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Old Strategy, New Synergy

With the merger of RIL & RPL, the seeds of a future giant in oil & natural gas have been sown

On Monday, March 2, 2009, Reliance Industries, the most valuable company in India (by market cap) decided to absorb Reliance Petroleum through share swap ratio. RIL would issue one share for every 16 held in RPL. This would give RIL direct control over the world's largest refinery complex. In the past also Reliance has used this strategy by launching new companies to build large projects and then folding them back in when the projects begin operation.

In the intraday RIL dropped over 4 per cent as according to some analyst the swap ratio allowed edge to the RPL shareholders and RIL shareholders has got a raw deal. But this would depend on whom you're asking, according to BRICS swap ratio should have been 21:1 based on its intrinsic value ratio. According to book value, the ratio should have been 14.8:1 and by market capitalization it would be 16.6:1. So, for the time being it would look like the RPL shareholder's are rejoicing at the expense of the RIL shareholders, but the long-run upside for the RIL cannot be denied.

In the long run this synergy makes is heavily tilted for the RIL. Among the immediate benefits the merger would enable RIL to save on the dividend distribution tax that RPL would have to pay when it declares dividend had it maintained the separate identity.

There are other benefits, but that would take some time to clear-up, like the SEZ benefit of RPL, would entitle RIL to seek depreciation tax shield.

The new refinery of RPL is expected to bring in additional revenues of Rs 100,000 crore and net profit of Rs 8,500 crore annually, which is over half of the RIL's net profit for the 12 months ended December 2008. Moreover the cost-optimisation and boost in free-cash flow is further going to add to the financial muscle of the Reliance Industries.