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Sunday, Dec 05, 2004

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Understanding the Ambani squabble

S. Vaidya Nathan

THE reasons for Mr Mukesh Ambani going public now over `ownership issues' have more to do with the business of Reliance Industries than anything else. Also, these may hold the key to the settlement — whatever its shape — that emerges. Whichever way it goes, the outcome would be to the advantage of the Mr Mukesh Ambani.

At the core is securing unequivocal control over Reliance Industries' massive cash flows that can finance business plans and drive wealth accretion.

Reliance's three key business initiatives — retail marketing of petroleum products, natural gas and telecommunications — are set to catapult the company to a scale that would be significant even by its standards.

In the event, any delayed settlement would only make the exercise more expensive for Mr Mukesh Ambani. A settlement would end the uncertainty; a patch-up may be perceived only as a cosmetic exercise.

Factors such as Mr Anil Ambani's entry into politics, his association with the Samajwadi Party, his close links with the Sahara India Parivar, and his unilateral announcement of a big-ticket power project in Uttar Pradesh are all cited for Mr Mukesh Ambani taking control over the decision making at Reliance Industries.

But these may not fully explain the public squabbling. Yet what is clear is that if Mr Mukesh Ambani reaches a settlement soon with his brother, he would do it at a far lower price tag than he can five or ten years hence, for then the business profile of Reliance Industries would have grown dramatically larger. The following factors could have a bearing on the change:

  • As Reliance's petro-product retail network gets going, the value attached to its oil business could rise manifold. As the rollout of its marketing network — it plans to open about 2000 outlets over the next two-three years — attains a critical mass, its profitability will improve further. This will also provide a cushion in periods when the refining margins recede. Global oil majors, too, place a higher value on their marketing operations than the refining business.

  • Reliance Infocomm's business is likely to gather momentum as it is likely to garner a sizeable share of the additions to the mobile subscriber base; the base may not touch the 100 million connection mark by end 2005, but it should in three years.

    Reliance Infocomm is likely to account for at least a fourth of this. With its nation-wide optical fibre network the company is well set to emerge the leader in the broadband business. Its initial public offering may be deferred till the ownership issues are settled.

    This would ensure that in any division of wealth, this business is valued at less than the likely price that the stock could command; such a development would suit well Mr Mukesh Ambani, as he is widely perceived to be the brain behind the foray into telecom and controls Reliance Infocomm ownership through privately-held companies.

  • Over the next three-five years, gas finds in the Krishna-Godavari basin are likely to be monetised in a phased manner. Till there is concrete evidence, a degree of scepticism over the quantum of the gas find is natural.

    But even if production turns out substantially lower than the reserves, it would drive up the revenue and earnings potential. This would strengthen Reliance's presence in the fuel and energy space.

  • These businesses would require massive investments. Reliance's internal cash generation and the ability to raise funds at competitive rates — equity or debt — is an added advantage. The ability to bankroll such business ventures easily could only enhance their attractiveness from a valuation perspective.

  • As much as these aspects, of keen interest to the brothers would be the cash flows of Reliance (see accompanying story).

    In FY 04, the cash flows from operations exceeded Rs 11,000 crore and the picture is bound to be healthier in this fiscal.

  • Over five-ten years, the advantage that such cash flows can confer would be unmatched in Corporate India. Even a conservative Rs 1 lakh crore would not just bankroll growth in existing business but also enable the person in control create a legacy that could equal, if not better, what was left behind by Dhirubhai Ambani.

    Consider the debt that can be raised on the strength of such cash flows and the potential for equity mobilisation (a skill the group has mastered over the past two decades), the available resources can create a business at least twice the present size of Reliance Industries. This is the reality-check on what is at stake.

    Obviously, these issues have kept the rift on the front pages of newspapers and the prime television time. But what does all this mean for investors? A look at the possible outcomes and their implications.

  • Mr Mukesh Ambani has moved into a position of such strength that Mr Anil Ambani may be left with limited negotiating power in a settlement.

    If the former decides so, the latter may be left out on a limb with just the assets from any settlement to pursue his business ambitions but with no say in the manner in which Reliance's cash flows are used.

  • A compromise between the two may not provide comfort to investors in Reliance Industries. It would only create a façade of normalcy, till the next battle.

  • A settlement rather than a compromise, would be a positive for the shareholders in the group, as that would remove the element of uncertainty that can affect stock valuation.

  • A carving up of Reliance Industries is unlikely. Its businesses are so integrated that the advantages would be frittered away if select businesses are segregated. It would also affect the group's pursuit of global scale operations.

    Quite apart from the larger consideration of business synergies, the Ambani family would largely be loath to see the break up of an empire built so assiduously by Dhirubhai Ambani over more than three decades.

  • Much attention has been focussed on Reliance Energy with the resignation of six of its directors (they have been asked to reconsider this step).

    Its gas-based power project in Uttar Pradesh is at risk. But this appears to be a mere skirmish in the larger battle.

    In a settlement, Reliance Energy could be a part of the assets vested in favour of Mr Anil Ambani along with Reliance Capital, the mutual fund and insurance businesses.

    A hefty cash component is also likely to be part of the package to compensate for any shortfall in the share that ought to go to Mr Anil Ambani.

    The right to use the `Reliance' name for a defined period or indefinitely may also be integral to this process.

  • The worst case scenario is a protracted legal battle. Even a settlement could take up to two years as a maze of investment companies hold the equity stakes in the various group companies.

    A legal battle would drag the process on for a longer period. It may also lead to a scrutiny of the group's business structures as has never happened in the past.

    As such a denouement could be detrimental to the Group, the brothers may stay clear of such a course, except as the final option where one of the brothers sees the settlement offer as an inequitable one.

  • As for the political aspect, the group is known for its clout with various parties at the national and regional level.

    Every now and then, when it runs into impediments to business growth due to difficult political situation, it has successfully overcome it.

    An involvement of political interests is possible, including efforts at bringing about a rapprochement. A truce brought about by political interests that merely perpetuates the status quo would be perceived as a negative as the issue could be re-opened if those who broker it become less relevant with changes in the political milieu.

    Even if the brothers battle it out, Reliance shareholders should remain invested through the troubled times. Sharp price dips could be used to accumulate the stock. They can remain invested even if a compromise solution is found though this could affect the stock's price earnings multiple.

    A similar strategy may be appropriate in the case of IPCL, which is likely to be a part of Reliance's long-term plans.

    Shareholders of Reliance Energy could contemplate switching a part of their exposures to Tata Power, which is pursuing a similar growth strategy and now offers greater certainty on execution of business plans.

    Shareholders of Reliance Capital should retain their holdings as it could be a critical with its investment portfolio and also because it is attractively valued.

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