Can shareholders rely on the Ambanis?

"I am shaken. For the first time in the past 27 years I am inclined to sell Reliance shares," says Ashwin Mehta, a Mumbai-based chartered accountant and a Reliance Industries shareholder. Mehta, 45, has been a Reliance shareholder since its maiden offering in October, 1977.

He has held on to his initially-allotted shares and not let go of any opportunity to invest even when the company made rights or preferential offers.

This is not, of course, the first time the Reliance group has been in the news for the wrong reasons. From the initial bear raids on Reliance shares by a cartel of Marwari businessmen to The Indian Express group's anti-Reliance campaigns to the umpteen court cases filed against it, the Reliance share has weathered them all.

Mehta watched these events unfold with some consternation, but his confidence in the Dhirubhai Ambani flagship never wavered.

Not this time, though. In the last 10 days, even as the seven listed companies of the group lost Rs 7,717 crore (Rs 77.17 billion) in market-capitalisation, Mehta is wondering whether it is time to sell.

As he sees it, the main difference between the past crises and this one is simple: earlier, the Ambanis were fighting enemies outside. This time, the enemy may be within, with chairman Mukesh Ambani is fighting his brother Anil for control of the empire.

Mehta isn't the only one worrying about it all. With huge businesses spread across refining, petrochemicals, oil and gas exploration, power, telecom and life sciences, the Reliance group accounts for collective shareholder wealth in excess Rs 85,000 crore (Rs 850 billion).

Net sales of the seven companies listed on the bourses add up to Rs 82,270 crore (Rs 822.7 billion). But growing differences between the two Ambani brothers after the demise of group patriarch Dhirubhai Ambani in 2002 are raising questions about whether the group will stay together or split.

The differences reached a high pitch after elder brother Mukesh referred to the rift to a TV reporter, admitting that there were "ownership issues" in the group.

As newspapers and news channels latched on to the story, stock prices of all group companies have tumbled, as individual investors like Mehta and institutional investors hit the panic button.

Of the Rs 7,717-crore loss in the Reliance group's market capitalisation since November 18, two-thirds is accounted for by the fall in the share prices of flagship company Reliance Industries. RIL's share price has fallen 7.69 per cent (see table). The biggest fall was seen in Reliance Energy, a subsidiary of RIL, managed and controlled by younger brother Anil Ambani.

Reliance's key numbers
(In Rs crore)	Net Sales FY 04	Net profit FY 04	M-cap Nov 25, 04	Abs. chg.in M-cap since Nov 18	Price (Rs) Nov 18     Nov 25	Price % chg
Reliance Industries	69972.4	5160.14	70314.21	-5863.36	545.54      503.55	-7.7
Reliance Energy	3415.84	367.08	10183.61	-1471.63	628.45      549.1	-12.63
IPCL	8097.82	273.56	4366.22	-332.42	188.7        175.35	-7.07
Reliance Capital	48.14	105.79	1741.68	-33.87	138.9        136.25	-1.91
Recron Synthetics	483.79	-9.13	219.54	-9.91	9.03          8.64	-4.32
Reliance Ind Infra	43.81	17.01	110.46	-4.53	76.15        73.15	-3.94
India Polyfibres	209.8	9.3	54.65	0.93	7.48          7.61	1.74

In contrast to statements made by group chairman Mukesh Ambani referring to "ownership issues," the flurry of news reports published post-November 18 suggests that the real issue is not about ownership of the controlling interest in Reliance, but control itself.

"The real issue here is one of control and management," says a Mumbai-based lawyer. For the stock markets, this has more serious implications than merely a fight about ownership of shares.

Usually, ownership does not affect stocks because stock prices are a reflection of a company's business performance, which, in turn, depends on the quality of a company's management.

The Ambani ownership of Reliance Industries flows from a complicated structure. In all, the promoters hold 46.67 per cent in the company, of which, the Ambani brothers directly hold only 5.13 per cent.

The family-controlled Petroleum Trust holds another 7.5 per cent while the rest is held by an intricate web of hundreds of investment companies (some reports peg it at over 1,400) - 14 of which hold shares in excess of 1 per cent of Reliance's total paid-up capital.

Sister companies like Reliance Energy are part held effectively through the flagship.

The Reliance 'ownership issue'

Reliance watchers believe that a spilt between the two brothers may be inevitable. Right now, Mukesh Ambani manages the flagship by virtue of being chairman and managing director -- the same post held by his father Dhirubhai Ambani.

Anil Ambani, who is also vice-chairman and managing director of RIL, manages and controls Reliance Energy, of which he is chairman and managing director. The telecom business, Reliance Infocomm, is run by Mukesh.

