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Reliance demerger: Updated!
Jan 3, 2006

When it comes to valuing stocks during demergers, reverse mergers and equity stake sales, which are aimed at enhancing shareholder value, the stock market typically underestimates the value of the combined company (post the corporate action). Take for instance Indo Gulf ‘s demerger (the copper division was merged with Hindalco) and more recently, L&T’s demerger of the cement division into Ultra-Tech Cemco. The benefit to the shareholders has been much higher than expected. With this as a background, in this article, we analyse the impact of the Reliance demerger and what investors in the stock should do. To start with, the graph below highlights the first step of the demerger process, wherein four resulting companies are formed viz. Coal-based Energy Resulting Undertaking, Gas-based Energy Resulting Undertaking, Financial Services Resulting Undertaking and Telecommunication Resulting Undertaking.

Share entitlement ratios…

  1. In the ratio of 1 equity share of Rs 10 each in the case of the Coal Based Energy Resulting Company (Reliance Energy Ventures Limited) for every 1 equity share of Rs 10 each held by such member in the Demerged Company i.e. Reliance Industries.

  2. In the ratio of 1 equity share of Rs 5 each in the case of the Gas Based Energy Resulting Company (Global Fuel Management Service Limited) for every 1 equity share of Rs 10 each fully paid-up held by such member in the Demerged Company.

  3. In the ratio of 1 equity share of Rs 10 each in the case of the Financial Services Resulting Company (Reliance Capital Ventures Limited) for every 1 equity share of Rs 10 each held by such member in the Demerged Company.

  4. In the ratio of 1 equity share of Rs 5 each in the case of the Telecommunication Resulting Company (Reliance Communication Ventures Limited) for every 1 equity share of Rs 10 each held by such member in the Demerged Company.

Since all the aforesaid resulting companies are not listed, the actual entitlement to a Reliance shareholder is not clear. However, in the case of Reliance Capital Ventures Limited, on January 2nd, the Board of Reliance Capital had announced a swap ratio of 5:100 i.e. indirectly, for every 100 shares held in Reliance Industries, the investor will get 5 shares of Reliance Capital (a listed company). What this means is that Reliance Capital will be the listed company as far as the group’s interest in financial services sector is concerned.

In the case of Reliance Energy Ventures Limited, the Board of Reliance Energy announced a swap ratio of 7.5:100 i.e. indirectly, for every 100 shares held in Reliance Industries, the investor will get 7.5 shares of Reliance Energy (a listed company). In effect, once the demerger comes into effect, Reliance Communication Ventures Limited and Reliance Natural Resources Limited (formerly Global Fuel Management Services Limited) will be the unlisted entities.

What will be the cost of acquisition post the demerger?
The Hon. High Court of Bombay has approved the scheme of demerger of the aforesaid undertakings and consequently, the following are the details of the book value of net assets transferred and equity shares issued to the resulting companies.

Transfer value…
Resulting Company Book value of
net assets transferred (Rs m)
No. of
shares (m)
Book value
(Rs)
Reliance Com. Ventures 153,890 1,223 126
Reliance Energy Ventures 29,210 1,223 24
Reliance Capital Ventures 5,120 1,223 4
Reliance Natural Resources 2,970 1,223 2
Total of the above 191,190    
% of Reliance's networth (FY05) 47.3%    
Source: Company, Equitymaster research

Secondly, for the purpose of the determining the post-demerger cost of acquisition of equity shares of Reliance Industries (since Reliance’s stock price will decline to reflect the demerged operation), the Hon. High Court has suggested following apportionment.

Post demerger cost determination…
Company % of cost of acquisition
of Reliance Industries shares
Reliance Industries 52.0%
Reliance Com. Ventures 38.7%
Reliance Energy Ventures 7.3%
Reliance Capital Ventures 1.3%
Reliance Natural Resources 0.7%
Source: Company

What this means is that if an investor bought Reliance’s share at Rs 900 (pre-special trading market price), 52% of the same i.e. Rs 468 will be the acquisition cost pertaining to the Reliance Industries. We have put up a detailed table in the interest of subscriber, assuming various cost price points. Ideally, considering the current price of Rs 900 of Reliance Industries, the stock could adjust to Rs 468 post the demerger.

Cost price at various purchase price for tax purpose…
Company Cost of acquisition
at Rs 900
at Rs
800
at Rs
700
at Rs
600
at Rs
500
Reliance Industries (Rs) 468 416 364 312 260
Reliance Com. Ventures (Rs) 348 310 271 232 194
Reliance Energy Ventures (Rs) 66 58 51 44 37
Reliance Capital Ventures (Rs) 12 10 9 8 7
Reliance Natural Resources (Rs) 6 6 5 4 4
Source: Company, Equitymaster research

However, we also have to take into consider the post-demerger holdings of Reliance in the new companies, IPCL and treasury stock. In our view, as mentioned earlier, excluding Reliance Communication Venture and Reliance Natural Resources, the holding value is Rs 146 per share. Even if one assumes Rs 55 as the holding value of Reliance in the telecom venture and calculates the value based on the book value, the value of Reliance is estimated at Rs 669 per share. In the special trading session (January 18th, 2006), Reliance opened at Rs 702 per share (the core business) and finally closed at Rs 715 per share.

What to expect?
At Rs 715, Reliance is trading at a price to earnings multiple of 11.2 times our estimated FY06 earnings.
  1. Based on shareholding pattern as on September 2005, the per share value of Reliance’s holding in Reliance Capital (based on the swap ratio) works out to Rs 19 per share (based on the current market price of Reliance Capital).

  2. Taking the swap ratio of 7.5:100 in the case of Reliance Energy, the per share value of Reliance’s shareholding in Reliance Energy translate into Rs 40 per share.

  3. Also, Reliance holds 46% stake in IPCL, which is valued at Rs 19 per share.

  4. The value of treasury stock translates into Rs 68 per share.

Valuation of Reliance's holdings…*
(Rs m) Rel Capital Rel Energy IPCL Treasury stock
No. of shares (m) - post demerger 61 92 114 105
Current price 442 602 235 900
Value of holding 27,028 55,224 26,846 94,194
Per share value (Rs) 19 40 19 68
*Equitymaster estimates

In our view, if you are a Reliance shareholder, we suggest you to hold on to the same and wait for more clarity. We believe that the value of sum-of-parts is likely to be much higher than the current valuation of Reliance Industries. All Reliance shareholders will get a share of new business and therefore, there is a significant upside.

P.S. Considering the demerger, we will be removing Reliance from our research coverage, as the numbers will not reflect the re-organisation in its true sense. As more clarity emerges on how the existing shareholders of Reliance will benefit, we shall update investors.

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