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Highlights from concall on the BP deal
Reliance concluded its investor conference call on the BP-transaction
earlier today where it confirmed that it expects its accounting treatment
to nullify any tax incidence and lower the depreciation rate. Together with
higher other income from the cash inflow, we expect Rs0.5-3.5/sh+
upgrades to FY12-13 EPS. We also expect the US$7.2bn payment to
accrue in 1HFY12 while Reliance indicated that part of the US$1.8bn
contingent upside may be triggered by the finalisation of the development
plans of existing discoveries – these increase our estimate of the risked
NPV attributed by the deal to Reliance’s India E&P portfolio by Rs40/sh.
Reliance may receive the US$7.2bn in 1HFY12
Reliance did not comment on the payment schedule of the US$7.2bn beyond
confirming that it will be received in FY12. Media reports speculate that it be
phased across an upfront payment (US$2bn), a payment on deal closure
(US$2.2bn) and a third payment around 3QFY12 (US$3bn).
The downside risk of the contingent payment of US$1.8bn is limited
Reliance also clarified that the US$1.8bn contingent payment is linked to the
filing of field development plans (FDP). This includes FDPs from discoveries
already made, indicating that this will be triggered even from a finalisation of
NEC-25 and the KG-D6 satellite FDPs as well. This also indicates that it is
incorrect to construe the US$1.8bn as payment for future exploration success
and US$7.2bn as payment for discoveries already made.
Attributed value of the deal is Rs20/sh lower than our SOTP estimate
The reasonably up-fronted nature of the US$7.2bn cashflow and the limited
downside risk to the contingent payment of U$1.8bn indicates that the risked
deal value is closer to the US$9bn that what we originally estimated. This will
help boost our estimate of the risked NPV assets attributed by the transaction
by Rs40/share to Rs389/share and to Rs408/sh overall including the other
India E&P assets not part of the transaction (cf. Rs428/share in CLSA SOTP).
Why are some blocks outside of the transaction
The deal encompasses 23 of Reliance’s existing blocks in India. In addition,
Reliance already has a stake in another block with BP in India. The producing
PMT and CBM blocks are outside the transaction as well given the different
nature of competencies and asset maturity as well as consortium issues. This
leaves five more blocks have been kept outside the transaction of which two
are pre-NELP blocks with potential regulatory hurdles and consortium issues
(CB-ON-1, GK-OSJ-3) and three (GS-01, KG-III-5, KG-III-6) are where
Reliance and BP probably do not see material upsides at this time.
Effective date of the transaction is 1st Jan 2011
The deal is effective from 1st Jan 2011 indicating that attributed production
to Reliance will fall from 4QFY11. We expect E&P Ebitda to fall by a ~30%
given that Reliance’s stake in KG-D6 will fall by a third to 60% from 90%.
Accounting treatment will nullify tax and increase EPS
Reliance confirmed it will offset proceeds from the transaction (US$7.2bn)
from its capitalised E&P asset base leading to a fall in E&P DD&A; we estimate
a drop from ~$12.5/boe now to ~$9.5/boe. The one-third fall in Ebitda
(Rs17-18bn for FY12-13) will be partly compensated by a proportionately
higher fall in depreciation allowing E&P Ebit to fall by just Rs6-8bn. Higher
other income on the cash inflow would result in a Rs0.5-3.5/sh upgrade to
FY12-13 EPS, therefore. Reliance also clarified that there would be no tax
incidence as it is disposing a block of assets where book value is lower than
the proceeds from sales. Please see our note titled Stemming bad news; up
rec to BUY dated 22-Feb-2011 for more details on this treatment.
No comment on resource base of the 23 blocks
Reliance did not offer any comments on the size of the resource base in the
transaction. BP has indicated before that the transaction implies US$7.5/boe
and that the assets under consideration have 15tcf of indicated resources
(2.5bn boe). Our own estimate of the aggregate of 2P, 2C and risked best
estimate of prospective resources for the 23 assets under the transaction is
~9.1bn boe implying that BP paid US$3.3/boe on total risked resource base.
