IBP – IOC: Who got a better deal? - Views on News from Equitymaster

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IBP – IOC: Who got a better deal?

Dec 22, 2004

The press release from Indian Oil Corporation (IOC) reads as “Indian Oil Corporation Ltd has informed BSE that the Board of Directors of Company in their meeting held on December 22, 2004 have approved the Scheme of Amalgamation for merger of IBP Company Ltd (IBP) with the Company. The Board of Directors have also recommended a swap ratio of 125:100 i.e. 125 equity shares of Rs 10/- each of the Company ('the Transferee Company') as fully paid up for every 100 equity shares of Rs 10/- each of IBP Company Ltd ('the Transferor Company')” Before going any further, it is pertinent for investors to consider the business model of both the majors.

IBP: IBP is a standalone marketing major with a strong presence in the northern markets. Being a standalone major. It has over 2,925 retail outlets and utilizes parent IOC’s infrastructure for refined products and storage. The company also has other minor business operations, which are industrial explosives and cryogenics. IOC holds 53.58% in IBP.

IOC: IOC is the country’s largest downstream oil refining and marketing company accounting for over half the number of retail outlets along with its subsidiary IBP. Indian Oil is also the country’s largest refiner, with ownership of 10 out of the 18 refineries in the country. It imports over 33% of the crude oil imported by the country and has nearly 55% market share in the petroleum products segment. The company has 22,000 retail outlets (9.5 times of IBP). The Government of India holds 82.03% in IOC.

Who got a better deal – IOC shareholder or an IBP shareholder?
As is evident from the profile, though the administered pricing mechanism (APM) was dismantled in 2000, the fact remains is that prices at the consumer end are not market determined. At the same time, prices are completely de-regulated at the refinery gate level. Owing to the government interference, despite the sharp rise in crude prices over the last one and half years, retailing prices was not increased. This meant that IBP was buying petroleum products to be sold through its retail distribution network at international rates and selling the same products at the ‘regulated’ price. This is evident from the fact that IBP’s operating margin in 1HFY05 was a negative (1.2%) and as compared to a net profit of Rs 819 m in 1HFY04, the company incurred a loss of Rs 695 m in 1HFY05. It was very clear that unless the petroleum product pricing is de-regulated, IBP stands to lose and therefore, the merger with IOC was important from a long-term standpoint.

Investors have to consider two key aspects here:

  1. That IOC has nothing to lose without IBP, except for the fact that it holds a stake in the company. Even this stake, if one goes back in time, IOC actually placed the bid at Rs 1,551 in February 2002, which was far higher than the nearest bidder (Royal Dutch Shell, reportedly). In fact, the offer price was 80.8% premium to the then market price. So, it was the government that benefited from this ‘disinvestment‘ of IBP to IOC.

  2. Based on the current price of IBP at Rs 626 per share, IOC’s investment value in IBP is already lower by 60%!

  3. The bargaining power of IOC, considering its strong refining and marketing presence, is far larger than that of IBP.

Given this backdrop, it is clear that IBP shareholders have got a better deal i.e. they will be buying IOC at a discount, based on the current price. IOC, despite having a better bargaining power, has to pay hugely just because the government owns it.

Having said that, IBP’s strong presence in the northern markets will complement IOC’s marketing strengths and therefore, on a consolidated basis, the combined entity will benefit (but in FY05, the merger is likely to affect IOC’s profitability marginally). Investors should note that IOC also has a 74.5% stake in Bongaigaon Refineries and 52.2% stake in Chennai Petroleum (both standalone refineries). Both are likely candidates for a merger next!

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