The Rs 50,000 crore all-stock merger deal between Reliance Natural Resources (RNRL) and Reliance Power (RPL) is being seen as insignificant from the value-creation perspective for the latter. In fact, analysts believe the deal has been done out of necessity and is earnings dilutive for RPL share holders. Most analysts continue to maintain the sell rating on the stock as it seems to be overvalued at current levels, considering major power capacity additions may contribute to the company’s earnings only from 2014.
The boards of RPL and RNRL had on Sunday approved the merger of the two companies, with a share swap ratio of 1:4 (1 equity share of RPL for every 4 shares of RNRL). Post the deal, the RPL stock surged 8.36% on Monday morning before closing the day at Rs 181.40, still up 3.57% over Friday’s close.
RNRL, which was created as an intermediary to source gas from Reliance Industries (RIL) at a cheaper rate and supply to RPL, had been left with no business model after the revised gas supply master agreement (GSMA) with RIL provides for gas supply at higher rate of $4.2/ mmBtu. Also, the government has indicated that gas supply will be made to end users first rather than to traders.
The RPL management believes the deal will facilitate faster implementation of its 8000mw gas-based power projects as RNRL had recently signed the revised GSMA with RIL. Also, RPL will get access to RNRL’s four coal bed methane (CBM) blocks that can support 2000 mw of distributed power generation capacity, and its logistics business for captive transportation purposes.
However, analysts believe RPL would have anyway got the gas supply and this was already factored in the stock price of RPL.
Terming the deal as more a merger of necessity than of value creation, Jeff Evans of Macquarie Equities Research, in a report dated June 05, said, “The only real fundamental value that RNRL could bring to RPL shareholders is the undeveloped gas assets. Again, it seems that RPL has paid an enterprise value of around $1.4 billion for this more speculative upside.”
“RPL has spent only ~5% of the potential capex required to roll out its growth pipeline and financial closure has been achieved for only 17% of its projects. We believe there is still a long way to go regarding execution,” he added.
JP Morgan India analysts Shilpa Krishnan, Sumit Kishore and Deepika Belani said the move appears earnings dilutive for RPL. “RNRL’s share in CBM blocks and proposed coal supply logistics and shipping business plans is still nascent and will not contribute materially to earnings of the merged entity in the medium term,” they said.
RPL, which is implementing several power projects with a combined capacity of over 35000 mw has very little operational capacity at the moment. Its operational projects include Rosa I (600 mw) apart from three other gas-based projects - Kochi (165 mw), Goa(48 mw) and Samalkot (220 mw). Majority of the capacities would start coming into effect from FY14 onwards.
Goldman Sachs India analysts Durga Dath and Uma M Yanamandra believe the merger may make gas supply costlier for RPL. “With implied marketing margins under GSMA to RPL being 3x the margins charged by RIL to other gas consumers, we believe the high cost will negatively impact the internal rate of return of RPL’s gas-based projects,” they said.
For last fiscal, RPL reported consolidated revenues of Rs 20.72 crore and a net profit of Rs 683.9 crore. RNRL had revenues of Rs 298.4 crore and a net profit of Rs 90.80 crore. Considering the combined entity financials post merger, RPL would be trading at over 64 times its FY10 EPS of Rs 2.80.
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