Final Report

Merger acquisition and Corporate Restructuring

Merger of Reliance Natural Resource Ltd. and Reliance Power Ltd.

Submitted by

Group 1- Section C2DE

Neeraj Jain (2010130)

Pawan Janiani (2010146)

Priyank Jain (2010167)

Rishabh Maheshwari (2010179)

Ravi Mittal (2010176)

Introduction

Reliance Anil Dhirubhai Ambani Group (R-ADAG) company Reliance Natural Resources Ltd. (RNRL) will merge with Reliance Power (RPower), another group firm, in a 4-for-1 share swap deal. After the merger, shareholder of RNRL will get one share of RPower for every four shares of RNRL held on the record date, the R-ADAG announced on Sunday after the board meetings.

As of Friday's close of trading, RNRL was valued at nearly Rs 10,400 crore, while RPower's market capitalization was almost Rs 42,000 crore, so jointly the combined market capitalization is worth over Rs 50,000 crore. A statement from the R-ADA group said that the valuations were done by consulting major KPMG. The merger is subject to approvals from the shareholders of the two companies and also other regulatory nods. The completion of the merger could take about six months.

RNRL

Reliance Natural Resources Ltd is a part of the Reliance Anil Dhirubhai Ambani Group. The company is engaged in sourcing, supply and transportation of gas, coal and liquid fuels. They also engaged in exploration, production and distribution of gas. They have four blocks, over acreage of 3,251 square kilometers for the exploration and production of CBM. They also have a block in the state of Mizoram under the NELP- VI for the exploration and production of oil and gas. The company is also engaged in the supply of coal to the power plants. 

Reliance Natural Resources Ltd was originally incorporated on March 24, 2000 as a private limited company with the name Reliance Platforms Communication.com Pvt Ltd. In January 3, 2003, the name of the company was changed to Reliance Energy Pvt Ltd and they further changed their name to Reliance Wattage Pvt Ltd on January 16, 2003. In the year 2005, Reliance Patalganga Power Ltd became a wholly owned subsidiary of the company. 

In July 25, 2005, the company was converted into public limited company and the name was changed to Reliance Wattage Ltd. In August 3, 2005, the company changed their name to Reliance Fuel Management Ltd and in August 10, 2005, they further changed their name to Global Fuel Management Services Ltd.  

In August 2005, the company became a wholly owned subsidiary of Reliance Industries Ltd. As per the scheme of arrangement, all the properties, investments, assets and liabilities relatable to 'Gas based Energy undertaking' of Reliance Industries Ltd was transferred and vested in the company on a going concern basis with effect from December 21, 2005. 

In January 9, 2006, the company changed their name from Global Fuel Management Services Ltd to Reliance Natural Resources Ltd. In February 7, 2006, the Reliance Anil Dhirubhai Ambani Group acquired the management and control of the company pursuant to the scheme of arrangement and became the promoters of the company.  

The equity shares of the company were listed on Bombay Stock Exchange Ltd and the National Stock Exchange of India Ltd with effect from March 1, 2006. During the year period 2006-07, the company disposed of their majority stake in Reliance Patalganga Power Ltd and therefore Reliance Patalganga Power Ltd ceased to be a subsidiary of the company.  

In June 30, 2006, the company led consortium submitted bids for 10 Coal Bed Methane (CBM) blocks offered by GOI. In October 5, 2006, they received letters of award for 4 CBM blocks from MoP & NG. In November 7, 2006, the company signed contracts for all four blocks with the GOI for exploration and production of the CBM blocks. In March 2, 2007, they signed the contract with the GOI for exploration & production of Oil & Gas block having acreage of 3,619 Sq. Km.  

During the year 2007-08, the company purchased 100% shareholding in Reliance Fuel Resources Ltd and consequently, Reliance Fuel Resources Ltd became a subsidiary of the company.  During the year 2008-09, Reliance Natural Resources (Singapore) Pte Ltd became a wholly owned subsidiary of the company. Also, Reliance Cementation Pvt Ltd, and their subsidiaries Reliance Cement and Infra Pvt Ltd, Reliance Cement Works Pvt Ltd, Reliance Cement Corporation Pvt Ltd became wholly owned subsidiaries of the company. In March 2009, Reliance Cement Resources Pvt Ltd. (formerly known as AAA Traders Pvt Ltd) became a wholly owned subsidiary of Reliance Cementation Pvt Ltd. 

In September 2008, the company secured four limestone mining licences in Satna in Madhya Pradesh. During the year 2009-10, the company sold 100% shareholding in Reliance Cementation Pvt Ltd to Reliance Infrastructure Ltd. In June 2009, PT Somuka Coal Services have become a step down subsidiary of the Company. 

