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Reliance Industries
Upside from BP deal
We raise our TP from Rs900 to Rs966 based on the higher value of RIL's E&P
assets implied by the BP deal. The BP tie-up should help resolve production
issues at KG-D6, but commercial issues in terms of gas pricing will still need to
be resolved. Use of cash will remain crucial for RIL going forward.
BP deal covers domestic E&P and LNG
BP is acquiring a 30% stake in 23 blocks owned by RIL for US$7.2bn. In addition, it will make
future performance payments of up to US$1.8bn based on exploration that results in
developments of commercial discoveries. Both partners also plan a 50:50 JV that involves
creating the infrastructure to receive, transport and market natural gas around the country.
Valuation is positive from our perspective
The acquisition price implies a value for RIL E&P assets which is US$4.2bn (24%) above our
earlier valuation. This is in line with the acquisition premiums that have been paid in M&A
deals recently. And, given that BP is, at a stroke, getting a considerable foothold in the Indian
E&P space, it does not look that exciting to us considering that just one month ago, our
valuation of the same E&P assets was nearly 21% higher than BP has paid (we had sharply
cut our value on production/reserve disappointments). The negative newsflow on RILís E&P
business has related to technical issues on production as well as commercial issues with the
Indian government on gas pricing. The BP deal should be able to handle the technical
challenge, but the commercial one remains.
Raise TP to Rs966, maintain Hold
We factor in the higher value for the E&P assets as implied by the BP deal and raise our
SOTP-based TP from Rs900 to Rs966. The proceeds from BP (US$7.2bn) expected in FY12
are virtually equal to our current RIL net debt forecast for end-FY12 (US$7.45bn). Even
before this transaction, RILís planned outlay over the next five years (US$30bn) was well
below its own forecasts of investible funds (US$55bn-60bn). With this deal, RIL would need
either to provide new investment plans or perhaps return cash to shareholders.
Upside from BP deal
We raise our target price by Rs66 on the back of the BP deal. However, the upside from
consensus valuations may not be that high, given that our valuation before the deal
announcement had been well below consensus.
BP deal covers domestic E&P and LNG
BP and RIL have announced a partnership deal whereby BP is taking a 30% stake in 23 oil and
gas production sharing contracts (PSCs) that RIL operates in India, including the producing KGD6 block. This acquisition would have to be subject to approval of the Indian government. The
partners also plan to form a 50:50 JV which involves creating the infrastructure to receive,
transport and market of natural gas in India.
Our understanding/assumptions for this deal is as follows:
! BP acquires a 30% stake in 23 of the 29 blocks that we believe RIL has in India (excluding the
older Panna-Mukta-Tapti [PMT] fields and the domestic coal-bed methane [CBM] blocks). RIL
owns a stake of 90-100% in all of these blocks and accordingly its stake drops to 60-70%;
! BP is paying RIL US$7.2bn as equity value for its 30% and this payment will be made in three
tranches in FY12;
! RIL will not be liable to any income tax on receipt of funds from BP; and,
! The JV will concentrate on building an LNG import and distribution business in India as gas is
sold in the country at prices approved by the government which decides which customers can
receive it.
Background on RIL E&P assets
RIL has been awarded a total of 43 blocks to date from the pre-NELP and eight NELP rounds.
Fourteen of these blocks had been relinquished by 1QFY11 and we estimate current block
inventory is 29 (details provided in appendix). Out of these 29, there have been discoveries in
nine blocks (details below).
Table 1 : RIL domestic blocks summary (excluding CBM)
Awarded Relinquished Blocks with discoveries
Pre-NELP blocks (excl PMT) 4 2
NELP I 12 8 3
NELP II 4 2 1
NELP III 9 3
NELP IV 1
NELP V 5 2 2
NELP VI 7
NELP VII 1
NELP VIII 0
Total 43 14 9
Source: Company data
RIL names its discoveries in numerical order. The first was called D1 (after its founder Dhirubhai
Ambani) and 52 discoveries have been made to date. Of these, four have been made in the
overseas Yemen bock (which is producing small quantities) and one in a block that has since
been relinquished. So, 47 discoveries have been made in nine domestic NELP blocks. 19 of these
discoveries relate to KG-D6.
