CLSA: Reliance-RPET merger analysis: 54-135bps increase in neutral weights; reiterate BUY

The impending Reliance/RPET merger comes along expected lines but earlier than we anticipated. In our base case (1:17 swap ratio, Reliance’s holding in RPET cancelled), the merger is marginally accretive for EPS (0.7-1.6%) and valuations (+0.6%) although minority shareholders in Reliance will get diluted by 4%. Standalone net gearing will rise but there is little change at the consol level, return ratios rise by 20-60bps. Operationally we see minimal benefits although conflicts of interest will be negated. Institutional under-ownership will get exacerbated with neutral weights in key indices rising by 54-135bps. Fundamentally, we continue to view valuations (12.8x Mar09 PE) as attractive given its 25% FY09-11CL EPS Cagr. Reliance and RPET to merge; Chevron to sell out of RPET

The boards of Reliance and RPET will meet on 2nd March to consider a merger. We viewed such an eventuality as very likely given the impending free cashflow in RPET. Operationally we see minimal synergy benefits but it does nullify conflicts of interest (especially in crude sourcing and product placement), makes it easier to fund RPET’s fund ramp-up working capital and also creates a more balanced overall refinery slate. Conversely it also increases the share of refining in overall consol EPS by 3-4ppt. We expect shareholder approval by April-09 and the merger to be consummated by Sept- 09. Chevron will sell its 5% stake in RPET to Reliance prior to transaction close.

Key decisions: swap ratio and whether more treasury shares are created The exact impact will depend on the swap ratio and whether Reliance’s 75.38% holding in RPET is cancelled or carried through as additional treasury stock. We view a cancellation as likely; keeping more treasury stock only increases overall promoter holding by ~3ppt, makes negligible impact on voting rights and results in large dilution for minority shareholders and reported EPS. The swap ratio (to be announced premarket on 2nd March) will also likely converge around current market prices (1:16.6).

4% dilution for minority, +0.7-1.6% impact on EPS, +0.6% on SOTP In our base case (1:17 merger ratio, Reliance’s holding in RPET cancelled), overall shares will rise by 4.1% to 1,639m. Promoter holding (including non-voting treasury shares) will reduce 1.9ppt to 53% while control over voting shares will also reduce by 1.9ppt to 50.2%. Minority shareholders in Reliance will get diluted by 4% but the merger is positive for EPS (0.7-1.6% accretive) and fair value (+0.6%). Standalone net debt to equity will rise 14ppt to 41% but there is little change at the consolidated level (~43%). Consol return ratios in FY10-11CL will rise by 20-60bps while FY09 book value adjusted for revaluation and depreciation changes will reduce 1.9% to Rs713/sh.

54-135bps increase in neutral weights; reiterate BUY
Reliance is under-owned by institutional investors; this will get exacerbated with its neutral weights in key indices rising by 54-135bps. Fundamentally, we continue to view valuations (12.8x Mar09 PE) as attractive given its 25% FY09-11CL EPS Cagr. BUY.