In May 2010, the ADAG group signed an Non-Compete Pact Agreement with Reliance Industries Ltd canceling all existing non-compete arrangements entered between two groups in January 2006 pursuant to the scheme of reorganization of the Reliance Group and entered into a new simpler, Non Compete Agreement with respect to Gas Based Power Generation. In June 25, 2010, the company and Reliance Industries Limited signed a Gas Supply Master Agreement and the said Gas Supply Master Agreement is compliant with the Gas Utilization Policy and EGOM decisions.  Reliance Power Ltd.

Reliance Power Ltd is part of the Reliance Anil Dhirubhai Ambani Group, one of India's largest business houses. The company is engaged in the development, construction and operation of power generation projects with a combined planned capacity of 35,000 megawatts. Their projects are diverse in geographic location, fuel source and offtake. 

Reliance Power Ltd was incorporated on January 17, 1995 as a private limited company with the name of Bawana Power Pvt Ltd. In February 1, 1995, the name of the company was changed from Bawana Power Pvt Ltd to Reliance Delhi Power Pvt Ltd. During the year 2003-04, the company started 3740 MW Natural Gas based Combined Cycle Power Plant at Dadri. 

In February 17, 2004, the name of the company was changed from Reliance Delhi Power Pvt Ltd to Reliance EGen Pvt Ltd and in March 10 2004, the name of the company was further changed to Reliance Energy Generation Pvt Ltd. In March 19, 2004, the company was converted into a public limited company and the name was changed to Reliance Energy Generation Ltd. 

During the year 2006-07, the company signed a joint communique with Govt of Orissa to set up a 12000 MW coal based pit head power project at Hirma in Dist Jharsuguda in Orissa. In November 2006, the company acquired 100% shareholding in Rosa Power Supply Company Ltd, which is implementing the 1,200 MW coal based power plant in Uttar Pradesh. Thus, Rosa Power Supply Company became a wholly owned subsidiary company.  

During the year 2007-08, Sasan Power Ltd, Maharashtra Energy Generation Ltd, Vidarbha Industries Power Ltd, Tato Hydro Power Private Ltd, Siyom Hydro Power Private Ltd, MP Power Generation Pvt Ltd, Urthing Sobla Hydro Power Pvt Ltd, Kalai Power Pvt Ltd, Coastal Andhra Power Ltd and Reliance Coal Resources Pvt Ltd became the subsidiaries of the company. 

During the year, as per the scheme of amalgamation, the assets and liabilities of the erstwhile Reliance Public Utility Private Limited (RPUPL), were transferred to and vested in the Company with effect from September 29, 2007. In July 2007, the name of the company was changed from Reliance Energy Generation Ltd to Reliance Power Ltd. 

During the year 2008-09, the company entered into an MoA with Government of Arunachal Pradesh for execution of four hydro power projects of 1,200 MW Kalai II on Lohit River Basin, 420 MW Amulin, 500 MW Emini and 400 MW Mithundon on river Dibang in the state of Arunachal Pradesh. 

During the year, Reliance Power International Sarl, a Perpetual, Limited Liability Company became a subsidiary company with effect from October 30, 2008. In March 2009, Sasan Power Infrastructure Ltd and Sasan Power Infraventures Pvt Ltd became the subsidiaries of the company.   During the year 2009-10, the company incorporated Amulin Hydro Power Pvt Ltd, Emini Hydro

Power Pvt Ltd and Mihundon Hydro Power Pvt Ltd as wholly owned subsidiaries of the company. In August 7, 2009, the entire investment of Power Finance Corporation Ltd in Jharkhand Integrated Power Ltd was transferred to the company for a consideration of Rs 6988 lakh. Thus Jharkhand Integrated Power Ltd became the wholly owned subsidiary of the company. 

Rosa Power Supply Company Ltd, a wholly owned subsidiary, commissioned their first unit of 300 MW with effect from March 12, 2010. In June 2010, Reliance Patalganga Power Ltd, Bharuch Power Ltd, Ballerina Advisory Services Private Ltd and Reliance Futura Ltd became wholly owned subsidiaries of the company. In addition, the company disposed of their majority shareholding in Sasan Power Infrastructure Ltd and Sasan Power Infraventures Pvt Ltd. In May 2010, the company acquired three power plants with a total capacity of 433 megawatts from Reliance Infrastructure Ltd at a transfer value of Rs 10.95 billion. 

