On a YOY basis, the stock is up 73.5%, which is a phenomenal annual return for a stock of that size. However, from the lows of late Mar-20, the stock is up 135% in a span of just 5 months. This value was entirely created by the fact that RIL monetized its stake in Jio Platforms at a pace that most analysts hardlyenvisaged. Despite the Aramco deal not going through, Reliance managed to successfully bankroll its net zero-debt ambitions.
It is in this light that the decision to hive off the O2C business has to be viewed. Over the last few years, the O2C business had been the cash cow funding the group’s telecom, digital and retail plans. Now all these businesses are well established and sustainable and RIL needs to look at the future of the O2C business. Even if the original valuation of the O2C business by Aramco is correct, it is just 40% of the market value of Reliance, This, despite being the biggest cash cow. That is the context for the decision to hive off the O2C business in a separate subsidiary; as a precursor to an eventual stake sale.
Key takeaways from the O2C spin-off
The scheme of arrangement announced by Reliance Industries to spin off its O2C or Oil-to-Chemicals business is as under.
a) The transfer of O2C business will be by way of slump sale with all relevant and assets transferred to an O2C subsidiary. The valuation will be on an overall basis only.
b) The O2C business will include refining, petrochemicals and minority interest in the oil marketing business. However, O2C will exclude exploration and production.
c) The assets and liabilities of the O2C business at an operational and financial level will be transferred to the O2C subsidiary company.
d) The shareholders of Reliance Industries will not be impacted in any way as all the assets and liabilities will continue to reside in the consolidated balance sheet of RIL.
e) However, this is a precursor to eventually sell some stake in the O2C business to investors to monetize and help internally fund the growth.
f) The assets and liabilities of Reliance Industries will stand reduced to the extent of assets transferred and lead to an improvement in the Return on assets or ROA.
g) The capital of Reliance industries will also stand reduced proportionately with the capital transferred to Reliance O2C and that will help improve the ROE.
h) With this transfer, RIL will have a barometer to value its O2C business apart from the first two segments of digital and retail. That sets the tone for stake sale.
Watch out!This is the first big step towards New Energy
O2C will still drive the cash flows for some more time as is evident from the $10 billion investment planned in the COTC complex at Jamnagar. But the core focus will shift. In its last AGM, the Chairman of the Reliance Group outlined a grand plan to convert the O2C franchise of Reliance into a New Energy model. That is hardly surprising. Global oil giants like Exxon, Royal Dutch Shell and British Petroleum have been consistently losing value because they are still too focused on the traditional energy story.
RIL has already laid out a 15-year vision to build a new energy franchise that will recycle carbon dioxide, create value from plastic waste and ensure an optimal mix of clean and affordable energy. As Mukesh Ambani outlined in the AGM, new energy based on the principle of carbon recycling and circular economy is a multi-trillion dollar opportunity.
Reliance has crude processing capacity of 1.24 million bpd at Jamnagar. The O2C business, once spun off, can offer a big opportunity to transform into a green energy company. New Energy will include the use of non-recyclable plastic in road construction. But, can new energy add value to RIL?
The significance of the New Energy plan is much bigger from a valuation perspective. RIL managed to rethink the telecom story in India by positioning it as a digital enabler. The experience of global oil majors has underlined that traditional oilcan be more of value destroyers. If RIL has become the second most valuable oil company in the world after Saudi Aramco, it is due to the value created by digital and retail. The hiving of the O2C is the first step to making New Energy count in the overall valuation stakes.