The bone of contention is obviously who gets to manage and control the flagship. Reliance Industries's core business of oil refining and petrochemicals generates cash flows of roughly Rs 10,000 crore (Rs 100 billion) per annum. It is on the back of this financial muscle that the group has been able to realise its mega plans, including its successful foray into the telecom venture.

Splitting the oil company is no solution. "Neither of them (Mukesh and Anil) is stupid enough to shoot themselves in the foot by breaking the oil chain," says an analyst.

Analysts say integrated oil players get better valuations on the stock markets compared to companies which are present in only some segments of the oil chain that spans from oil exploration and production to refining and petroleum marketing.

Extended parts of the chain can reach further downstream into petrochemicals. "There are several other advantages in keeping the refining and petrochem business together - sales tax incentives and depreciation benefits - which are significant," says an analyst.

But then, if the issue of management control has to be sorted out, businesses may have to be divided in a manner acceptable to both the brothers.

"The ownership may have to be realigned in tune with the businesses they manage," says a leading investment banker. If there is to be a split, after all, what investment bankers envisage is a restructuring effort to spin off the Reliance Infocomm business, followed by a consolidation of the treasury operations and the gas business.

Speaking of synergies, the gas and power businesses go well together - the former being a feedstock for the latter, say analysts. Considering that Reliance Energy has ambitious plans to set a 3,700-mw gas-based power project, it makes eminent sense to club the power business with the gas business.

Reliance Industries currently owns 10.5 trillion cubic feet of gas reserves in the Krishna-Godavari basin and various analysts value the gas business between Rs 7,700 (Rs 77 billion) and Rs 10,000 crore (Rs 100 billion).

The stock markets, though, are worried about two fall-outs. Every split needs to be financed; assuming one brother is willing to let go of assets in favour of the other, the latter still have to finance the purchase.

The key, therefore, lies in the ability of the latter to finance the buyout of the split business. Not an easy task given the size of the businesses involved.

The second cause for worry is the possible negative effect of a prolonged dispute on the main business. If the issues are not resolved quickly, "the focus of the leadership will be divided and business will get less priority in the process. That's definitely bad for the companies," says an analyst.

Again, there could be boardroom battles on critical business decisions. Especially, with the company's gas project slated for commercial production in 2007, the management could simply lose time.

Equity analysts are - as yet - not suggesting a sell. For them, it is the business fundamentals that matter. And till last week, most broking houses were only reiterating their buy/market outperformer calls on Reliance, citing excellent business fundamentals and attractive valuations.

Leading oil analyst Sanjeev Prasad of Kotak Securities reiterated a positive view on the Reliance stock and called the initial panic selling an opportunity to accumulate the stock.

"We see the recent fall in the Reliance stock price and relative underperformance to the Sensex as an opportunity to accumulate the stock," he said.

Another equity research firm, Brics, also put out a buy call on the stock with a 12-month price target of Rs 623, though it did note that the ownership imbroglio spells uncertainty for minority shareholders.

Says Sandeep Shenoy, strategist, Pioneer Intermediaries, "Looking at the refining and petrochemical cycle, the business prospects look enticing for Reliance Industries."

Shenoy is confident that the issue will get sorted out sooner than later. "Given Reliance's size and the large institutional stakes in the company, the management will be under pressure to resolve the dispute sooner. That itself is a self-correcting mechanism," he says.

How the value of reliance adds up
	Value (In Rs million)	Rs/share	Comments
Petrochem and refining	7,06,750	506	Core business EV at 5.5x FY05 EBIDTA
Gas reserve value	77,649	64	DCF-based, with 15% premium to account for new discoveries
Reliance Infocomm debt	16,000	11	@ book value
Recron Infocomm pref equity	81,000	58	@ book value
Reliance infocomm equity	104,730	75	At par with Bharti's valuations
Reliance Energy	48,650	35	@ market price
IPCL	17,171	12	@ market price
Reliance treasury stock	86,203	62	@ market price
Total	11,38,153	823
Net debt	207,204	148
Equity value	13,45,357	675

Source: Motilal Oswal Securities

Murali Krishnan, head of research, Anand Rathi Securities, begs to differ. "Normally succession issues take a long time to get settled and the sentiment on the stock usually suffers in the meanwhile," he says.

While maintaining that Reliance's business is good fundamentally, he says, division of assets may not be the best thing.

If the flow of news continues to be bad next week, one could expect some analysts to downgrade the stock to underperformer, an equity sales officer noted. Amid this pessimism, there are investors who can look through the clutter and spot opportunities.

