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Rel. Energy buyback: Our view - Views on News from Equitymaster
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Rel. Energy buyback: Our view
Mar 7, 2008

The management of Reliance Energy (REL) has announced a share buyback, seemingly to appease shareholders following the rout its stock has seen over the past couple of months. In fact, the company’s stock price has almost halved from a peak of Rs 2,630 that it touched in January 2008. This weakness follows a period of overvaluation where the stock price had reached dizzying heights not conforming to the company’s inherent value. Then came the Reliance Power shocker, which investors had originally believed to be a ‘fairytale’ IPO, but that turned out to be a ‘nightmare’. Anyways, the management, with a view to "reduce short term volatility in the company's share price, deter speculative activity in the company's shares, send a strong signal to the capital markets on the perceived under-valuation of the company's share price and reiterate the confidence of management in future growth prospects of the company", has declared a buyback programme that will be spread over two stages.

  1. Firstly, shares worth Rs 8 bn will be bought back, pursuant to the approval granted by the company’s board of directors.

  2. Then, a further amount of Rs 12 bn will be spent towards a further buyback, again subject to necessary approvals by the shareholders.

In totality, REL has proposed to buy-back shares worth Rs 20 bn for a maximum price of Rs 1,600 per share. This price represents a premium of around 10% to the closing share price on Wednesday, the last trading day before the buyback was announced.

In effect, for a transaction worth Rs 20 bn and at a maximum price of Rs 1,600 per share, REL will buy back around 12.5 m shares, or just about 5.3% of the current shares outstanding. This reduction in share base will improve the company’s earnings per share by just around 5.8%, which is miniscule. How does the management then expect to provide ‘substantial’ benefits to shareholders through this buyback is thus questionable!

The fact that the stock has declined by over 10% after the buyback announcement points to the inadequacy of the entire exercise. Also, considering that the buyback amount of Rs 20 bn is just around 23% of the company’s estimated net cash for FY08 (after reducing debt from cash and investments), the company could have given away more (bought back higher number of shares). This is also considering that due to the fact that all capex related to power generation will be taken care by Reliance Power going forward, REL’s cash requirements will not be high in the future.

We had recommended a ‘Sell’ on Reliance Energy in January 2008 at Rs 2,135. The stock is down 37% since then. We had valued REL’s core businesses at Rs 808 per share and its investment in Reliance Power at Rs 1,224 per share, thus arriving at a total value of Rs 2,032 per REL share. While we maintain our view with respect to the company’s intrinsic value and the stock does look attractive on a valuation basis, we still prefer other power stocks under our coverage for simple reasons like their lower execution risks and management integrity.

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