Mukesh Ambani's biggest test yet

The swiftness and the savagery of the global downturn have caught business by surprise—the bigger the corporation, the bigger is the surprise. But few analysts expected Mukesh Ambani’s Reliance Group to be hit. After seven years of a heady upcycle, Reliance Industries finds itself hemmed in a downturn that’s perhaps the worst ever since it went public 31 years ago. Suman Layak reports.

In the second week of March 2009, Reliance Industries Ltd (RIL) cancelled a tender offer for naphtha (April 2009-March 2010) as it received very low price bids. In the same week, it also terminated a contract for a drill ship Neptune Explorer that was contracted for use from the April-June quarter for exploring oil and gas on the east cost.

The symptoms of a slowdown are getting starker as every day of the downturn goes by. On the one hand, RIL is grappling with low demand for refined products and petrochemicals—businesses that are at the core of this Rs 1,33,000-crore conglomerate. This comes at a time when the group’s second refinery in Jamnagar, with a capacity to process 5,80,000 barrels of crude per day, has begun production— and when refining margins globally are near an all-time low. On the other hand, it is trying to optimise its expenses to start production of oil and gas in the D6 block of the Krishna-Godavari (KG) Basin, even as it holds back on further exploration in other blocks of the KG Basin. Production in the D6 block is expected to soak up investments of Rs 17,000 crore ($3.3 billion) over a one-year period, whilst India’s largest private sector corporation has so far spent Rs 60,000 crore in oil & gas exploration activities and building a gas pipeline. The swiftness and the savagery of the global downturn have caught business by surprise—the bigger the corporation, the bigger is the surprise.

Around this time a year ago, signs of hiccups in the global economy were evident. But few analysts expected Mukesh Ambani’s Reliance Group to be so badly hit. The core operations were visibly affected even then—although RIL’s superior profitability and resilience were expected to hold it in good stead. Yet, it was Ambani’s largescale growth plans that were eliciting ecstatic responses from equity analysts, many of whom were putting out fanciful (at least in hindsight) target prices for the company on the basis of the sum of the group’s parts.

The sum of these many parts— right from exploration and production of oil and gas to special economic zones (SEZs), organised retailing, city gas distribution, and other new forays reported in the media like semiconductors, for one, not to mention reports of a third refinery— was indeed huge. But like most valuations, this number was based on future cash flows. Today, some of those new projects are stuck in the economic slowdown, although the RIL top brass doesn’t see next fiscal’s cash flows being hindered. They are still confident of churning out $8 billion in hard cash in 2009-10—that’s in line with what the RIL top brass had told analysts a year ago.

Opportunity in adversity the slowdown is doing RIL no favours…

  • Both its flagship businesses of petrochemicals and refining—which typically move in opposite cycles—are in the dumps

  • Focus on cash conservation means that forays into SEZs, a new cracker at Jamnagar and organised retailing have to take a backseat

  • According to Macquarie, the return on equity is expected to drop to 14 per cent in 2008-09 from 19-2 per cent in 2007-08

  • The reported earnings per share is also expected to drop to Rs 90-43 in 2008-09 from Rs 124-07 in 2007-08---but it hopes to use the tough market conditions to its advantage

  • It is the lowest-cost producer of petrochemicals in the world

  • The new refinery at Jamnagar will be amongst the top three in sophistication and complexity (which will result in higher margins)

  • The merger of RIL and RPL will allow it significant synergies to manage the refining business better

  • The oil & gas business will bring new revenue streams into the company’s books



Not just that—RIL’s top team, which includes Ambani’s lieutenantin-chief, Manoj Modi, is confident of maintaining the track record since going public in 1977 of doubling profits every three years. RIL now aims to feature in the top 50 most profitable firms in Fortune’s Global 500 in three years. In the last Global 500, it was ranked at 206 in terms of its revenues. With profits of $4.85 billion, Reliance was within striking distance of China Mobile’s $8.42 billion (China Mobile was ranked last in the top 50 most profitable companies by Fortune in 2008). 

