The merger is good for RIL because it will have access to RPL’s cash flows.
The merger ratio of one share of Reliance Industries (RIL), for every 16 shares of Reliance Petroleum (RPL) has, quite unexpectedly, been in favour of RPL shareholders. That’s probably why RIL stock stayed in the red on Monday, at levels of around Rs 1,225. Even the news that the treasury stock will be cancelled, implying a very small dilution in the equity base of just 4.4 per cent, making the merger earnings accretive, wasn’t good enough for the Street. As also the fact that the company will have access to between $1.5-$1.8 billion worth of cash flows from RPL when it scales up operations fully.
In fact, little changes at RIL since it already owned about 70 per cent in RPL and at a consolidated level, the net debt to equity ratio will hardly change. What the merger achieves is that it allows the cash generated in RPL to be used more effectively and at the same time, eliminates any transfer pricing, dividend distribution tax and other such issues. For sure, the two companies must have exploited synergies where possible but from now on, it will be easier to do so.
While the management has clarified that the merger will be tax neutral— the carry forward unabsorbed depreciation of RPL cannot be set off against RIL’s profits — the alleged losses of around Rs 8,000 crore posted by RIL’s retail business will now be part of a much bigger balance sheet. With earnings per share (eps) for the combined entity estimated at around Rs 127 in 2009-10, the stock at Rs 1,225 levels, trades at just under 10 times.
However, the merged entity has a slightly bigger exposure to refining and while gross refining margins (GRM) have strengthened in the region, moving up to around $5.5 a barrel in the last couple of months, the near -term outlook is not too positive. Of course, RIL will post better GRMs than its peers thanks to the fact that its refinery can process cheaper and heavier crude oil. Nevertheless, until the global economy shows signs of recovering, the additional refining capacity coming into the market, especially in Asia, could keep GRMs in check.