What does BP bring to the table
BP reiterated Reliance’s assertion yesterday that it has the best track record
among global majors in finding hydrocarbons. It also highlighted its cutting
edge sub-surface capabilities in optimising production indicating that it may
be able to help in stemming and reversing the decline in KG-D6 gas
production. Reliance reiterated that there is no change in its outlook for
production; Niko has indicated earlier that it expects gas production from KGD6 to remain near current levels of ~50-52mmscmd for FY12. BP also
highlighted its global gas trading network as a criteria as well; with Reliance
as a partner it hopes to better penetrate the Indian gas market and did not
rule out setting up LNG import infrastructure and pipeline investments.
Does Niko have a right to increase its stakes in D6, D4 and NEC-25
Niko has announced that it has the right to increase its stake in KG-D6
(10%), NEC-25 (10%) and MN-D4 (15%) by 30%. Reliance clarified that this
is off Niko’s existing base; it can hike its stake in KG-D6 to 13%, for example.
No clarity on use of cash and growth strategy
Reliance declined to comment on the larger question of use of cash. This is
pertinent given the rising cash levels (US$7.1bn as of December) which will
rise to US$14bn on completion of the deal turning Reliance into a near zero
net debt company by end FY12 (current gross standalone debt of
US$15.6bn). Concerns around unrelated diversifications (for example
telecoms, sports, hotels) and expensive in-organic growth remain.
The transaction gives a benchmark for E&P valuations
While we await further clarity use of cash and a concrete plan to stem the
disappointments in KG-D6, we note that the transaction does set a
reasonable indicative base-case benchmark for Reliance’ E&P valuation –
albeit ~Rs20/sh less than our own estimate.
Focus to shift to downstream; we maintain BUY
Such a benchmark should allow focus to shift away from E&P that has been
plagued by poor production and lacklustre exploration newsflow towards
refining and petchem. Our spot margin EPS indicator for example, shows
~Rs90/sh+ as FY12 earnings at this time. While this should moderate,
cyclically and seasonally, this underscores that robust margins may stem and
reverse the EPS downgrade cycle that has led to three years of
underperformance. Maintain BUY with a Rs1,125/share target (+14%).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Highlights from concall on the BP deal
Reliance concluded its investor conference call on the BP-transaction
earlier today where it confirmed that it expects its accounting treatment
to nullify any tax incidence and lower the depreciation rate. Together with
higher other income from the cash inflow, we expect Rs0.5-3.5/sh+
upgrades to FY12-13 EPS. We also expect the US$7.2bn payment to
accrue in 1HFY12 while Reliance indicated that part of the US$1.8bn
contingent upside may be triggered by the finalisation of the development
plans of existing discoveries – these increase our estimate of the risked
NPV attributed by the deal to Reliance’s India E&P portfolio by Rs40/sh.
Reliance may receive the US$7.2bn in 1HFY12
Reliance did not comment on the payment schedule of the US$7.2bn beyond
confirming that it will be received in FY12. Media reports speculate that it be
phased across an upfront payment (US$2bn), a payment on deal closure
(US$2.2bn) and a third payment around 3QFY12 (US$3bn).
The downside risk of the contingent payment of US$1.8bn is limited
Reliance also clarified that the US$1.8bn contingent payment is linked to the
filing of field development plans (FDP). This includes FDPs from discoveries
already made, indicating that this will be triggered even from a finalisation of
NEC-25 and the KG-D6 satellite FDPs as well. This also indicates that it is
incorrect to construe the US$1.8bn as payment for future exploration success
and US$7.2bn as payment for discoveries already made.
Attributed value of the deal is Rs20/sh lower than our SOTP estimate
The reasonably up-fronted nature of the US$7.2bn cashflow and the limited
downside risk to the contingent payment of U$1.8bn indicates that the risked
deal value is closer to the US$9bn that what we originally estimated. This will
help boost our estimate of the risked NPV assets attributed by the transaction
by Rs40/share to Rs389/share and to Rs408/sh overall including the other
India E&P assets not part of the transaction (cf. Rs428/share in CLSA SOTP).
