Corporate File

Decoding Reliance’s demerger of oil-to-chemicals biz

Hari Viswanath | Updated on March 28, 2021

Green light: Eco-friendly pod taxis from US-based skyTran, in which RIL recently increased its stake   -  SKYTRAN

Connecting the dots, it looks as though RIL may have found its next big scalable opportunity

Reliance Industries (RIL) has been hogging the headlines in FY21. First it was Facebook’s big investment in the group’s telecom business Jio. Then followed a mega rights issue and a series of investments from marquee global private equity players, netting RIL $36 billion. Late last month, RIL also announced that it was initiating a demerger of its oil-to-chemicals (O2C) business, which has been its cash cow over the past decade.

Not surprisingly, the analyst community is all agog. The shape of the new Reliance emerging is a holding company with three mega subsidiaries — O2C, Jio, and Retail — each valued well above $50 billion. With its consolidated EBITDA (earnings before interest, taxes, depreciation, and amortisation) expected around $18 billion by FY23, the company is now nearly net-debt-free. Potentially, RIL can receive up to $25 billion at the holding company level via a minority stake sale in O2C.

There is no end to the speculation on the group’s next moves. What exactly does the man on the RIL throne, Mukesh Ambani, have in mind?

O2C demerger

All RIL businesses linked to petrochemicals/ oil and gas, except the upstream oil business, will be hived off into a separate subsidiary — O2C. The transfer of O2C assets to a subsidiary on a slump sale basis includes a consideration of interest-bearing loans from RIL to O2C, which will allow RIL to raise up to $25 billion from a minority stake sale in O2C in a tax-efficient manner, similar to how it raised capital in Jio and paid zero tax.

According to the company, talks are on with Saudi firm Aramco for one of the largest downstream transactions in India. This would leave RIL with net cash of around $12 billion at a standalone level ($25 billion + current cash and equivalents – debt). This apart, according to a report by JP Morgan, RIL has a real estate and land bank with potential to generate $1-5 billion from stake sale. Added to this, any further capital raise in Reliance Retail, where RIL still holds 85 per cent vs 66 per cent in Jio, implies there is a lot of liquidity at play for Mukesh Ambani’s next big ambition. Even on a conservative basis, there is a potential to invest around $15 billion without taking on any debt.

Why the demerger?

The Reliance DNA is built around its stated motto of ‘Growth is Life’. What started small as Reliance Textile Industries in 1973, with a paid-up capital of ₹1.5 lakh, is now a conglomerate with market cap just shy of ₹15 lakh crore. Size and scale is paramount to RIL.

This goes back to founder Dhirubhai Ambani’s vision to produce best quality products at the cheapest price, which is possible only with scale. Whether the business is refining, petrochem, organised retail or telecom, if scale is not possible, then RIL quietly shelves its plans. For instance, it put off plans for the power sector and financial services early last decade after initially showing strong interest with the scrapping of the non-compete pact with ADAG Group in 2010. Could the demerger and capital raising spree be a sign that RIL has identified new opportunities that can be built to scale? It seems likely.

After being the fulcrum of RIL for decades, the O2C business now does not entirely fit in with the ‘Growth is Life’ DNA of RIL. With revenue expected to decelerate as the business has reached a mature state, the Reliance DNA mandates investing in the next growth story by monetising some stake in O2C to potential partners like Aramco. Also, the intent seems to be to gradually shift from fossil fuels, given that Environmental, Social, and Governance (ESG) themes are accelerating.

What next?

While Reliance’s move in petrochemicals/refining mirrors that of global oil majors in the past, and its Retail strategy is reminiscent of Walmart in the US, what it achieved with the Jio juggernaut is unparalleled globally.

Nowhere in the telecom world has a player entered so late and become number one so soon. This has raised expectations on Ambani’s next moves.

The big bet on a green future was evident from the demerger presentation and his comments. During the group’s AGM in July last year, he said, “Transforming our energy business to tackle one of the biggest challenges (climate change and need for clean and affordable energy)... is our new growth opportunity.” RIL wants to be a Net Carbon Zero company by 2035 and has identified a few focus areas — affordable energy and storage using solar, wind and batteries; transition to a hydrogen economy; investing in carbon capture and storage technologies; and developing a portfolio of advanced and speciality materials.

While the O2C business will take on carbon capture technology and hydrogen economy, the other new energy and new materials initiatives will be under a standalone RIL (holding company).

Significantly, days after announcing the demerger, RIL increased its stake in US-based skyTran to 54.46 per cent. skyTran develops transport solutions via pod taxis. Connecting the dots, it appears Ambani may go global with his new energy and new materials, and eco-friendly transport initiatives. Spurring this is the ongoing advanced innovation in developed countries like the US and strong policy intents like the EU leaders recently agreeing to cut greenhouse gases by 55 per cent by 2030.

Morgan Stanley, in its report on the demerger, noted, “With this reorganisation, RIL will have four growth engines — digital, retail, new materials and new energy. While the market appreciates the value for the first two businesses, we see significant upside risk to earnings and multiples for 02C as RIL invests in new energy/ technology.”

Admittedly these new initiatives involving early-stage technology projects will be long-drawn.

So, as the maxim goes: ‘If I have eight hours to chop down a tree, I’d spend six hours sharpening the axe’; that is what one can expect Mukesh Ambani to do.

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Published on March 28, 2021
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