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The RIL-RPL merger: Our view - Views on News from Equitymaster

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The RIL-RPL merger: Our view
Mar 2, 2009

The demand outlook for petroleum products worldwide is weak due to the economic slowdown. However, some interesting developments are taking place in the petroleum industry. First, there were reports that Sinopec and PetroChina will add a refining capacity of more than 2 m barrels per day. China is clearly trying to build its way out of the economic slowdown. Closer home, there is the Reliance Industries (RIL) and Reliance Petroleum (RPL) merger. The swap ratio has been set at 1 share of RIL for every 16 shares of RPL. The appointed date of the merger is April 1, 2008.

The management sights operational and financial synergies as the reason for the merger. On the operational front, it is being said that RPL will benefit by becoming a part of an integrated player instead of operating as a pure refining company. It may be noted that the refineries are located close to each other. Moreover, with a 70% stake in RPL, RIL exercises control over the operations of the RPLís refinery. So, we wonder what additional operational synergies are generated by rearranging cooperate ownership of the assets, when control is already within the group.

There are several reasons on the financial front. Depreciation on new RPL plant will provide a tax shield for the merged entity. If and when RPL would have generated cash flow, it would have had to pay it to RIL in the form of dividends, attracting dividend distribution tax. The merged entity is a more efficient method of transfer because it eliminates the dividend distribution tax.

But if the financial considerations led to the merger decision, RPL would not have been floated as a separate company in the first place. After all, the tax laws have not sprung all of a sudden. It is possible that the management wanted to ring fence the flagship company RIL from project risk of building the new refinery. But given RILís prior track record of building the first Jamnagar refinery, the Ďproject riskí rationale doesnít cut much ice.

Conclusion
We believe the actual reason for the merger has more to do with the crash in gross refining margins and Chevronís lack of interest in upping its stake in RPL. Being a pure refiner, RPL is subject to volatile earnings and inventory losses. After the merger, its volatility will be masked in the numbers of the larger RIL. It is already difficult to segregate the financials of RILís various business, which are lumped together. With the operations of RPLís refinery also lumped together, the investor is likely to receive even lesser disclosure than before. The quality of information is vital for investors if they have to make informed decisions. Indian conglomerates need to disclose more information, not less. As such, we believe this is a negative development for investors.

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