Valuation positive from our perspective
The US$1.8bn that BP is paying for future exploration success is mainly for blocks where
exploration efforts are yet to commence, in our view. More importantly, the payments are subject
to development of commercial discoveries, which would imply approval from the upstream
regulator of a field development plan. The time from discovery to FDP approval will be at least
three years and, hence, we have ignored this payment in our valuation for RIL assets.
The US$7.2bn payment for a 30% stake translates to a valuation of US$24bn for 100% stake.
Given that RILís stakes in the key blocks where discoveries have already been made (KG-D6,
NEC-25, KG-V-D3) are around 90%, we believe that the resultant valuation for RILís E&P portfolio
is around US$21.6bn (90% of US$24bn). Our current valuation for these blocks is US$17.4bn or
Rs263/share (note that the PMT fields are not part of the BP deal).
Thus, using BPís valuation, the implied value of RILís E&P assets rises by US$4.2bn or
Rs66/share. We assume that BPís higher payment is for exploration upside, though it may be a
plain premium for strategic access to Indian assets.
Premium is in line with recent M&A deals
The price paid by BP is 24% above our asset values. This is in line with the acquisition premiums
that have been paid in recent M&A deals involving listed corporates. Given that BP is getting
access to significant Indian exploration and producing assets in one stroke, we would have
expected the company to pay some premium over and above core asset value.
The implied value of RIL assets from the BP deal works out to Rs327/share compared to our
estimate of Rs263/share. However, we note that just a month ago, we sharply cut our valuation of
RILís E&P assets due to disappointing newsflow on production and reserves (see our note, A
mixed bag, dated 24 January 2011). Our valuation of the same assets before this cut was nearly
Rs395/share, ie BP has paid a lower price for these assets than our valuation of them just one
month ago.
Thus, while the deal does provide a positive surprise for us, after our cut, we suspect that the
consensus valuation for the E&P business is much higher, given that our target price of Rs900
before this announcement was the lowest on the street. Therefore, the deal the deal is unlikely to
positive versus street expectations.
Commercial issues still pending
As explained above, we cut our E&P valuations a month ago. These cuts were driven by newsflow
which indicated that RIL was facing technical challenges that were lowering gas production in its
KG-D6 blocks. Further, development plans for discoveries within the D6 and other blocks were not
getting approved, which we believed was related to commercial issues on gas pricing.
The deal with BP should bring in much needed technical expertise that should hopefully resolve
any production issues. However, the commercial challenge persists. New deepwater gas
discoveries will be expensive to develop relative to the D1/D3 field reserves within KG-D6, which
are already producing. Hence, new discoveries would need a higher gas price than is currently
being charged for the D6 gas (US$4.2/mmbtu). Our existing model assumes that the gas price
rises to US$5.5/mmbtu after 2014. But for new discoveries to be developed, the government
needs to provide clarity on future pricing. The D1/D3 fields were developed with pricing being
decided just a year ahead of production. However, we now believe that new developments are
unlikely to start unless the pricing issue is settled further in advance.
Target price raised to Rs966, maintain Hold
As explained above, we have factored in the higher value for the E&P assets as implied by the BP
deal and raise our SOTP target price from Rs900 to Rs966.
The deal is now likely to shift focus on RILís balance sheet and use of its cash. According to
management, investible funds over 2010-15 would be US$55bn-60bn after considering cash in
hand and internal cash generation. Announced capex plans on other hand amount to only
US$30bn spread as follows:
! US$10bn on petchem, from which investment decisions have been taken for only US$2.5bn;
! US$10bn on E&P (US$5bn on shale gas, rest domestic E&P);
! US$5bn on telecom and retail; and,
! US$2bn-2.5bn on maintenance capex.
With this deal, RIL will receive cash inflow of US$7.2bn and its future capex on domestic E&P
assets will drop by 33% (since its stake will reduce from 90-100% to 60-70%). This cash inflow,
expected in FY12, is virtually equal to our current RIL net debt forecast for end-FY12
(US$7.45bn). Thus, with this deal, RIL would need either to provide new investment plans or
perhaps return cash to shareholders. The dividend payout ratio, which has historically been in the
11-13% range, could perhaps be increased.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries
Upside from BP deal
We raise our TP from Rs900 to Rs966 based on the higher value of RIL's E&P
assets implied by the BP deal. The BP tie-up should help resolve production
issues at KG-D6, but commercial issues in terms of gas pricing will still need to
be resolved. Use of cash will remain crucial for RIL going forward.