The ownership and management restructuring, if it does materialise, could unlock value for shareholders eventually. "If a split happens, then there is a possibility that a lot of value will get unlocked," says one of India's best performing fund managers.

According to analysts' estimates, a fair value of Reliance's share, based on a sum-of-the-parts analysis, should be around Rs 600-675. The value of other businesses - which include the gas and telecom businesses, apart from treasury and investments - is reckoned to be around Rs 250-300. If this is stripped off Reliance Industries, the company will see cash or cash equivalents flow into its coffers after a split.

Will spin-offs add value to shareholders, in that case? Some studies show that stocks of spun-off companies and those of their former parent companies significantly and consistently outperform market averages.

A study done at Penn State, covering a 25-year period ending in 1988, found that stocks of spun-off companies outperformed their industry peers and the Standard & Poor 500 by about 10 per cent per year in their first three years of independence.

The parent companies also managed to do pretty well - outperforming the companies in their industry by more than 6 per cent annual during the same three-year period.

More recently, the spin-off of the cement division from L&T has unlocked the engineering giant's value, with the stock now quoting at Rs 875 (against Rs 502 pre-split). UltraTech Cemco, the cement division that was spun off, quotes at Rs 295.

One reason why spin-offs succeed is that the management intention is to bring in more focus into the business by restructuring. Spin-offs are usually done for economically sound reasons.

"But in this (Reliance's) case, spin-offs may not be for entirely rational reasons," says a Mumbai-based broker. The benefits of spin-off in terms of greater focus and accountability may come by default, however, he adds. But that is assuming the split is done in a manner that the sum of the parts actually turns out to be great than the whole.

But as nervousness grips the market, market participants expect buying interest to evaporate if the rift continues beyond a reasonable span of time.

"Till a couple of days ago, investors were looking to buy at every slip. But as the issue becomes more controversial and with no easy solutions in sight, the markets may be wary of committing itself further," a broker said.

There's some evidence of this already happening. Reliance Energy was already considered by many analysts as an overvalued stock before the Ambani rift hit the fan.

"When the controversy broke out investors just used the opportunity to sell," says a broker. Even after the recent fall, analysts are not recommending a buy on the stock. "Reliance Energy seems to be under a cloud now as the funding of its ambitious expansion plan could be a problem now" says Shenoy.

Ashwin Mehta, whose decision to hold on to Reliance shares in the past had little to do with any equity analyst's buy or sell calls, may be listening to them more closely this time.

He would like to see an amicable solution to the rift between Mukesh and Anil if he is to repose faith in the stock once again. His gut feel is that the stock could tank further.

Earlier, he would have seen it as an opportunity to buy. But now he doesn't feel so. "I would not try to bargain hunt, unless the stock crashes to some ridiculously low level - say, half of what it is now," Mehta says.

When loyalists like Mehta speaks thus, it is time for the Ambanis to listen.

The long and short

Looking at the refining and petrochemichal cycle, the business prospects look enticing for the company. Given Reliance's size and the large institutional stakes in the company, the management will be under pressure to resolve the dispute sooner. That itself is a self-correcting mechanism. One could look to bargain hunt if the stock plunges further.
Sandeep Shenoy, Pioneer Intermediaries

Succession issues take a long time to get settled and the sentiment on the stock usually suffers in the meanwhile. Reliance's business is good fundamentally, but division of assets may not be the best thing as far as markets are concerned.
Murali Krishnan, Anand Rathi Securities

Reliance Industries looks weak on the charts. If the stock closes below Rs 500 for one-two trading sessions, one could see a further downside of 5-7 per cent since 500 is not only a psychologically important level but also the 200-day moving average.
Vijay Bhambwani, Technical analyst

We view the recent fall in Reliance stock price and relative underperformance to the Sensex as an opportunity to accumulate the stock. We do not expect the reported management 'ownership issues' to meaningfully impact the company's business fundamentals. The stock offers potential upside of 14 per cent to our sum-of-the- parts-based 12-month target price of Rs 600.
Sanjeev Prasad, Kotak Securities

We contend that ownership determines management (at Reliance) - especially given the intricate ownership structure of the Reliance group. We would be worried if the promoters of RIL can't concur on ownership of newer businesses. To that extent, a rift between the Ambani brothers would indisputably be a negative development for the minority shareholders of RIL. RIL's current stock price implies a value of Rs 129 billion (Rs 1.29 billion) for the company's Infocomm and auto-fuel retailing businesses, but we value these businesses at Rs 231 billion (Rs 2.31 billion). Our 12-month price target on RIL is Rs 623.
Methin Desai, BRICS