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Nevin \n John, Businessworld<\/i><\/p>\n Nevin \n John, Businessworld<\/i><\/p>\n
New \n Delhi, 26 December 2014<\/i><\/p>\n
The Annual General meeting (AGM) of Reliance Industries (RIL) \n on 18 June 2014 was significant. RIL chairman Mukesh Ambani’s \n wife Nita was inducted to the board of the $67 billion petroleum \n giant with the overwhelming support of shareholders. She is the \n first woman from the family to join the key decision-making body.
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\n Four months later, on 11 October, RIL subsidiaries — Reliance \n Jio Infocomm and Reliance Retail Ventures — announced the \n appointment of Ambani scions, daughter Isha and son Akash, to \n their boards.
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\n The induction of family members to the boards of group companies \n comes at a time when RIL, India’s largest private company \n by revenue, is in the midst of its largest investment cycle. The \n company will pump in Rs 1.8 lakh crore into a large pet coke gasification \n plant, a petchem cracker unit, a country-wide fourth-generation \n (4G) digital network and India’s largest network of retail \n stores spanning ‘value’ and ‘speciality’ formats.
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\n Again, while the telecom and retail businesses hold promise, many \n of the group’s businesses are struggling.<\/p>\n
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The hydrocarbon exploration and production (E&P) business \n is falling apart, with no significant recovery in sight. Anomalies \n surrounding gas pricing and the fast depleting Dhirubhai-1 and \n -3 gas fields — due to geological complexities in the Krishna \n Godavari (KG) basin — are stifling the growth prospects of \n the company’s upstream business. Even the organised retail \n business is yet to come anywhere close to the projected revenue \n growth, while the broadband foray has been delayed on account \n of the extensive technical work involved in creating a pan-India \n network.
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\n That sure is a lot to handle for the Ambani family, which faces \n the tough task of rebuilding the company into a global force to \n be reckoned with.
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\n Spending Spree
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Based on RIL’s March 2014 annual report, Moody’s estimates \n that the company has invested around Rs 40,000 crore in Jio, with \n Rs 30,000 crore more to be pumped in over the next two years. \n Jio, the only private player with broadband wireless access (BWA) \n spectrum in all 22 telecom circles, is expected to provide high-speed \n broadband connectivity and rich digital services on a pan-India \n scale.
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\n In 2010, the company bought 20MHz of spectrum in the 2,300MHz \n band for Rs 12,847 crore. Three years later, in October 2013, \n it received the unified licence — against a one-time entry \n fee of about Rs 1,673 crore — for all the 22 service areas \n to offer all telecom services, including voice telephony. This \n February, adding to its broadband reach, it acquired more spectrum \n in the 1,800MHz band in 14 circles for Rs 11,054 crore.
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\n To ensure high data transmission speeds, Reliance Jio has laid \n around 100,000 km of optical fibre across the length and breadth \n of the country. In areas it doesn’t cover, the company has \n signed agreements with Bharti Airtel, Reliance Communications, \n BSNL, Tower Vision, ATC India, Viom Networks, Bharti Infratel, \n Indus Towers and GTL Infrastructure that will allow it to share \n tower infrastructure, among other things.
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According to a Credit Suisse report, the company has installed \n approximately 32,000 long-term evolution (LTE, which is a technology \n standard for high-speed wireless data networks) base stations. \n It has signed on Samsung Electronics for supplying equipment for \n 60,000 base stations and is expected to sign an agreement for \n an additional 50,000-70,000 base stations soon, says the report. \n In all, the number would be on a par with big operators such as \n Bharti Airtel, Vodafone India and Idea Cellular.
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\n Work In Progress
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Ever since broadband licences were handed out, the industry, \n Jio’s rivals, analysts and consumers have never ceased to \n speculate about the launch of services. But Mukesh refuses to \n set a deadline for his team. “Broadband is going to be a \n big stroke. He wants his team to be free from compulsions,” \n says a company executive.
