RIL's Bid for LyondellBasell - A Compelling Opportunity

By making a bid for LyondellBasell’s assets, Reliance seems to be getting serious about the global petrochemicals business.

When Reliance Industries sold treasury stocks of Rs 3,188 crore in September 2009, analysts were suggesting that the company would invest the proceeds in a global acquisition. These expectations do not seem unfounded now. Not even a week had elapsed since Reliance Industries’ Annual General Meeting that things started rolling as the company firmed up its plans to acquire a controlling interest in the bankrupt petrochemicals company LyondellBasell Industries (LBI).

LyondellBasell was created from a merger of Basell and Lyondell in 2007. Basell was the one of the largest chemical companies situated in Europe, and is one of the largest producers of polypropylene and polyolefins products. Lyondell was one of North America's largest producer of chemicals and plastics, and a refiner of heavy and sulphur crude oil. Although it’s still premature, the big-ticket investment is termed as the most expensive buy-out done by an Indian company, valued at about $10-12 billion or around Rs 50,000 crore. The deal, if it goes through, would create a global energy and chemicals giant with nearly $ 75-80 billion in combined revenues, which is more than twice RIL’s FY09 revenues.

What’s in it? 


With LBI’s revenues of $50.7 billion, being almost five times that of RIL’s petrochemical revenues, the acquisition has the potential to make RIL a leading global petrochemical company. The deal comes at a time when asset valuations in the Western markets are relatively lower as the global economy would need more time to come out of the woods completely.

Deepak Pareek, analyst, Angel Broking, “On account of a global economic slowdown and the decline in margins in the petrochemical segment, there has been a steep decline in replacement costs and asset values. Hence, the timing of the deal seems fair from a valuation perspective. With this backdrop, RIL is likely to press hard for an attractive bargain, which, in turn, could mean even better valuations.”

At cheaper valuations, buying a facility would make more sense for RIL compared to setting up a new plant as it would involve a long gestation period and higher opportunity cost. So strategically, a purchase like LBI is perfect.

With LBI, RIL can grow from a dominant domestic petrochemical player to an important global player though it is difficult to ascertain a specific figure in terms of market share increase as both companies are present in diverse products. Besides, the acquisition would allow it to gain access to LBI’s main markets of the US and Europe. With LBI being a technology-leader in polyolefins, the acquisition would enhance RIL’s technological advancement in RIL’s domestic operations. As a combine, both companies could enjoy a global monopoly in the polypropylene and polyethylene segments.

However, Vishwas Katela, analyst at Anand Rathi Securities, cautions: “A global acquisition of the size of  LBI would mean that RIL will have to manage operations not across few countries, but across continents.”

Another big difference is that RIL uses the cheaper natural gas route, and enjoys better margins, while LBI’s plants primarily use oil-based feedstock. This could pull down the blended margin as a combine. To an extent RIL can tackle this problem and create cost efficiencies, by shutting down LBI’s high-cost commodity chemicals and plastics facilities in the West and outsource it to the Indian facilities.

The right price

With this acquisition, RIL will have to contend with a company that carries a substantial debt of over $20 billion from a leveraged buyout done earlier. The massive debt deteriorated LBI’s financials and along with weak petrochemical margins in the second half of 2008, questions were raised on the survival of the third largest petrochemical player in the world. Subsequently, LBI had to file for bankruptcy protection under Chapter 11 in January 2009 to restructure its debt. At the end of September 2009, LBI has $22 billion in liabilities, with around $12 billion subject to compromise. This includes about $8.1 billion of its debtors-in-possession bankruptcy loan, which is a loan available to bankrupt companies at favourable terms. LBI needs to repay this loan by December 2009. To come out of bankruptcy, LBI is considering several non-binding equity financing offers including RIL’s offer.

Obviously, trying to estimate what value RIL will ascribe to LBI is a multi-billion-dollar question. There is consensus that LBI‘s enterprise value could be in the range $10 to 12 billion. On sizing up the probable deal, Jal Irani, head of research, Macquarie Securities, says, “Large global chemicals companies quote at an enterprise value/earnings before interest, tax and depreciation (EV/EBITDA) multiple of about 10 times and the US-based pure refiners quote an EV/EBITDA of 9 times. Applying these multiples to LBI’s annualised EBITDA (2009E), we get an EV of $20 billion. On the other hand, since LBI’s net worth is negative, the entire value lies in the $25 billion of outstanding debt. LBI’s bonds are quoting an average 50 cents to a dollar, implying an EV of $12.5 billion.” However, we cannot rule out a possibility of RIL attaching a premium to LBI as the opportunity is impressive in terms of size, product segments as well as geographical diversification.

Funding the purchase

Although the exact contours of the deal are not known, most of the stake that RIL proposes to buy would be in cash. The question is, does RIL have the wherewithal. RIL has cash worth $ 4.9 billion (about Rs 23,000 crore) and around $ 8 billion (Rs 37,000 crore) in treasury stock. Thus, RIL has the required amount in its books to make a cash offer. Crisil observes, “RIL’s majority ownership in LBI could get funding without any additional debt on the books of RIL or that of its consolidated group companies. Existing cash and sale of treasury stock will be used for the purpose of funding the acquisition.”

Crisil further adds that RIL’s gross debt to equity ratio would not exceed 0.75 times during the deal process. With RIL’s gross debt-to-equity at around 0.6, gives enough scope for RIL to further leverage its book and borrow another $3-4 billion

The funding might not be an issue. But the deal is not likely to be closed in a hurry -- the courts are expected to deliver the verdict on the fate of LBI’s restructuring in February 2010. So other potential bidders still have time to throw their hat in the ring to communicate their interest in the distressed company.

Outlook

This deal could be value accretive. This is why, at an enterprise valuation of $12 billion and an EV/EBITDA multiple of 5 (compared to average peer value at 8.6 and RIL at 9.6), could deliver an additional earnings per share of around Rs 25.5 in 2011. With RIL projected to deliver an EPS of around Rs 157, the value accretion is about 16 per cent.

As far as the other bidders are concerned, a higher proportion of the cash drain and monopoly issues could act as a hindrance for American companies. For Chinese companies, their preference for upstream buy-outs compared to downstream might go in favour of RIL.

Operationally, Reliance’s petrochemicals business delivered better margins (around 17 per cent) in the first half of 2009, on the back of better domestic realisations and pick-up in volumes. RIL’s overall margins were down in H1 FY10 as gross refining margins halved to around 6-7 per cent compared to previous period. For the future, the ramp-up of gas production, incremental refinery volumes from Reliance Petroleum refinery and sustained petrochemical margins would drive the earnings growth.

The RIL stock has underperformed the broader indices since March (the Sensex grew 95 per cent, while RIL went up 70 per cent in this period). Experts believe the stock could be a market performer from now on. The stock is trading at around 18-19 times and 13-14 times, its estimated 2010 and 2011 earnings. It can be accumulated on dips.

Source: Business-Standard

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