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Raghuvir Srinivasan

IT is a behemoth that was long in the making. Given the evolutionary history of the Reliance group, the proposed merger of Reliance Petroleum with Reliance Industries will not surprise company watchers.

Reliance Industries as we know it today is an amalgam of the erstwhile Reliance Textiles Ltd, Reliance Petrochemicals Ltd, Reliance Polyethylene Ltd and Reliance Polypropylene Ltd. Each of these companies was separately floated, accessed the capital markets independently and later merged with the parent company.

Given this, a merger of Reliance Petroleum with Reliance Industries was always on the anvil. The only surprising element is the timing. Why now?

First the facts. The merger will create a company that is truly big by Indian standards. It will have a turnover exceeding Rs 60,000 crore ($12 billion), net profit of about Rs 5,000 crore ($1 billion), gross assets of more than Rs 40,000 crore ($8 billion) and finally, market capitalisation of a whopping Rs 48,821 crore (about $10 billion).

But it would still not rank as the largest company in India in turnover and earnings terms. That honour would go to Indian Oil Corporation (IOC) and Oil and Natural Gas Corporation (ONGC). IOC could end this fiscal with a turnover exceeding Rs 1,25,000 crore ($25 billion), roughly double the merged entity's size.

Similarly, ONGC may end the fiscal with earnings in excess of Rs 6,000 crore ($1.2 billion), a little higher than the merged entity.

Synergies from the merger

From a business angle, the merger certainly offers immense synergies. Reliance Petroleum's Jamnagar refinery supplies a critical raw material, naphtha, to Reliance Industries for the cracker unit at its Hazira complex. This quantity is estimated to be around 2.5 million tonnes per annum. Besides this, the Jamnagar refinery also supplies another 1.5 million tonnes per annum of aromatic naphtha for the paraxylene/PTA plants in the Jamnagar complex.

In addition to this, the refinery also supplies about 1.8 million tonnes per annum of C3 (a refinery output) stream for extraction of propylene, which is used for the production of polypropylene at the Jamnagar complex of Reliance Industries. With the merger, all these transactions would turn into inter-divisional transfers from inter-company transfers as they are now.

Possible benefits from the merger

The merged company will save on sales tax on supply of naphtha and C3 by the refinery, which will be treated as inter-divisonal transfer. Now, Reliance Petroleum enjoys a sales tax waiver for a period of seven years from the date of commencement of production.

As of now, this waiver is being used for the sales of naphtha and C4 to its sister company Reliance Industries. On petroleum products marketed through Indian Oil Corporation the sales tax liability falls on IOC and not on Reliance Petroleum.

However, in the post-APM scenario, Reliance Petroleum would become liable for sales tax on products sold in the open market. Now, that would account for a major part of the sales tax credit and in association with the inter-company sale of naphtha and C3, it may liquidate the total sales tax credit rather quickly.

By merging Reliance Petroleum with Reliance Industries, the sales tax on inter-company sales can now be avoided. This would release extra credit, which can be used for setting off the liability on petro product sales in the open market from April 1 thus extending the period of concession for a longer time.

There is another important benefit as well. Reliance Petroleum will bring with it additional tax shield in the form of depreciation. It accounted for an amount of Rs 660.75 crore as depreciation in 2000-01 and in the first nine months of this fiscal it has provided for an amount of Rs 608 crore as depreciation.

This will be a valuable tax shield for the merged entity especially because polymer prices are projected to start rising from the end of 2002 and Reliance Industries could, consequently, be entering a period of high profit-growth. With Reliance Petroleum's margins under pressure from the low oil prices, the depreciation cover that it generates could be transferred to Reliance Industries for better use. With Reliance Industries no longer in the investment mode, it could certainly do with some additional depreciation support.

The merged entity will present a strong balance sheet, which can be leveraged to raise fresh funds, which the group may need for its telecom foray now. That will be an additional benefit stemming from the merger. Thus, both from a technical and commercial perspective, the merger makes eminent sense. The commercial reasons may probably explain the timing of the merger. The focus of the market would be on the share exchange ratio. Going by current market prices, a ratio of 10 shares of Reliance Petroleum for every share in Reliance Industries appears to be the possibility.

But given the fact that Reliance Industries is the largest shareholder in Reliance Petroleum, the ratio may be more in the region of six to eight shares of Reliance Petroleum for every share of Reliance Industries.

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