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\n At the 2013 AGM, Mukesh announced that the launch of Jio’s \n services would take place in 2014. But in the latest meeting, \n he extended the date and said services would only start in 2015. \n According to him, the project would cover all states — around \n 5,000 towns and cities, accounting for over 90 per cent of urban \n India, and over 215,000 villages. The target is to cover over \n 600,000 villages. The company’s acquisition of Network 18, \n a media group, is said to be helping in the creation of content \n for its 4G services. In the midst of Jio preparing to launch its \n services, a controversy erupted recently when the Comptroller \n and Auditor General (CAG) of India reported that RIL had benefitted \n unjustly to the tune of Rs 22,842 crore in the grant of 4G licences. \n Despite repeated attempts by BW | Businessworld, RIL did not revert \n with a response to BW’s queries.
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\n The spectrum issue aside, among other things working against the \n company is the price war in the telecom space. Bharti Airtel is \n already offering high-speed 4G packs at rates lower than those \n of 3G plans, signalling a tariff war on the mobile data front. \n Anil Ambani’s Reliance Communications, on the other hand, \n has launched ‘Pro 3’, an unlimited data plan for Rs \n 999 a month, with speeds of up to 14.7 Mbps, enabling lightning-fast \n data streaming. Handsets are another pressing issue for the company. \n RIL shareholders still remember the Monsoon Hugama of 2003. Then, \n as part of Reliance Infocomm’s cellular services, the company \n gave away mobile handsets for Rs 500 along with a CDMA connection. \n The customer base skyrocketed within months of the launch. Though \n CDMA as a technology failed to catch up with GSM, Monsoon Hungama \n went down as a super success.
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\n Jio has to come up with something similar on the gadget front. \n The Credit Suisse report says smartphones below $100 could become \n a reality and prove disruptive in the market. Jio is already testing \n its services through its products at Navi Mumbai and Jamnagar. \n Also, it has written to the Department of Telecommunications for \n a network test to be conducted along with security agencies.
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\n For The Long Haul
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The other area where RIL is looking to make its mark is retail. \n It was Mukesh’s idea to enter the sector, essentially with \n the aim of expanding the company’s revenue base. But Reliance \n Retail, which opened its first store in 2006, has not contributed \n even half a per cent to RIL’s revenues in the past five years.
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\n The company has, however, emerged as the largest retailer in the \n country after the degrowth of other big names such as Big Bazaar, \n More and EasyDay. Reliance’s various speciality formats — \n Trends (apparel), Digital (consumer durables and information technology), \n Footprint (footware) and Fresh, Mart and Super (value formats), \n have achieved the leadership position in their respective segments.
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\n In its initial years, Reliance Retail had more than its fair share \n of problems from state governments and kirana traders. In excess \n of 50 licences and permits are needed to set up a store in India. \n So, setting up a pan-India supply chain and store network wasn’t \n a walk in the park. Mukesh stayed the course and his persistence \n began to pay off. The business now spans 2,000 stores, covering \n an area of 11.7 million sq. ft across 155 cities. Last year, 367 \n new stores were added — effectively one store every day!
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\n In the first half of the current financial year, the revenue from \n retail stood at Rs 8,166 crore — up 17.3 per cent from the \n same period in the previous year. The earnings before interest \n and taxes (EBIT) went up more than two times,to Rs 180 crore. \n In the last fiscal, the retail business posted revenues of Rs \n 14,496 crore and profit before depreciation, interest and taxes \n (PBDIT) of Rs 363 crore.
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\n “In the coming years, retail will emerge as a major growth \n engine for our consumer business and for Reliance by creating \n significant societal value,” said Mukesh at the AGM. Reliance \n Retail’s projection on the revenue front for 2017 is Rs 40,000-Rs \n 50,000 crore, which S.P. Tulsian, an independent analyst, says \n will be tough to achieve.
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\n Devangshu Dutta, chief executive of retail consultant Third \n Eyesight, says RIL is in retail with a long-term plan. “They \n have the cash flow to stay put in the business and experiment \n with different business models. They recently rationalised their \n stores — closing non-profitable ones and opening at other \n locations. Even the top team changed several times as part of \n the experiments.”
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\n In 2012-13, the retail business’s earnings before interest, \n taxes, depreciation and amortisation (EBITDA) turned positive \n for the first time. But Tulsian doesn’t buy it. “I am \n not very excited about it (positive EBITDA) because interest and \n depreciation are major factors in the retail business. Reliance \n has a huge interest burden. Since it is a cash-rich company, it \n doesn’t have an interest in counting the liability of the \n retail business or is not factoring in the liability,” he \n says.