Rationale for the mergerThe main reason behind the merger was the recent government policy. RNRL was created five years ago to buy natural gas from RIL at a subsidized rate and transmit it to R-Power but Supreme Court decision on May 7th 2010 over the RNRL-RIL case highlighted that only actual users of gas, such as power and fertilizer companies, are entitled to the gas.

Supreme Court also asserted that government has ultimate control of how gas supply in India is allocated. RNRL itself has no power projects of its own—it’s essentially trading the gas—against the government’s desire to allocate gas to end-users and not traders.

For ADAG, it was essential to merge RNRL with RPL because now RNRL have no role in getting gas available for RPL and if left on its own, RNRL was a redundant entity without any assets. Without the merger, RNRL’s share value would have eroded rapidly.

The merger is expected to accelerate R-Power’s plans for setting up an 8,000 mw gas-firedpower unit. Post merger, R-Power will have ownership of RNRL’s share in four coal-bed methane blocks and an oil and gas block in Mizoram. RNRL’s proposed shipping venture will also come in handy for R-Power because it will be able to use the vessels for captive usage. On the other hand, RNRL shareholders will benefit from R-Power’s generation portfolio of 37,000 mw and its coal reserves in India and abroad.

RNRL was formed to supply gas from RIL’s KG basin to the ADAG companies. The company has no power projects of its own, so it has to resell the gas purchased from RIL to R-Power. This comes under gas trading.

Merger of R-Power and RNRL will ensure that RNRL ceases to exist and R-Power gets the gas directly from RIL. The gas supply will be ensured for R-Power as RIL and RNRL had signed a new gas supply agreement to comply with the Supreme Court ruling in May 2010.

The merger was the only way out for ADAG to allocate gas to Reliance Power as the government's gas-utilization policy does not give priority to a gas-trading company like RNRL but to only actual gas users like power and fertilizer companies. This was again affirmed by the Supreme Court of India in May this year stating that the government has the right and power to set up the price and users for gas. This supposedly left no or little opportunity for RNRL which was set up five years before with the only purpose of procuring gas for Reliance Power.

Objectives behind merger

The Reliance ADAG said the merger would accelerate the implementation of Reliance Power's plans for creating more than 8,000 MW of gas-based power generation capacity. The gas would be supplied under the RNRL's Gas Supply Master Agreements with Reliance Industries Ltd (RIL).

Reliance Power would also benefit from the prospects for gas from the RNRL's Coal Bed Methane (CBM) blocks, comprising 45 per cent interest in four blocks with an acreage of 3,251 sq. km. and an estimated resources of 193 billion cubic metres; and a 10 per cent share in an oil and gas block in Mizoram, with an acreage of 3,619 sq. km. and a reserve potential of up to 28 billion cubic meters.

It also envisages reliability and cost efficiency for fuel supplies through the RNRL's coal supply logistics and shipping business; contribution from the RNRL's net worth of Rs.1,900 crore, leading to an increase in Reliance Power's net worth to more than Rs.16,000 crore; and a significant further enhancement of the Reliance Power's overall growth prospects.

The Reliance ADAG also believes that the RNRL's shareholders will benefit from the amalgamation by taking part in future growth prospects of Reliance Power's diversified generation portfolio of 37,000 MW, and its substantial coal reserves in India and abroad.

Accounting treatment

Method of Accounting: ‘Purchase Method’

Reliance power after the issue of shares to the shareholders of RNRL will recognize the difference being excess of assets over liabilities as general reserve instead of capital reserve.

If there being a shortfall in assets the difference will be treated as goodwill.

If case of differences in accounting policies between RNRL and Reliance Power, the impact of the same till the appointed date will be quantified and adjusted against general reserve of reliance power.

The exploration SPVs shall instead of issuing any shares against the block transfer or paying any consideration to reliance power or its shareholders, record the amount equal to the fair value of the exploration undertakings as general reserve.

As regards RNRL is concerned upon the scheme becoming effective the original share capital of RNRL will be cancelled. But, upon the sanction of the scheme but before the appointed date reliance power shall place a deposit of rs.5 lacs which will be converted into equity.

The amount arising on cancellation of issued and paid up share capital shall be credited by RNRL as capital reserve. The goodwill in the books of RNRL shall be adjusted by RNRL against such capital reserve account; Securities Premium account and balance in p/l account in that order to the extent such balances are available.

The reduction of original share capital and securities premium account of rnrl shall be affected as an integral part of the scheme without having followed the process under section 78 read with sections 100 and 103 of the companies act, 1956 separately.

Pricing and ValuationKPMG India was the independent third party valuation firm which has set an exchange ratio in the proposed merger $11 billion of Reliance Anil Dhirubhai Ambani Group (Reliance ADAG)’ s group company Reliance Natural Resources Limited (RNRL) with another group company Reliance Power Limited (Reliance Power)in an all-stock deal.

