Financial Engineering Behind RIL Portfolio Rejig — JIO Platforms (EV-70 Bn), RIL Retail ( EV-65 Bn) and RIL O2C (EV-65 Bn)
RIL’s dealmaking and financial engineering lured about $20 billion of investments from Google to Facebook Inc. and others into its digital JIO Platforms in recent months by divesting nearly 33 per cent stake in Jio Platforms to an eclectic mix of 13 investors. Behind this goes a meticulously planned financial engineering exercise that only RIL could have drawn up which is being extended into Retail and O2C as well. Smart deal structuring helped them achieve multiple objectives Between April 22 and July 15 this year as we announced the largest, fastest fund-raise so far in India Inc — more ₹1.5-lakh crore through a stake sale of about 33 per cent in its subsidiary Jio Platforms to 13 marquee foreign investors.
The groundwork for the mega stake-sale was set into motion in the latter part of the last year — when Jio Platforms was established as a holding company to house all of RIL’s digital businesses.
This included the flagship Reliance Jio Infocomm (RJio) that has rapidly risen to a position of dominance in the country’s telecom sector. RIL set up Jio Platforms as a wholly-owned subsidiary, which, in turn, held full or majority stakes in several digital businesses including RJio (see chart). So, when investors bought a part of Jio Platforms, they got a part of RIL’s entire digital business as well.
The key objective behind this two-layer structure was to set up an integrated, digital business entity that was light on debt — one that could command top-dollar valuations, similar to global tech majors. RIL had invested big money in its digital businesses, a good part through debt, and it needed handsome payback to de-leverage its books.
The ingenious capital re-organisation was also a complex one involving RIL, Jio Platforms and RJio. While there are many scenes in the act, here’s the key one.
RIL took over a chunk (about ₹1-lakh crore) of RJio’s debt, but along with it, RJio also gave RIL an equal amount of consideration, read cash. Nice, but how did RJio get the cash? That came from Jio Platforms, when it subscribed to the OCPS (Optionally Convertible Preference Shares) issued by RJio.
OCPS are quasi-equity instruments. But how did Jio Platforms get the cash to subscribe to the OCPS of RJio? Well, that came from RIL when it subscribed to the OCPS issued by Jio Platforms. Net-net, RIL used its cash to finance Jio Platforms, which used the cash to finance RJio that, in turn, transferred the cash back along with the debt to RIL. So, effectively RIL took over the chunk of the RJio debt and got back its own cash, with Jio Platforms being the go-between (see chart).
Now, to monetise its digital businesses and also pay down the increased debt on its books, RIL decided to sell stakes in Jio Platforms. The sale kicked off in late April this year when Facebook came on board, buying 9.99 per cent in Jio Platforms for ₹43,574 crore. Of this, Jio Platforms will retain ₹14,976 crore and the balance ₹28,598 crore will go towards redeeming the OCPS held by RIL in Jio Platforms.
For subsequent stake sales, too, a portion — 10 per cent — has been retained in Jio Platforms, while the rest has gone to RIL by redeeming the OCPS held by it in Jio Platforms.
Tax Free Raise
The stake sale happened at top-dollar valuations. Interestingly, neither RIL nor Jio Platforms will be paying any tax on the stake sales, thanks to some smart deal structuring.
Jio Platform’s total equity as of March 2020 comprised equity share capital (₹4,961 crore) plus other equity (₹1,77,064 crore). This ‘other equity’ was optionally convertible preference shares (OCPS) issued to RIL. It was earlier believed that when investors bought stake in Jio Platforms, they were given equity shares by converting the OCPS held by RIL. So, the amount of OCPS would have reduced while the share capital increased, keeping the total equity the same. Thus, dilution of earlier shareholders (except RIL) did not happen when shares were issued to new investors. Ergo, the stake sales seemed to have been structured as a transfer of shares from RIL .
But this arrangement would have left RIL liable to pay capital gains tax as it would have sold equity shares converted from the OCPS that it held in Jio Platforms to the investors at a premium. The gains on such transfer of securities would have been categorised as short-term (taxed at the highest applicable rate, in excess of 30 per cent), given that Jio Platforms was incorporated only late last year.
The potential tax pain seems to have been avoided by a simple method — fresh issue of shares by Jio Platforms to the various investors. To Facebook, the first investor, and also a strategic one, Jio Platforms issued both equity shares and 0.01 per cent CCPS (compulsorily convertible preference shares) at ₹488.34 per share. Google, the latest investor and also a strategic one, was issued equity shares at the same price — ₹488.34 apiece. All the other investors were issued equity shares at a higher price — ₹549.31 a share. With these total share proceeds of ₹1,52,318 crore, Jio Platforms redeemed OCPS worth ₹1,29,046 crore held by RIL and retained ₹23,272 crore with itself(see table for break-up).