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\n Arvind Singhal, chairman of Technopak Advisors, justifies the \n numbers and says the return will not be robust if retailers invest \n in size and scale. “Reliance has created solid back-end resources \n to travel the distance.”
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\n Lately, the organised retail market has not been doing too well. \n Very few Indian retailers have increased the number of stores \n in the past four years; instead, many have cut down. Future Group’s \n Big Bazaar and Aditya Birla Group’s More have shut down 30-50 \n per cent of the value format stores and are now focusing on the \n high-margin supermarket and hypermarket businesses.
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\n Since RIL is number-focused, it continued adding floor space. \n This could turn out well for the company in the near future, unlike \n the investments in some of its ‘successful’ businesses \n that are experiencing a downturn.
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\n Pain Point
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RIL entered the E&P business in line with the backward integration \n concept propounded by founder Dhirubhai Ambani. Since its very \n first extraction of oil from KG-D6, the business offered humungous \n margins to the company. But in the last two years, the production \n of natural gas has witnessed a steady decline. The revenue share \n from exploration and production fell to 1 per cent in the last \n financial year from 5 per cent in 2010, while the EBIT plunged \n to 7 per cent from 27 per cent.
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\n In the first quarterof the current financial year, the average \n production from KG-D6 stood at 13 million standard cubic metres \n a day (mscmd), against the projected production of over 80 mscmd. \n In 2010-2011, the revenue and EBIT from the E&P vertical was \n Rs 17,250 crore and Rs 6,700 crore, respectively; both fell to \n Rs 6,068 crore and Rs 1,626 crore, repectively, in 2014.
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\n An RIL press release calls E&P highly complex operations, \n having a low success rate , saying “initial interventions \n have not met expectations.” But, statistically speaking, \n RIL made profits in this business too. Of the nearly $10.5 billion \n invested on productive offshore assets, the company has already \n recovered partial costs through the sale of gas. In addition, \n it raised $7 billion by selling its 30 per cent stake in its upstream \n assets to British giant BP in 2011.
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\n While its D1 and D3 discoveries have no scope of producing gas, \n RIL has decided not to make further investments on developing \n the R-series, MJ1 and satellite fields till the government gives \n its nod to the ‘market price’ — linked to the international \n price of crude — for gas.
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\n According to the Rangarajan Committee report, while the UPA government \n had approved doubling of gas prices to $8.4 per mbtu, the Election \n Commission stalled the move during the elections, leaving it to \n the new government to decide. The NDA government, on its part, \n sanctioned a lower price of $5.6 per mbtu (up from $4.2), making \n deepwater exploration unviable.
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\n The new government also imposed an additional fine of $579 million \n on RIL for reduction in gas production, taking its total penalties \n to $2.4 billion. The company has begun arbitration proceedings \n to seek redressal.
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\n Tulsian says there is no logic to increasing gas prices since \n the contractor has recovered costs. “BP’s investment \n in these fields is a big mistake. It cannot recover the cost…. \n They (RIL and BP) are trying to link their cost recovery to gas \n prices, which is wrong.”
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\n Considering this, BP, in the last quarter, wrote down the value \n of its investment in KG-D6 by $770 million. “The charge arises \n as a result of uncertainty in the long-term gas price outlook, \n following the introduction of a new formula for Indian gas prices,” \n the company said in a statement.
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\n But RIL’s view is that it, along with its partners, spent \n $7.4 billion on developing non-KG-D6 blocks and on exploration \n work at relinquished blocks. “In case prices are to be fixed \n on the basis of cost of production, the additional cost of $7.4 \n billion will also need to be reimbursed,” the company said \n in a report titled Flame Of Truth. Besides, the interest burden \n on its investments spread over 10 years is yet to be recovered, \n says a senior company executive. V.K. Vijaykumar, investment strategist \n at Geojit BNP Paribas Financial Services, says the market’s \n short-term worry is gas production from KG-D6 and its price. “The \n revenue from shale gas is the cushion for RIL when KG-D6 underperforms. \n But shale gas will not become a substitute in the long run,” \n he says.
