RELIANCE, RPL TO MERGE

Spotlight now on swap ratio In a typically audacious move, catching markets by surprise, RIL and RPL decided to merge, creating an Indian oil, natural gas, refining and petrochemical giant comparable with the world's best

RELIANCE Industries will combine with Reliance Petroleum to create a mammoth oil and gas company with a projected topline, comprising nearly 20% of the combined turnover of the 30 companies in the BSE Sensex.
    The two companies said in separate statements on Friday evening that their respective boards will meet on March 2 to discuss a possible merger. The plan, when implemented, will further strengthen RIL's position as one of India's top companies and one of the world's biggest producers of petroleum and petrochemical products.
    Using analyst estimates for RPL, ET Intelligence Group calculations show that the merged entity will become India's biggest company in terms of net profit overtaking PSU major Oil and Natural Gas Corporation (ONGC). In terms of net worth, and sales, it will continue to remain second after Indian Oil Corporation.
    The combined firm's turnover will be 19.7% of the total 30 Sensex companies while its net profit will be 16.5% of the overall profitability of the Sensex 30. The merged firm's market cap will be 16.8% of the market cap of all the Sensex companies.
    The merger will help the combined entity save on income tax and dividend distribution tax. It will also create a much bigger balance sheet, which will help RIL raise money for working capital and for expansion.
    The merger will create a truly global colossus in the area of petroleum refining and marketing. The merged entity will be the sixth-biggest private sector refiner in the world with a total capacity of 1.2 million barrels per day. The combined cash flow will be immense, and will help finance ambitious investments in the difficult and expensive areas of oil and gas exploration.
    "The merger makes good business sense, given the current global environment. The merger will help lower costs and give you size as a company," says Enam Securities head (broking) Dharmesh Mehta.
    Meanwhile, RIL in a latenight announcement said that it will buy back US oil major Chevron's 5% stake in RPL. Post the deal, RIL stake in RPL will rise to 75.3%. Chevron had bought a stake in the company in 2006 with an option to increase it to 29% around the time of the commencement of the 29-million tonne refinery, or three months after that.
    RIL, India's biggest private sector company, has grown to its current stature and size through mergers, acquisitions and rapid growth fuelled by massive investments in chemicals and oil and gas. Merger move fits in with Reliance's strategy
IT has followed a strategy of implementing mega projects quickly, developing expertise in a number of areas, especially financing.
    "It is positive for shareholders of Reliance Industries. There will be savings in costs due to a combination of businesses," said Deepak Sawhney, research head at Networth Stock Broking.
    The current move, coming amidst a sharp slowdown in demand for many RIL products, continues an Ambani tradition of launching big projects under separate, publicly-listed companies and then folding them back into the main company. Two petrochemical projects were launched under this route in the 1990s. This was followed by the first major refinery project, which raised money from the public in 1993 and began operations in 1999. In fact, it is exactly seven years ago that the first RPL was merged into the main company. Four years later, RIL adopted the same route when it decided to implement a second refiner project.
    The strategy makes good sense for RIL as it is able to implement big projects quickly and that too without incurring any major cost.
    Reliance Industries shares ended the day 1.97% down to Rs 1,265.05. Shares of RPL ended the day 1.23% down at Rs 76.20.
    The announcement came after market hours but that did not stop frenzied speculation about the possible share-swap ratio. Many analysts speculate that it could be 1:18.6, or one share of RIL, for every 18.6 shares of RPL.
    Independent investment advisor SP Tulsian feels the merger is "slightly negative" for RPL while only "mildly positive" for the Reliance Industries.
    "I think that the swap ratio would be around 20:1 or 24:1," he adds. Mr Tulsian expects RPL shares to drop to around Rs 70 on Monday. On Friday, RPL shares closed 1.2% lower at Rs 76.20. The shares have fallen 5% over the last one month.
    It is not clear what the companies propose to do with RIL's holding in RPL. Having promoted the company in 2005, RIL owns a little over
70% in RPL. The company has two options. The shares can either be cancelled or be held as treasury stock through a trust. During the time of the merger of the first Reliance Petroleum in 2002, the shares were held in a separate trust. The advantage this gives RIL is that the shares can be either sold, or pledged, to raise money for the company's projects.
    However, it is also possible that these shares could be cancelled, as holding them separately would only increase the dilution in RIL's equity and lower earnings growth. The treasury stock could amount to as much as 10% to RIL's existing equity base, unless of course the shares are cancelled.
    Speculation has been raging for quite some time that RPL has suffered large inventory losses due to the sharp fall in crude prices in the months of November and December. Some analyst and industry experts have also said the current proposal is a way for RPL to escape the damaging effects of such losses as they can be absorbed in a bigger balance sheet. RPL officials, however, have consistently maintained that they have not suffered any major losses and that the losses, if any, are very small in relation to the size of the company.
    Where RIL stands to benefit clearly is in savings on income tax and dividend distribution tax.
    The current tax holiday for RIL's Jamnagar unit is set to expire by March 31, 2009, while RPL's refinery, which has SEZ status, has a tax holiday for another seven years. RPL can also escape paying dividend distribution tax in a merger. Otherwise, it would have to pay tax every year when it is returning money to shareholders.
    "The combined entity can also use the large cash flows of the new refinery for expansion plans in E&P without having to pay dividend distribution tax (17%), which would be applicable in case Reliance Petro was a separate company and it was returning cash to its shareholders (including RIL) through dividends," said Sanjeev Prasad, executive director and co-head institutional equities, Kotak Securities.
    The RPL refinery was commissioned in December 2008. It is expected to be fully operational by the middle of 2009.

INVESTORS OF RIL MAY GAIN MORE
The market widely believes that the swap ratio will be in favour of RIL shareholders. This is based on the simple arithmetic that there are more minority shareholders in RIL than in RPL.