Why are some blocks outside of the transaction
The deal encompasses 23 of Reliance’s existing blocks in India. In addition,
Reliance already has a stake in another block with BP in India. The producing
PMT and CBM blocks are outside the transaction as well given the different
nature of competencies and asset maturity as well as consortium issues. This
leaves five more blocks have been kept outside the transaction of which two
are pre-NELP blocks with potential regulatory hurdles and consortium issues
(CB-ON-1, GK-OSJ-3) and three (GS-01, KG-III-5, KG-III-6) are where
Reliance and BP probably do not see material upsides at this time.
Effective date of the transaction is 1st Jan 2011
The deal is effective from 1st Jan 2011 indicating that attributed production
to Reliance will fall from 4QFY11. We expect E&P Ebitda to fall by a ~30%
given that Reliance’s stake in KG-D6 will fall by a third to 60% from 90%.
Accounting treatment will nullify tax and increase EPS
Reliance confirmed it will offset proceeds from the transaction (US$7.2bn)
from its capitalised E&P asset base leading to a fall in E&P DD&A; we estimate
a drop from ~$12.5/boe now to ~$9.5/boe. The one-third fall in Ebitda
(Rs17-18bn for FY12-13) will be partly compensated by a proportionately
higher fall in depreciation allowing E&P Ebit to fall by just Rs6-8bn. Higher
other income on the cash inflow would result in a Rs0.5-3.5/sh upgrade to
FY12-13 EPS, therefore. Reliance also clarified that there would be no tax
incidence as it is disposing a block of assets where book value is lower than
the proceeds from sales. Please see our note titled Stemming bad news; up
rec to BUY dated 22-Feb-2011 for more details on this treatment.
No comment on resource base of the 23 blocks
Reliance did not offer any comments on the size of the resource base in the
transaction. BP has indicated before that the transaction implies US$7.5/boe
and that the assets under consideration have 15tcf of indicated resources
(2.5bn boe). Our own estimate of the aggregate of 2P, 2C and risked best
estimate of prospective resources for the 23 assets under the transaction is
~9.1bn boe implying that BP paid US$3.3/boe on total risked resource base.
What does BP bring to the table
BP reiterated Reliance’s assertion yesterday that it has the best track record
among global majors in finding hydrocarbons. It also highlighted its cutting
edge sub-surface capabilities in optimising production indicating that it may
be able to help in stemming and reversing the decline in KG-D6 gas
production. Reliance reiterated that there is no change in its outlook for
production; Niko has indicated earlier that it expects gas production from KGD6 to remain near current levels of ~50-52mmscmd for FY12. BP also
highlighted its global gas trading network as a criteria as well; with Reliance
as a partner it hopes to better penetrate the Indian gas market and did not
rule out setting up LNG import infrastructure and pipeline investments.
Does Niko have a right to increase its stakes in D6, D4 and NEC-25
Niko has announced that it has the right to increase its stake in KG-D6
(10%), NEC-25 (10%) and MN-D4 (15%) by 30%. Reliance clarified that this
is off Niko’s existing base; it can hike its stake in KG-D6 to 13%, for example.
No clarity on use of cash and growth strategy
Reliance declined to comment on the larger question of use of cash. This is
pertinent given the rising cash levels (US$7.1bn as of December) which will
rise to US$14bn on completion of the deal turning Reliance into a near zero
net debt company by end FY12 (current gross standalone debt of
US$15.6bn). Concerns around unrelated diversifications (for example
telecoms, sports, hotels) and expensive in-organic growth remain.
The transaction gives a benchmark for E&P valuations
While we await further clarity use of cash and a concrete plan to stem the
disappointments in KG-D6, we note that the transaction does set a
reasonable indicative base-case benchmark for Reliance’ E&P valuation –
albeit ~Rs20/sh less than our own estimate.
Focus to shift to downstream; we maintain BUY
Such a benchmark should allow focus to shift away from E&P that has been
plagued by poor production and lacklustre exploration newsflow towards
refining and petchem. Our spot margin EPS indicator for example, shows
~Rs90/sh+ as FY12 earnings at this time. While this should moderate,
cyclically and seasonally, this underscores that robust margins may stem and
reverse the EPS downgrade cycle that has led to three years of
underperformance. Maintain BUY with a Rs1,125/share target (+14%).
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