BP deal covers domestic E&P and LNG
BP is acquiring a 30% stake in 23 blocks owned by RIL for US$7.2bn. In addition, it will make
future performance payments of up to US$1.8bn based on exploration that results in
developments of commercial discoveries. Both partners also plan a 50:50 JV that involves
creating the infrastructure to receive, transport and market natural gas around the country.
Valuation is positive from our perspective
The acquisition price implies a value for RIL E&P assets which is US$4.2bn (24%) above our
earlier valuation. This is in line with the acquisition premiums that have been paid in M&A
deals recently. And, given that BP is, at a stroke, getting a considerable foothold in the Indian
E&P space, it does not look that exciting to us considering that just one month ago, our
valuation of the same E&P assets was nearly 21% higher than BP has paid (we had sharply
cut our value on production/reserve disappointments). The negative newsflow on RILís E&P
business has related to technical issues on production as well as commercial issues with the
Indian government on gas pricing. The BP deal should be able to handle the technical
challenge, but the commercial one remains.
Raise TP to Rs966, maintain Hold
We factor in the higher value for the E&P assets as implied by the BP deal and raise our
SOTP-based TP from Rs900 to Rs966. The proceeds from BP (US$7.2bn) expected in FY12
are virtually equal to our current RIL net debt forecast for end-FY12 (US$7.45bn). Even
before this transaction, RILís planned outlay over the next five years (US$30bn) was well
below its own forecasts of investible funds (US$55bn-60bn). With this deal, RIL would need
either to provide new investment plans or perhaps return cash to shareholders.
Upside from BP deal
We raise our target price by Rs66 on the back of the BP deal. However, the upside from
consensus valuations may not be that high, given that our valuation before the deal
announcement had been well below consensus.
BP deal covers domestic E&P and LNG
BP and RIL have announced a partnership deal whereby BP is taking a 30% stake in 23 oil and
gas production sharing contracts (PSCs) that RIL operates in India, including the producing KGD6 block. This acquisition would have to be subject to approval of the Indian government. The
partners also plan to form a 50:50 JV which involves creating the infrastructure to receive,
transport and market of natural gas in India.
Our understanding/assumptions for this deal is as follows:
! BP acquires a 30% stake in 23 of the 29 blocks that we believe RIL has in India (excluding the
older Panna-Mukta-Tapti [PMT] fields and the domestic coal-bed methane [CBM] blocks). RIL
owns a stake of 90-100% in all of these blocks and accordingly its stake drops to 60-70%;
! BP is paying RIL US$7.2bn as equity value for its 30% and this payment will be made in three
tranches in FY12;
! RIL will not be liable to any income tax on receipt of funds from BP; and,
! The JV will concentrate on building an LNG import and distribution business in India as gas is
sold in the country at prices approved by the government which decides which customers can
receive it.
Background on RIL E&P assets
RIL has been awarded a total of 43 blocks to date from the pre-NELP and eight NELP rounds.
Fourteen of these blocks had been relinquished by 1QFY11 and we estimate current block
inventory is 29 (details provided in appendix). Out of these 29, there have been discoveries in
nine blocks (details below).
Table 1 : RIL domestic blocks summary (excluding CBM)
Awarded Relinquished Blocks with discoveries
Pre-NELP blocks (excl PMT) 4 2
NELP I 12 8 3
NELP II 4 2 1
NELP III 9 3
NELP IV 1
NELP V 5 2 2
NELP VI 7
NELP VII 1
NELP VIII 0
Total 43 14 9
Source: Company data
RIL names its discoveries in numerical order. The first was called D1 (after its founder Dhirubhai
Ambani) and 52 discoveries have been made to date. Of these, four have been made in the
overseas Yemen bock (which is producing small quantities) and one in a block that has since
been relinquished. So, 47 discoveries have been made in nine domestic NELP blocks. 19 of these
discoveries relate to KG-D6.
