would go on stream and would add around Rs70,000 crore to the consolidated top line.

Assuming an average price of $3.5-per million BTU, natural gas from the KG basin would lead to annual revenues of over Rs16,000 crore at the indicated production of 80-million cubic metres per day. Revenues from other upstream assets would also rise, but not very significantly.

The existing businesses would also see an increase in capacities and revenues. Even after assuming a very conservative 10 per cent average growth over the next five years, total revenues from existing businesses would move close to the Rs2-lakh crore mark.

Adding up all these estimates, RIL is likely to achieve consolidated annual revenues of close to Rs4 lakh crore when these projects are all fully operational. In all likelihood, RIL would be the first Indian company to hit $100 billion annual revenues — probably a couple of years after the new projects fully go on stream.

The company may reach these milestones even earlier if it is successful in making a big-ticket acquisition. If markets remain firm, it is also likely that the company's own market capitalisation would also be close to the $100- billion mark by then.