One stone, many birds
This fresh issue of shares by Jio Platforms helped kill many birds with one stone. RIL got repaid a chunk of its OCPS, thus reducing its own net-debt position significantly. The redemption of OCPS held by RIL is essentially repayment of funds earlier infused by RIL into Jio Platforms, and will not attract tax. Jio Platforms could retain a portion of the funds for its own purposes. Since it was Jio Platforms that issued the shares, RIL will not have to pay tax on the stake sale. Jio Platforms, too, would not have to pay tax though it issued shares at a tidy premium — that’s because the pricing of the shares took into account their fair value based on the report of an independent valuer. Even if the shares’ sale price was higher than the fair value, the tax law provides concessions if the buyer is a non-resident investor. In case the shares are issued at a price which is higher than the fair value, then the amount in excess of the issue price over the fair value, is deemed to be income in the hands of the issuing company per Section 56(2)(viib) of the Income Tax Act. However, this provision is not applicable when shares are issued to non-residents (this would include foreign institutional investors and strategic foreign investors). As such, when shares are issued by the company to non-residents investors, there is no tax liability for the issuing company on this account.
No dilution of investor stakes
But when fresh shares were issued to new investors, how did the shareholding of the earlier investors not get diluted? This is where a specific provision in Jio Platform’s altered Articles of Association (AOA) comes in: “No dilution of any shareholder (other than RIL or any of its permitted transferees) shall occur as a result of any permitted share transaction (after taking into account the redemption and/or conversion of any OCPS in connection with such permitted share transaction).”
In the amended AOA, permitted share transactions comprise ‘incremental equity financings’ and ‘conversion share sales’. The former refers to fresh issue of shares to new investors while the latter refers to shares issued to new investors by conversion of OCPS held by RIL. Jio Platforms seems to have opted for ‘incremental equity financings’.
The start-up model
Also, Jio Platforms seems to have opted for a fund-raising model adopted by many start-ups that raise capital from a series of investors within a time window. In this model, a company agrees with investors that a particular number of shares, eventually representing a certain percentage of the fully diluted share capital, will be allotted to them at the end of the fund-raise from multiple investors. Also, adjustments, if necessary, are made to the capital structure to maintain the agreed shareholding of investors.
This way, earlier investors do not get their stakes diluted when new investors are brought in. In the case of Jio Platforms, though the deals with the different investors were announced on various dates, the shareholder resolutions for the allocation of shares to all the investors were passed on July 6, 2020.
RIL and Jio Platforms in their June quarter results releases said that after completion of these investments, RIL would hold 66.48 per cent in Jio Platforms which corraborates with the documents on the MCA website.
OCPS conversion to equity
Interestingly, the shareholding of the previous investors in Jio Platforms did not get diluted when new investors came in; only the shareholding of RIL in Jio Platforms kept reducing.
Jio Platform’s total equity as of March 2020 comprised equity share capital (₹4,961 crore) plus other equity (₹1,77,064 crore). This ‘other equity’ is OCPS issued by Jio Platforms to RIL.
When the many investors bought stake in Jio Platforms, they were given equity shares by converting the OCPS held by RIL. Due to this adjustment, the total share capital base did not increase, and dilution of previous shareholders (except RIL) did not happen when shares were issued to new investors. The amount of OCPS reduced while the equity share capital increased, keeping the total equity the same.
Essentially, the stake sales seem to have been structured as a transfer of shares from RIL.
But some money being retained at Jio Platforms suggests a Jio Platforms issuing to investors its own treasury shares (if it had them), or Jio Platforms getting funds from RIL in the form of debt or redeemable preference shares which will be clarified in next Annual Report or an IPO of Jio Platforms, whichever happens earlier.
After Reliance Industries Ltd (RIL) raised a record 1.5 trillion by selling stakes in Jio Platforms Ltd (JPL), expectations have been running high with regard to stake sales in the group’s retail venture. RIL stock price at the current level of ₹2,100 is likely pricing in a $65–80 billion value for Reliance Retail.
Using the valuation of this deal in retail (US$65bn), recent deal in Jio Platforms (EV of ~US$70bn) and proposed deal with Saudi Aramco (EV of US$75bn) and adjusting for the minority interest in Jio (33.5%) and retail (5.6%) gives us an equity value of US$210bn. This is very close to the current market cap excluding the value of treasury shares.
The fallback is the so-called optionality of RIL’s technology businesses such as JioMart and a much-awaited superapp. Analysts at JP Morgan now value this optionality as high as $65 billion. However, these businesses are already housed in RRVL and Jio Platforms respectively and the valuations of the two firms already capture this optionality.
