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| RIL: Fishing downstream | |
| Sunaina Vasudev / Mumbai November 24, 2009, 9:22 IST | |
Reliance Industries, which had declared an intention to seek inorganic growth opportunities, confirmed a preliminary offer for a controlling interest in global petrochem major, LyondellBassel. The timing is prime for acquisitions in the space as there has been a steep decline in replacement cost and asset value given the plummeting of margins in the petrochemical space.
The Rotterdam based target is the third largest chemicals company in the world with annual revenues of $ 50.7 billion (2008) and present across 19 countries with sales in over 100 countries. While, 55% of its revenues were derived from North America and Europe contributes 38% and about 7% is derived from the rest of the world. It has the largest production capacity globally for polyolefins, propylene oxide and derivatives, and besides the chemicals and polymer space has two refineries – in Houston, Texas and Southern France.
Target analysis
Weighed down by high debt on its book post the merger of Basell and Lyondell in 2007 (through a leveraged buyout by Basell), LB was hit hard by the precipitous fall in petrochemical margins in the second half of 2008. It filed for protection from bankruptcy proceedings under chapter 11 of the U.S. Bankruptcy Code in January 2009. It submitted its Plan of Reorganization and Disclosure Statement to the U.S. Bankruptcy Court on 11 September, 2009 and the RIL offer is a potential alternative route for the company.
It obtained $8 billion debtor-in-possession financing to fund its current operations which matures on 03 February, 10. LB has classified over $ 22 billion liabilities as subject to compromise in terms of amounts allowed in court which, however, can be potentially settled much lower as of 30 September 09. Its total debt, as per an Angel report, includes liabilities subject to compromise of $ 12 billion, debt payable in the near term of about $8.2b illion and other debt of US $3.2 million. It carries a negative equity value $ 7.4 billion, as per HSBC research.
RIL has about 60% share of the domestic market, making it the largest Indian petrochemical company. However, its global market share is only 8% according to an HSBC research report. The acquisition will propel it into a prominent global positioning. HSBC analysis expects that RIL should be able to drive a hard bargain and push through the acquisition at a discount to asset price given the tough market scenario where petrochem margins are under significant pressure. However, it cautions, that a turnaround in EBITDA will be challenging as manufacturing is primarily in US and Europe. Deal pricing details haven’t yet been released but reports suggest that it is priced around $ 10-12 billion.
RIL‘s second quarter results were mostly in line with analyst estimates. Net revenue growth was 5% y-o-y to Rs 46848 crore. Ebitda was up 11% in the same period with Ebitda margins up 72 bps. Segmentally, refining revenues grew 9% y-o-y while petrochem revenues dipped 14%. Gross refining margins dipped 55% y-o-y for RIL to $ 6 per bbl from $13.4 per bbl in Q2FY09 and this put pressure on earnings in the refining segment down 50% y-o-y. The relief came from the oil and gas front where revenues grew over 200% to Rs 2937 crore and earnings were up 90% to Rs 1226 crore.
However, crude and gas outputs from the PMT fields have come down by about 14% and 5% respectively reflecting the natural decline of these fields and higher depletion costs for the KG-D6 fields have pushed Ebit margins for oil and gas down to about 42% from 69% in Q2FY09.
Time to grow
A Morgan Stanley report estimates that the company should be Free cash flow positive from 2011 generating free cash flows of Rs 18000 - 23000 crore annually after that. However, the tough outlook for refining margins, higher depletion rates and marginally lower cracker margins going ahead has led to downward revisions of EPS estimates by analysts. In such a scenario and given its size, it would be difficult for RIL to deliver 10% annual profit growth rate purely through domestic organic growth as it has done in the past, according to a CLSA report. Global acquisitions are the logical next step in such a scenario, the report indicates; however the strategic synergies would have to be strong for it to add value.
A Macquarie report analyzing the possible targets for RIL held that an international distribution and marketing network for its high-end products with a focus on the large and higher margin (quality discerning) US market would be a good strategic fit. Captive product storage facilities would be an additional requirement. Question is, if LB, with high debt and compromised assets, is the right fish? The answer would hinge on the price paid for the acquisition.
RIL was up 3.3 % on 23 November, 09 and closed at Rs 2193.20. It trades at a P/E valuation of 14x FY11 consensus analyst EPS estimates. In contrast, RIL's 5 and 10 year corporate default swaps hardened by 17 and 20 bps since the announcement.
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