The RIL-RPL equation
Why Ambani is bullish on the merger.

  • Hopes to save up to $110 million a quarter in crude sourcing

  • It will allow RIL to better utilise its crude-processing capacities

  • According to Macquarie estimates, tax benefits can be as high as $500 million

  • It will allow RIL to offer a wider range under the same umbrella


However, at a time when petrochemical prices have fallen by 50-75 per cent from peak levels, touching five-year lows, and refining margins are at least $8 lower than recent highs, you have to wonder how is RIL going to generate so much of moolah? Clearly, cash conservation is one way out and cost-cutting is an integral part of that plan. According to BT estimates, RIL has downsized by at least 4,000 people over the past few months across its various businesses, including Reliance Retail and the SEZ ventures. With construction largely over at the second Jamnagar refinery as well as the gas pipeline, a lot of contracted workers have left Reliance’s indirect employment in 2008.

Reliance Industries officials said that the number is as low as around 1,200 out of which 600 were from the retail business and 400 were due to the voluntary retirement scheme at the Hazira plant. A SAP automation project implemented in 2008 also created some redundancies. The company also managed to cut its staff cost to Rs 588 crore in the September quarter from Rs 651 crore at the end of the June 2008 quarter. In the December quarter, however, it climbed back to Rs 605 crore. The global recession is hurting and is the biggest problem—aggravated, no doubt, by a “dysfunctional financial market,” as Alok Agarwal, Chief Financial Officer, RIL, puts it. Another way to conserve cash is to go easy on capital expenditure. A $2-billion gas cracker planned at Jamnagar has been put on the backburner; only Rs 1,000 crore—of the proposed Rs 25,000 crore— has been sunk into organised retail, with value retail becoming the focus area; and exploration of oil & gas is in go-slow mode.

P.M.S. Prasad, President & CEO, RPL says: “We have discussed the current situation with the Director General of Hydrocarbons and have decided to focus on production of gas and oil from D6. For that, we have to slow down our exploration activity.” In fact, exploration is facing problems globally. Prasad explains how in Canada the production cost of a certain grade of heavy crude is $60 per barrel and exploration has totally stopped—as the crude would be unviable at today’s prices. “It’s different from what was a given earlier—that if there is crude underneath you get it out—selling was never a problem.” Also, on the backburner, are SEZs in Haryana and in Mumbai—the latter involves a non-RIL company, that of Anand Jain.

It’s against such a backdrop that last fortnight’s merger of Reliance Petroleum Ltd. (RPL)—the company floated to build the second refinery at a cost of Rs 27,000 crore—with RIL has got the go-ahead. The amalgamation comes in the wake of 5 per cent shareholder Chevron, the US energy giant, walking away from a possible deeper alliance. The relationship with Chevron was rooted in two crucial agreements: The US major would supply heavy crude needed for the complex refinery (which means it can process heavier crude, and thereby rake in chunkier margins); and it would also pick up some of RPL’s offtake. However, the global downturn has hit Chevron, which makes it difficult for the company to guarantee these proposed agreements. Result: Exit Chevron, enter RIL. 

The Chevron Factor
How the changed prospects of the US energy giant triggered the RIL-RPL merger

  • In April 2006, RIL and Chevron India had entered into an agreement through which Chevron bought 5 per cent in RPL

  • According to the pact, Chevron was to buy additional shares at 5 per cent below market price and raise its stake to 29 per cent

  • But this deal could go through only if some additional pacts for supply of crude and offtake of products were signed between the two companies

  • As Chevron felt it would not be able to sell RPL’s additional products, it decided to opt out- Also, it isn’t in a position to provide RPL with the volume of heavy crude it needs at its complex refinery


The merger has many benefits, right from economies of scale in sourcing (for two refineries at a go rather than individually). Other similar advantages include offering package deals to vendors of crude, buying up all their grades and extending easy credit facilities with suppliers to the new refinery. “We do not need to open fresh letters of credit for our existing suppliers to RIL, after the merger, for the new refinery. After the merger, RIL’s easy credit norms will automatically get extended to the new refinery,” explains Agarwal.