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\n Big Money-spinners
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RIL’s last major asset creation happened five and a half \n years ago when it developed India’s largest offshore hydrocarbon \n block, KG-D6, along the Andhra coast, and commenced production \n in September 2008. Three months later, it completed the construction \n of the second refinery at Jamnagar in Gujarat.
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\n The only noticeable asset addition after that was the acquisition \n of stakes in shale gas blocks in the US. In 2010, RIL invested \n in shale gas, when there was no clarity about its prospects. Today, \n RIL has three joint ventures — with Chevron, Pioneer and \n Carrizo —and has made a cumulative investment of $7.7 billion \n (as on 31 September 2014). The JVs have witnessed strong growth \n in production, driven by good additions and strong productivity \n over the years. RIL’s revenues and profits from shale gas \n have overtaken its domestic E&P business. In the first half \n of the current financial year, RIL’s revenues from shale \n gas stood at Rs 3,236 crore, reflecting a year-on-year growth \n of 43.6 per cent, and EBIT was at Rs 1,047 crore, up 44.8 per \n cent. The EBIT margin was at 32.4per cent.
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\n So, from the financial point of view, RIL’s refineries and \n the petrochemical complex continue to be its financial backbone. \n The twin refineries with an aggregate capacity of 1.24 million \n barrels of oil per day (mbpd) generated a revenue of Rs 4,02,149 \n crore, which is 78 per cent of the total revenue, in the last \n financial year. The EBIT from the business was Rs 13,392 crore, \n about 55 per cent of the total. While refineries contributed over \n 70 per cent to RIL’s revenues in each of the past five financial \n years, the petrochemicals business stood second with over 20 per \n cent. But the contribution to the EBIT was much higher for the \n petrochemicals business — at 36 per cent last year. The business \n generated Rs 69,539 crore in revenues and an EBIT of Rs 8,403 \n crore in 2013-14.
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\n In the first half of the current financial year, when the company \n recorded Rs 2,21,301 crore in revenues and Rs 22,895 crore in \n profit before depreciation, interest and tax, the revenues and \n EBIT from the refineries were at Rs 2,01,671 crore and Rs 7,658 \n crore, respectively. The average gross refining margin for the \n second quarter rose to $8.3 per barrel from $7.7 a year earlier. \n The revenues and EBIT from petrochemicals in the first half were \n at Rs 52,049 crore and Rs 4,224 crore, respectively. The petrochemicals \n division has registered an 8.1 per cent EBIT margin.
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\n Debt For A Reason
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RIL was debt-free on a net cash basis until a year ago as cash \n reserves were higher than the consolidated debt. But the extensive \n borrowings for telecom and petrochemical capacity expansion have \n tested its balance sheet. On 30 September 2014, RIL had a consolidated \n debt of Rs 1,42,084 crore. Discounting the cash hoard of Rs 83,456 \n crore on its books, the net debt stood at Rs 58,628 crore.
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\n The analysts, however, support the massive capital investments \n by the company. Mukesh’s foray into broadband and the telecom \n sector at large will ensure effective deployment of its consistent \n cash flow from the traditional businesses, they opine. Deven Choksey, \n managing director of K.R. Choksey Securities, says RIL’s \n cash flow of around Rs 40,000 crore has forced it to invest in \n capital-intensive sectors. “Which means, the cash flow of \n three financial years and the existing cash reserve are enough \n for the company to fulfil the next three years’ investment \n commitment of Rs 1.8 lakh crore,” says Choksey.
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\n In the past four years (3 January 2011 to 19 December 2014), RIL’s \n scrip has dipped 14.69 per cent, while the BSE Sensex gained 33.12 \n per cent in the same period. In 2014 (till 19 December), its share \n price staged a modest recovery, gaining 1.28 per cent, to touch \n Rs 900, even as the BSE Sensex rose 29.48 per cent.
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\n According to Mukesh, the company is at an inflection point in \n its journey to create value for its stakeholders. “In the \n next two years, we will go up in debt to about Rs 60,000 crore. \n Our goal is to become debt-free by 2017-18 on a much larger base,” \n he said. It appears he is risking the short term for the long \n term.<\/p>\n