The Boards of Directors of both companies recently announced that they had approved an exchange ratio of 1 equity share of Reliance Power for every 4 shares of RNRL, based on the valuation made by audit firm KPMG. The merger is expected to happen in 90 days.

The merger would accelerate the implementation of Reliance Power's plans for creating more than 8,000 MW of gas-based power generation capacity. Reliance Power would also benefit from the prospects for gas from the RNRL's Coal Bed Methane (CBM) blocks; as well as reliability and cost efficiency for fuel supplies through the RNRL's coal supply logistics and shipping business.

RNRL's shareholders will benefit by participating in future growth prospects of Reliance Power's diversified generation portfolio of 37,000 MW, and its substantial coal reserves in India and abroad.

But KPMG’s valuation, though acknowledged as independent and unbiased, is not without multiple opinions across the capital markets spectrum. Even in an interview with CNBC TV-18’s Moneycontrol.com, JP Chalasani, the CEO of Reliance Power did not provide any more detail on the deal and ratio details, but did raise the question about varied market perceptions.

The valuation is done on weighted average of DCF, CBM and book value, but purely as an RNRL shareholder, an RNRL shareholder would have bought the stock thinking that the company will get gas at a particular price of course that didn’t take place.

Factoring in acquisition of RNRL

Reliance Power (RPower) completed its merger with RNRL in an all-stock deal. RPower issued 408.3m shares with a face value of INR10, in exchange for 1,633.1m shares of RNRL, with a face value of INR5. This results in an equity dilution of 17%. Our estimates now reflect the consolidated financials of RNRL and RPower. Table 1 provides a snapshot of RNRL’s assets comprising stakes in four coal bed methane (CBM) blocks and one oil and gas block. We value RNRL’s assets at INR9.10/share.

Table 1: RNRL Valuation

Valuation

We increase our TP slightly for RPower from INR140.00 to INR142.00. Our TP is based on a DCF valuation of 20GW of power-generation projects, external sales from its mines in Sumatra and RNRL assets. We estimate project free cash flows for the next 15 years and discount it with the applicable WACC. We add up the discounted free cash flows of each project to arrive at free cash flows to the firm. We assume a terminal growth rate of 3%. For our WACC calculation we assume a cost of equity of 14% and a cost of debt of 9.5%. We are also building in an equity dilution of about 11% over and above the 17% equity dilution resulting from the RNRL-RPower merger.

Table 2: Schedule of power generation capacity considered for valuation

Table 3: Peer Value Comparison

The pro forma figures for the valuation

Reliance Power Ltd.  RNRL

Market Price 174.31 44.35No. of equity shares 239.68 Cr

163.71 Cr

Debt Nil 1521.6EPS 1.14 0.44P/E 152.9 100.8

Growth potential as high as 28.47% for the three years spanning from 2011 till 2013, and 17.99% for the second stage which spans for the next three years till 2016 and a constant growth rate, which is the growth rate of the economy, for the rest of the years, has been forecasted for the parent company based on the projects lined for them and with the below mentioned resources and reserves:

Has a portfolio of almost 35,000 Mw of power generation capacity; Has over 1,000 Mw of operational power generation assets; and Has a coal reserve of over 2 billion tones in India.

For RNRL the growth potential is seen as high at 33.86% for the first stage which decreases to 17.18% growth for the next three years and then at a constant growth rate, which is that of the economy growth rate, for the rest of the years. The rationale behind the growth assumptions include:

The presence of four coal bed methane blocks with an acreage of about 3,251 sq km; and Holds oil and gas block in Mizoram awarded under Nelp-VI with an acer age of 3,619 sq. Kms.

The parties estimate that the new group will harness the potentials of the earlier gas supply company to the best possible extent and add value to the group as a whole. New group’s synergy would lead to an increase in the EPS by 11.1% from 1.140to 1.267; The study has been done post announcement of the merger with the reference date taken as 13th July 2010 and the corresponding market price as Rs.44.35 for RNRL and Rs.174.31 for R-POWER.

Valuation methodologies Discounted Cash Flow Analysis (3 stage growth model);

Conn and Nielson model; and

Market price approach.

Discounted Cash Flow Analysis

Determination of the discount rate and the perpetual growth rate

The rate used to discount cash flows (WACC) corresponds to the return required by investors for alternative investments having the same risk profile. Consistent with standard valuation practice, this rate was calculated by applying the Capital Asset Pricing Model (CAPM) which is expressed in the following formula:

Where

Ke = Cost of Equity; 9.80% for RNRL and 7.33% for R-POWER calculated using CAPM.