Indeed, Jio Platforms was valued at multiples much higher than peers such as Bharti Airtel Ltd and the reason given for this was that investors have attributed the difference to the option value of the Jio superapp. However, the fact that the JioMart optionality has not added much value to Reliance Retail comes as quite a disappointment.
Stock market investors, flush with liquidity, will perhaps conclude that private market investors such as Silver Lake have not fully appreciated the huge value that the e-commerce businesses can throw up. That’s a foolhardy assumption, given that large private equity investors have access to better investment tools, and more information.
Another hope is that the Silver Lake transaction will be followed up by a strategic investment announcement. The key will be whether Reliance Retail is able to attract strategic investors (global retailers and e-commerce companies that are competing with Reliance Retail in India), which could drive re-rating on expectations of reduced competition for Reliance Retail. Whether these expectations play out or not remains to be seen. For now, the fundraising spree at RIL puts it in a strong position vis-à-vis competition in the telecom, retail and e-commerce segments.
Reliance Oil-to-Chemical Business Spinoff Plan
RIL has started work on hiving off the oil-to-chemical (O2C) business into a separate unit for a possible stake sale to companies such as Saudi Aramco.
Reliance O2C Ltd will house
- Oil Refining and Petrochemical Plants and manufacturing assets
- Bulk and Wholesale Fuel Marketing
- RIL’s 51% interest in Retail Fuel Joint Venture with BP of the UK.
- RIL’s Singapore and the UK-Based Oil Trading Subsidiaries / Marketing subsidiary.
- Reliance Industries Uruguay Petroquimica SA.
- Reliance Ethane Pipeline Ltd that operates a pipeline between Dahej in Gujarat and Nagothane in Maharashtra.
- 74.9% stake that RIL holds in the joint venture with Sibur.
Reliance O2C Ltd will not house
- RIL’s Very Large Ethane Carriers.
- Gas Pipelines such as one that transports coal-bed methane from its CBM blocks.
- Overseas Oil and Gas Asset Holding Company Reliance Industries (Middle East) DMCC.
- Domestic Exploration and Production Assets.
- RIL’s textiles business as operated out of the Naroda site.
- Baroda township and land, including cricket stadium.
- Jamnagar power assets, and Sikka Ports and Terminals Ltd .
RIL values the O2C business at $75 billion and has been in talks with Saudi Arabian Oil Co (Aramco) for sale of a 20% interest.
The nature of risk and returns involved in the O2C business are distinct from those of the other businesses of RIL and the O2C business attracts a distinct set of investors and strategic partners. RIL has been exploring various opportunities to bring in strategic/other investors in the O2C business. Investors have expressed interest to make an investment in the O2C business. The process of spinning of O2C into a separate subsidiary would be completed by early 2021.
RIL owns and operates twin oil refineries at Jamnagar in Gujarat, with a combined capacity of 68.2 million tonnes per annum. It is also the country’s largest petrochemical manufacturer with units at Jamnagar, Dahej, Hazira, Nagothane, Vadodara, Patalganga, Silvassa, Barabanki, and Hoshiarpur.
The refineries, as well as the petrochemical plants, would now be housed in Reliance O2C Ltd & the ultimate ownership won’t change as a result of the plan. The company holds a 66.6% stake in the KG-D6 block where it is investing about $5 billion in developing a second set of gas discoveries along with BP. It also has a similar stake in the NEC-25 block in the Bay of Bengal and operates two CBM blocks in Madhya Pradesh. These upstream assets would not be transferred to the O2C unit.
Redeployment of billions from Jio stake sales into debt funds
RIL is delaying billions into Indian debt funds after receiving cash from stake sales and a rights issue. The monies have been deployed into ultra-short and money-market funds, and others focused on debt with an average of three-to-five year maturities, according to fund managers who asked not to be identified in discussing investment details. The monies have been deployed into ultra-short and money-market funds, and others focused on debt with an average of three-to-five year maturities.
The deluge of Reliance-related money pouring into the nation in recent weeks, which helped the rupee advance more than 1% in the past month to become Asia’s best-performing currency.
In June, RIL became free of net debt after selling stakes in Jio Platforms Ltd., its digital unit, its energy business, as well completing a rights issue.
The Reliance money is for longer-term investment, and isn’t just parked with the funds, but a bet on the interest-rate cycle with its investments
Giant in markets
The fund flow is adding to the rally in short-duration bonds, with banks and investors also jumping into such debt amid expectations for more rate cuts by the Reserve Bank of India. The 5.22% 2025 bond yield has dropped 19 basis points this month, more than the eight basis points decline in the benchmark 10-year yield.
Reliance’s influence in the financial market has in the past also drawn attention. Last year, the company and a unit accounted for more 60% of a currency swap auction held by the central bank. Back in 2017, it dropped more than 70 billion rupees into funds betting on interest-rate declines.