Reliance Industries: Why Dow?

The reasons may not appear compelling, but an alliance with Dow Chemical could help RIL.

India Inc's global ambitions are getting bigger. Barely has the ink dried on the $12 billion Tata-Corus and $6 billion Hindalco-Novelis acquisitions deals than there's talk that oil and petrochemicals giant the Rs 89,124 crore Reliance Industries (RIL) is attempting to partner with the $49 billion Dow Chemical Co, the largest chemicals maker in the US. RIL has not made any announcement to this effect but speculation is rife that the company hopes to be able to team up with Dow possibly through a joint venture. The possible reasons: RIL wants to be able to team up with buyers who will guarantee offtake of polymers that it produces or it wants to use its cash flows to pick up a stake in a world-class efficient player in the chemicals and hydrocarbons space. In the context of media speculation, Andrew Liveris, chief executive officer, Dow Chemical has said that he had no plans for a "big bang transaction" but adds that he "plans to create a new business model for polystyrene and polypropylene-resin production, which may include forming joint ventures with partners that have access to cheaper raw materials."

Opinion is divided on what RIL stands to gain if RIL partners Dow in a joint venture which houses the commodity plastics and chemicals business. Some say it's hard to see operational synergies or potential for any cost savings through an acquisition in any of the segments to be spun off from the parent company. Others believe that RIL is looking for buyers for products to be exported from the SEZ. Says Deepak Mahurkar, associate director, PricewaterhouseCoopers, "Joint ventures tend to work better than simply a buyer-seller agreement since they provide long term partnerships and not short-term solutions. The target would be to bring competitive advantage and support in processes, practices and people." Besides, Dow's marketing network, they point out could be useful to RIL. "Even in a commodity business such as plastics, client relationships can be leveraged," they point out. Not everyone buys this argument though.

As for shutting down a part of Dow's high cost commodity chemicals and plastics facilities in the west and shifting the manufacturing back home, almost everyone believes that it is near impossible. "The cost of relocation for Dow would be too high apart from the political problems that may arise," points out an analyst. He adds that Dow might want to set up incremental capacity in India with RIL, which makes sense in the long term because of the cost advantages that it would derive.

But in the near term, most analysts concur that it doesn't seem feasible at all for RIL to be supplying cheap feedstock to Dow which has a high proportion of its manufacturing assets in North America, the rest being in West Europe and Kuwait. Analysts point out that Dow's basic chemicals and plastics units are integrated from the cracker stage and they source raw materials locally. If it wants, it can source products from Malaysia or the middle-east, and it would get them at a good price. "So the question of RIL supplying cheaper feedstock to Dow doesn't really arise," says an industry watcher.

However, what RIL could get from Dow is technology; that would help it make high value-added plastics such as thermo plastics or performance plastics. It's not that RIL can't shop for technology elsewhere, though. Experts say there's plenty of technology available. And if all that RIL wants from Dow is technology, there's no need for a joint venture.

Would Dow be keen on a partnership? Analysts believe that by spinning off its plastics assets into a separate company and giving RIL a stake, Dow can unlock some value. Given that margins for chemicals are expected to taper off from peak 2006 levels, it might give Dow's share price a boost. Dow's enterprise value (EV) is currently around $51 billion and the estimated operating profit for the commodity chemicals and plastics business for 2008 is $3-3.2 billion. Ascribing a multiple of about 8 times EBITDA, analysts suggest that RIL would need to fork out about $12.5-13 billion for a 51 per cent stake in a JV. It doesn't get bigger than that.