RIL and RPL merge, swap ratio set at 1:16

MERGER EFFECTIVE APRIL 2008; RECORD DATE YET TO BE ANNOUNCED

THE boards of Reliance Industries (RIL) and Reliance Petroleum (RPL) on Monday approved the merger of the two companies, with a swap ratio of one RIL share for 16 RPL shares. While the merger will be effective April 1, 2008, the record date is yet to be announced. Brokers said the swap ratio was positive for RPL shareholders, but somewhat disappointing to RIL shareholders.
    The stock market seemed to have been expecting a swap ratio between 1:16 and 1:20. The disappointment over the swap ratio showed in the behaviour of the RIL stock price, which fell 3.1% to close at Rs 1,225.15. RPL shares fared only slightly better, shedding 1.4% to close at Rs 75.15 in a weak overall market.
    According to ETIG estimates, the merged entity is likely to report a cash profit of Rs 29,197 crore in FY10, compared to an estimated Rs 20,757 crore for RIL.
    Under the merger terms, RIL will issue 6.92 crore new shares to RPL shareholders, resulting in a 4.4% rise in its (RIL's) equity base to 1,643 crore shares. Global refining major Chevron, which held 5% in RPL, has decided to sell its stake to RIL.
    Post-merger, RIL's holding in RPL will be cancelled, and the promoter group's holding in RIL will fall to 47% from 49%.
    The merger process appears to have been executed in less than a fortnight. Banking sources said that the investment banks and accounting firms involved in the process were contacted around 10 days ago. The decision to go ahead with the merger appears to have accelerated after US oil giant Chevron decided not to hike its 5% stake in RPL to 29%. This happened after RPL and Chevron failed to sign a product-offtake agreement which had envisaged the US oil major buying 45% of RPL's products.
    "This merger follows RIL's philosophy of creating enduring value for all shareholders," Mukesh Ambani, chairman of both RIL and RPL, was quoted as saying in a media release, adding, "It is a significant step in our goal to be among the largest global corporations."
    RIL can now boast of the world's largest refining capacity at a single location, with a capacity to process 1.24 million barrels per day (mbpd). Company officials said RIL would have almost one-fourth of the world's complex refining capacity, which refers to the ability to blend crude of varying quality, including those of very low quality. Further, RIL — particularly the RPL unit — would have the capability to supply petroleum products, meeting Californian environmental standards, believed to be the world's toughest.
MERGER MATHS
RIL to issue 6.92 crore new shares to RPL shareholders, resulting in a 4.4% rise in its equity base to 1,643 cr shares Post-merger, RIL's holding in RPL will be cancelled, and promoter group's holding in RIL will fall to 47% from 49% Merger to increase synergies
FURTHER, it would have the capability to supply ultra-low sulphur diesel to western markets. Post merger, RIL's capability to process many varieties of crude would increase substantially, a senior RIL official said.
    The merger will reduce the earnings volatility for RPL shareholders and allow them to participate in the full energy value chain of RIL, the media release by RIL said. "Operationally, we see minimal benefits although conflicts of interest will be negated," brokerage firm CLSA said in a note to clients.
    "Standalone net debt-to-equity will rise 14 percentage points to 41% but there is little change at the consolidated level (around 43%). Consolidated return ratios in FY10-11(estimated) will rise by 20-60 basis points while FY09 book value adjusted for revaluation and depreciation changes will reduce 2.3% to Rs 711/share," the CLSA report added.
    Analysts opine the merger will provide operational synergies, as RIL already has a refinery, independent of the one it will be getting from RPL.
    "It (the merger) may not help Reliance much in financial terms because RIL anyway held 71% in RPL. However, it will help in improving cash flows (of RIL)," said an analyst at a domestic brokerage firm.
    But the company also made it clear that the merger was about operational benefits, and not about tax benefits as projected by most analysts.
    "Integrated energy companies have higher valuations as against the standalone refiners. The merger would unlock synergies in crude sourcing and product placement and lead to greater flexibility in operations planning," RIL's chief financial officer Alok Agarwal said, adding that it would reduce operating costs.
    "Since the two firms (RIL and RPL) will continue to function as separate entities as far as their accounts are concerned, the two companies will have their independent tax benefits. This merger is not about tax benefits," he said. Mr Agarwal also said that while RPL's cash flows would become available to RIL, that was not the main reason for the merger. Mr Agarwal said that gross refining margin (GRM) were strengthening in the January-March '09 quarter compared to October-December '08. A senior RIL source said the company's results in the current quarter would surprise on the upside.
    Meanwhile, Crisil has reaffirmed 'AAA/Stable/P1+' ratings on the debt instruments of RIL, and 'P1+' on bank facilities of RPL post approval of the merger. As many as eight advisors were involved in the transaction. These included Ernst & Young, Morgan Stanley India (both valuation advisors), JM Financial and Kotak Mahindra Capital (both transaction advisors), DSP Merrill (fairness opinion advisor for RIL), Citigroup Global Markets (fairness opinion advisor for RPL), Amarchand & Mangaldas & Suresh A Shroff & Co (legal advisor) and Price Waterhouse and Coopers (tax advisor).

This merger follows RIL's philosophy of creating enduring value for all shareholders. It is a significant step in our goal to be among the largest global corporations
MUKESH AMBANI CHAIRMAN, RIL