Valuation positive from our perspective
The US$1.8bn that BP is paying for future exploration success is mainly for blocks where
exploration efforts are yet to commence, in our view. More importantly, the payments are subject
to development of commercial discoveries, which would imply approval from the upstream
regulator of a field development plan. The time from discovery to FDP approval will be at least
three years and, hence, we have ignored this payment in our valuation for RIL assets.
The US$7.2bn payment for a 30% stake translates to a valuation of US$24bn for 100% stake.
Given that RILís stakes in the key blocks where discoveries have already been made (KG-D6,
NEC-25, KG-V-D3) are around 90%, we believe that the resultant valuation for RILís E&P portfolio
is around US$21.6bn (90% of US$24bn). Our current valuation for these blocks is US$17.4bn or
Rs263/share (note that the PMT fields are not part of the BP deal).
Thus, using BPís valuation, the implied value of RILís E&P assets rises by US$4.2bn or
Rs66/share. We assume that BPís higher payment is for exploration upside, though it may be a
plain premium for strategic access to Indian assets.
Premium is in line with recent M&A deals
The price paid by BP is 24% above our asset values. This is in line with the acquisition premiums
that have been paid in recent M&A deals involving listed corporates. Given that BP is getting
access to significant Indian exploration and producing assets in one stroke, we would have
expected the company to pay some premium over and above core asset value.
The implied value of RIL assets from the BP deal works out to Rs327/share compared to our
estimate of Rs263/share. However, we note that just a month ago, we sharply cut our valuation of
RILís E&P assets due to disappointing newsflow on production and reserves (see our note, A
mixed bag, dated 24 January 2011). Our valuation of the same assets before this cut was nearly
Rs395/share, ie BP has paid a lower price for these assets than our valuation of them just one
month ago.
Thus, while the deal does provide a positive surprise for us, after our cut, we suspect that the
consensus valuation for the E&P business is much higher, given that our target price of Rs900
before this announcement was the lowest on the street. Therefore, the deal the deal is unlikely to
positive versus street expectations.
Commercial issues still pending
As explained above, we cut our E&P valuations a month ago. These cuts were driven by newsflow
which indicated that RIL was facing technical challenges that were lowering gas production in its
KG-D6 blocks. Further, development plans for discoveries within the D6 and other blocks were not
getting approved, which we believed was related to commercial issues on gas pricing.
The deal with BP should bring in much needed technical expertise that should hopefully resolve
any production issues. However, the commercial challenge persists. New deepwater gas
discoveries will be expensive to develop relative to the D1/D3 field reserves within KG-D6, which
are already producing. Hence, new discoveries would need a higher gas price than is currently
being charged for the D6 gas (US$4.2/mmbtu). Our existing model assumes that the gas price
rises to US$5.5/mmbtu after 2014. But for new discoveries to be developed, the government
needs to provide clarity on future pricing. The D1/D3 fields were developed with pricing being
decided just a year ahead of production. However, we now believe that new developments are
unlikely to start unless the pricing issue is settled further in advance.
Target price raised to Rs966, maintain Hold
As explained above, we have factored in the higher value for the E&P assets as implied by the BP
deal and raise our SOTP target price from Rs900 to Rs966.
The deal is now likely to shift focus on RILís balance sheet and use of its cash. According to
management, investible funds over 2010-15 would be US$55bn-60bn after considering cash in
hand and internal cash generation. Announced capex plans on other hand amount to only
US$30bn spread as follows:
! US$10bn on petchem, from which investment decisions have been taken for only US$2.5bn;
! US$10bn on E&P (US$5bn on shale gas, rest domestic E&P);
! US$5bn on telecom and retail; and,
! US$2bn-2.5bn on maintenance capex.
With this deal, RIL will receive cash inflow of US$7.2bn and its future capex on domestic E&P
assets will drop by 33% (since its stake will reduce from 90-100% to 60-70%). This cash inflow,
expected in FY12, is virtually equal to our current RIL net debt forecast for end-FY12
(US$7.45bn). Thus, with this deal, RIL would need either to provide new investment plans or
perhaps return cash to shareholders. The dividend payout ratio, which has historically been in the
11-13% range, could perhaps be increased.
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