Krishnan Thiagarajan

SHAREHOLDERS of Reliance Industries Ltd (RIL) may not find the terms on which the company's holdings in the preference capital of Reliance Infocomm is being converted into equity of the latter attractive.

The RIL board has come up with a proposal that involves conversion of preference shares worth Rs 8,100 crore into equity shares at Rs 32 per share (of face value of Re 1 each).

The shareholders perhaps have a case for expecting it to be converted at a much lower price, considering the financial and operational risks borne by them in the telecom venture over the past two years.

To understand why, let us start with a conservative Reliance Infocomm's overall valuation of Rs 25,000 crore. The Reliance Industries share in this valuation works out to Rs 16,475 crore (at 65.9 per cent shareholding). Based on an initial investment of Rs 10,462.5 crore, the return will be 1.6 times. With the preference share conversion, the remaining promoter's stake comprising Mr Mukesh Ambani and associates and the employee trust should end up with 25 and 9.1 per cent respectively. The value of the former's stake will amount to approximately Rs 6,250 crore. In other words, with an initial investment of about Rs 2,360 crore (assumed on the same terms as RIL), their return works out to 2.6 times.

Though issued as preference capital, the investment by Reliance Capital had for all practical purposes resembled that of an equity investment. It carried an option to convert into equity, but the terms of the conversion were never spelt out in the beginning. In the event, the post conversion relationship among promoters inter-se ought to remain the same as before. That is to say, the sum invested by way of preference shares too ought to be treated as equity capital.

A rough calculation will show that these two parties will get to share their returns on more equitable terms only when the shareholding of RIL increases to 75 per cent and that of the promoters (leaving out the employees trust) is restricted to below 20 per cent.

It is interesting to note that Mr Anil Ambani, at the height of the ownership battle, did suggest that if the preference shares were converted at par, it would enhance the RIL holding to 75 per cent (from 42.35 per cent).

Sticking to that suggestion will yield the best return for RIL. In turn, it promises the best outcome for shareholders who are expected to get shares in proportion to their holding in RIL in the demerged entity.

As outlined by Dhirubhai Ambani, in the run up to the telecom venture, the promoters and RIL were supposed to own an equal stake of 45 per cent each in the venture, with the balance 10 per cent being held by the employees trust (in an independent capacity).

And this was also disclosed in most documents at the early stages of the telecom venture.

Besides this, a significant proportion of the financial risk was borne by RIL in this venture. Over the past two years, either directly or indirectly, the shareholders of RIL have been exposed to risks relating to preference share investments, financial/performance guarantees issued and substantial receivables in Reliance Infocomm's books.

(This article was published in the Business Line print edition dated June 30, 2005)
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