Kd = Cost of Debt;

D, E = Debt and the Equity of the firm;

T = Tax rate; Taken as 20% for both the companies;

Rf = Rate of return for risk free investments. For the current valuation, taking the reference time horizon into account, a risk free rate of 5.62% as on 13th July, 2010 was assumed;

Rm-Rf = Risk premium required by the market set at 5.5%, considered conservative and in line with current valuation practice; and

β = Correlation coefficient between the effective return on an individual share and the total return for the reference market; this measures the volatility of a share compared to the market portfolio.

On the basis of these assumptions, the discount rate WACC used for both RNRL and R-POWER as 9.13% and 7.32% respectively.

The nominal growth rate “g”, used to calculate the Terminal Value, was assumed to be 5% for both of the companies involved in the Merger.

Results

RNRL Reliance Power Ltd.

Sensitivity Analysis Sensitivity Analysis

Optimal value range optimal value range

Share swap ratio

Conn and Nielson Model

Whenever a firm „A‟ acquires another firm „B‟, the compensation to the shareholders of the acquired firm is usually paid in the form of shares of the acquiring firm. In other words, shares of firm A will be given in exchange for shares of firm B. Thus, the exchange ratio is a very important factor in any kind of merger. Firm A will want to keep this ratio as low as possible, while firm B will want it to be as high as possible. In any case, both firms would ensure that post merger, their equivalent price per share will at least equal their pre-merger price per share. Given below is the model developed by Conn and Nielson for determining the exchange ratio. The symbols used in this model are: -

ER = Exchange ratio

P = Price per share

EPS = Earnings per share

PE = Price earning multiple

E = Earnings

S =No of outstanding equity shares

AER = Actual exchange ratio

For firm A

For firm B

Results

Synergy result

The synergy yielded a PE of 137.62 for the combined firm i.e. an EPS of 1.26, 11% more than the EPS of the firm (R-POWER) taken alone.

RNRL Reliance Power Ltd.

Market Price Analysis

For listed companies, standard valuation practice suggests that market prices should be observed over time intervals which can be considered significant in terms of providing the necessary information to assess their economic value. The principal feature of this methodology is its ability to express the relationship between the values of the companies being examined, as perceived by the market, in relative terms. For the current valuation, it was considered appropriate to apply this methodology using the following criteria:

(i) Use of the arithmetic average of the closing prices and the weighted average of the official prices for RNRL and R-POWER;

(ii) Use of reference periods of 1 day, 1 month, 2 months and 3 months prior to 13 July 2010.

Results

Conclusion on Swap ratio

Post Merger Performance of Reliance Power Ltd.Stock price

Nov-10

Dec-10Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

020406080

100120140160180

Stock Price

Earnings per share

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

0

0.2

0.4

0.6

0.8

1

1.2

Earnings per share

Price to earnings ratio

Nov-10

Dec-10Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

0

50

100

150

200

250

300

Price to earnigs ratio

Price to book value ratio

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

0

0.5

1

1.5

2

2.5

3

3.5

Price to book value ratio

Market Capitalization to Enterprise Value ratio

Nov-10

Dec-10Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

0.95

1

1.05

1.1

1.15

1.2

1.25

Market Capitalisation / Enterprise Value

Conclusion

The merger ratio is one share of reliance power for 4 shares of RNRL. On current equity (approx. 2.4bn shares) of Reliance power, this would mean 14.3% dilution for Reliance power. At Friday’s close price, the market cap of Reliance power is Rs410bn and RNRL is Rs110bn. Assuming this to be the fair value of both the companies, the market cap of combined entity should have been Rs520bn. RNRL shareholders would have owned 14.3% of Rs520bn, which is Rs75bn (~ 30% lower than current market cap of RNRL). However, Since RNRL has been valued at Rs75bn in the merger, the market cap of RNRL is likely to correct which will reduce the combined market cap of the post merger reliance power, meaning further losses.

Also, Looking at the value add to reliance power in the gas deal, only the marketing margins would be saved because of this merger. This would add about Rs3-4/Share to reliance power. We believe, looking at that there are no significant businesses in RNRL; the merger is negative for Reliance power too.

“This deal has left the RNRL shareholders in a very tight situation. It will be a difficult time for the investors of both the firms, as it will take at least three-four years for Reliance Power to get the benefits of gas promised by Reliance Industries (RIL). The shareholders are left with no choice but to stay invested,” Geojit BNP Paribas Financial Services assistant vice president Gaurang Shah said.