According to Jal Irani, Equity Analyst at Macquarie Bank, the fact that the RPL refinery is in an SEZ and, that RIL’s export-oriented unit (EOU) status ends in 2010 provides “… incentive for RIL to maximise gross refining margins and profits at the new refinery even at the cost of lower profits at the existing refinery.

We believe this is practically possible by using cheaper crude and producing high-margin products at the new refinery.”

What’s more, since the two Reliance units at Jamnagar (postmerger) are amongst the three most complex refineries in the world (in a universe of 700 refineries, roughly half of which are complex), Reliance’s consolidated refining capacity will theoretically be amongst the last three standing if the world’s entire production shuts down. This, tied in with RIL’s claim of being the lowest-cost, highest-quality producer of petrochemicals, give it the staying power to not just survive the downturn, but in fact, to use the global recession as an opportunity to thrive even as a number of global rivals fall by the wayside.

Indeed, RIL’s ability to see opportunity in the face of adversity is legendary. Way back in 1989, its project in Patalganga—the village on the Konkan coast that is home to an RIL petrochem unit—was submerged under water. Some 400 people lost their lives and 1,500 families were rendered homeless. In less than three weeks, the RIL top brass got the plant running at normal capacity. Similarly, in 1998, in Jamnagar, when RIL’s first refinery was being built—then the world’s largest grassroots unit— was struck by a storm. Some 550 people went missing.

In 15 days, the company succeeded in getting 60,000 workers back to work. The Jamnagar unit was commissioned within the stated deadline—of less than 36 months. Other natural calamities that have struck the group include a plague (at Hazira, home to a polyester unit), and an earthquake (in Gujarat). Much like retail, Reliance’s mobile telephony game plan—then Reliance Infocomm, now Reliance Communications, which is owned by younger brother Anil after a famous split four years ago—had come unstuck initially. The biggest difference this time around, however, is that virtually every Reliance business—along with the global economy—is in the wars. Clearly, this is Mukesh Ambani’s biggest test yet.

Jain on the wane?
One of Mukesh Ambani’s trusted lieutenants is in the wars of late.

At the time of the split in the Reliance empire, two men faced the ire of the camp of younger brother Anil Ambani—Anand Jain and Manoj Modi. They were the two trusted lieutenants of Mukesh Ambani—the people derided by the Anil faction as chelas, chamchas and cronies.

Almost four years later, Modi seems to be at the helm of a lot of things at Mukesh’s Reliance Group, and perceptibly more in charge than before.

Jain, on the other hand, seems to be caught in a giant jam. Last fortnight, reports spread like wild fire that income tax officials were conducting a search at Jain’s office and residence. Jain’s Jai Corp has plans to implement two SEZs, over 17,500 acres and involving a total outlay of Rs 31,000 crore over an 8-year period. Mukesh Ambani holds a controlling stake in both the SEZ companies through his private equity investment vehicles. At least one of these projects, the larger Mumbai SEZ, has got caught in political quagmire with a referendum on whether the farmers wanted the SEZ. While participation in the referendum was low, more than 90 per cent of the voters opposed it. A saving grace is the jewellery SEZ planned by the company in Navi Mumbai over 33 acres that got an approval of the empowered group of ministers in February.

Jain had been called a “modern-day Shakuni,” by Anil Ambani at the time of the split, alluding to his role in dividing the Ambani family and alleged manipulations in IPCL where Anil Ambani and Anand Jain were board members. Jain did not respond to queries mailed by Business Today and his office said that Jain has not been to the office for the last few days.

So, has the close friendship between Jain and Mukesh Ambani soured? Or, are there other strategic mistakes involved? Some answers may lie in the share price of Jai Corp, which has crashed by almost 90 per cent from its last March’s peak.