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RIL: Signaling entry into EPC?

Nov 20, 2001

The Reliance Industries Ltd. (RIL) scrip shot up dramatically in yesterday's trading session crossing the psychological barrier, if you will, of Rs 300. Investors took to the stock, as the management announced sale of stake in Larsen & Toubro (L&T) for Rs 306.6 per share to Grasim Industries Ltd., the A.V. Birla group major. Realisation per share was at a premium of 47% to L&T's last traded price. As on March 31, 2001, RIL and its 100% subsidiary, Reliance Industrial Investments & Holding Ltd. (RIIHL), together held 16.5 m (6.6% stake) shares of L&T. Subsequently, in the current fiscal, RIIHL holdings in L&T were transferred to RIL. Also, RIL acquired an additional estimated 8.4 m shares from the market during this period raising aggregate holding to 24.9 m shares or 10% the EPC & cement major's share capital. Therefore, the entire consideration from sale of stake is to accrue to RIL resulting in estimated capital gains of Rs 3.6 bn.

Sale of L&T stake
Shares Outstanding Nos. m 249.1
Stake sold Nos. m 24.9
Sale price/share Rs 306.6
Realisation Rs m 7,635.9
Capital gains Rs m 3,600.0
Purchase price/share Rs 162.1
Proceeds from the sale are most likely to be invested in new growth opportunities, which include oil & gas, infocom and marketing of petroleum products. The sale seems to perform two functions. One, it unlocks value in existing investments for RIL shareholders. Two, to that extent, parent company shareholders are not likely to be burdened with fresh investment calls to fund new projects. Also, the Reliance group has built up significant expertise in engineering, procurement & construction (EPC) after successfully completing large, capital intensive projects. Therefore, it may wish to commercially exploit these skill sets. The L&T stake is likely to have created conflict of interest, unless of course the Reliance group made L&T their entry vehicle in the EPC business.

On an estimated capital gains of Rs 3.6 bn the per share acquisition cost of L&T works out to an estimated Rs 162. On a consolidated basis, the capital gains could be higher considering RIIHL also registers profits from the transaction. In the past week, the L&T scrip did witness frenzied activity leading to a 20% jump in value over two days. This is likely to attract the market regulator's, SEBI, attention towards any insider activity.

The capital gains is likely to augment estimated pre-tax earnings, for FY02, by 13.2%. We had estimated RIL to register a 5% drop in bottomline for the current fiscal. However, assuming a similar effective tax rate, with the extra-ordinary income per share diluted earnings are likely to rise to Rs 27.1 in the current fiscal. The stock seems to have fully reacted to the improved prospects. We may see profit booking in the counter today.

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