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THE boards of Reliance Industries (RIL) and Reliance Petroleum (RPL) have approved the merger of the two firms, with a swap ratio of one RIL share for 16 RPL shares. The merger will be effective from April 1, 2008, while the record date is yet to be announced. Brokers said the swap ratio was positive for RPL shareholders, but somewhat disappointing to RIL shareholders.

The stock market seemed to be expecting a swap ratio between 1:16 and 1:20. The disappointment over the swap ratio showed in the behaviour of the RIL stock price, which fell 3.1% to close at Rs 1,225.15. RPL shares fared only slightly better, shedding 1.4% to close at Rs 75.15.

According to ETIG estimates, the merged entity is likely to report a cash profit of Rs 29,197 crore in FY10, compared to an estimated Rs 20,757 crore for RIL.
Under the merger terms, RIL will issue 6.92 crore new shares to RPL shareholders, resulting in a 4.4% rise in its (RIL’s) equity base to 1,643 crore shares. Global refining major Chevron, which held 5% in Reliance Petroleum, has decided to sell its stake to RIL.

Post-merger, RIL’s holding in RPL will be cancelled, and the promoter group’s holding in RIL will fall to 47% from 49%.

The merger appears to have been executed over a short time-frame, less than a fortnight. Banking sources said the investment banks and accounting firms involved in the process were contacted around 10 days ago. The decision to go ahead with the merger appears to have accelerated after US oil giant Chevron decided not to hike its 5% stake in RPL to 29%. This happened after RPL and Chevron failed to sign a productofftake agreement that had envisaged the US oil major buying 45% of RPL’s products.

“This merger follows RIL’s philosophy of creating enduring value for all shareholders,” Mukesh Ambani, chairman of both RIL and RPL, was quoted as saying in a media release, adding, “It is a significant step in our goal to be among the largest global corporations.”

RIL can now boast of the world’s largest refining capacity at a single location, with a capacity to process 1.24 million barrels per day. Company officials said RIL would have almost one-fourth of the world’s complex refining capacity, which refers to the ability to blend crude of varying quality, including those of very low quality. RIL, particularly the RPL unit, would also have the capability to supply petroleum products meeting California environmental standards, believed to be the world’s toughest. Further, it would have the capability to supply ultra-low sulphur diesel to western markets.

After the merger, RIL's capability to process many varieties of crude would increase substantially, a senior RIL official said. The merger will reduce the earnings volatility for RPL shareholders and allow them to participate in the full energy value chain of RIL, the media release by RIL said. "Operationally we see minimal benefits although conflicts of interest will be negated," brokerage firm CLSA said in a note to clients.

"Standalone net debt to equity will rise 14 percentage points to 41% but there is little change at the consolidated level (around 43%). Consolidated return ratios in FY10-11(estimated) will rise by 20-60 basis points while FY09 book value adjusted for revaluation and depreciation changes will reduce 2.3% to Rs 711/share," the CLSA report added.

Analysts said the merger will provide operational synergies, as RIL already has a refinery, independent of the one it will be getting from RPL. "It (the merger) may not help Reliance much in financial terms because RIL anyway held 71% in RPL. However, it will help in improving cash flows (of RIL)," said an analyst at a domestic brokerage firm. But the company also made it clear that the merger was about operational benefits, and not about tax benefits as projected by most analysts. "Integrated energy companies have higher valuations as against standalone refiners. The merger would unlock synergies in crude sourcing and product placement and lead to greater flexibility in operations planning," RIL chief financial officer Alok Agarwal said, adding that it would reduce operating costs. "Since the two firms (RIL and RPL) will continue to function as separate entities as far as their accounts are concerned, the two companies will have their independent tax benefits. This merger is not about tax benefits," he said.

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