Reliance Industries (RIL), in its bid to expand its global footprint in the petrochemical space, has given a preliminary, non-binding cash offer to LyondellBasell (LB) for acquiring a controlling stake in the company. The offer is subject to due diligence and sufficient creditor support. As per media reports, the deal size could be in the range of US $10-13.5bn in cash. If the acquisition goes through, it would be one of the biggest overseas acquisitions by an Indian Company. The deal would provide RIL with the chance to vault into the top ranks of global corporations in one swoop, as a successful acquisition would take the combined sales of the entity to around US $100bn.
Rationale for the deal: The key rationales behind RIL’s bid for LyondellBasell are attractive pricing, the global footprint and distribution network, technological benefits and an effort to maintain its growth rate.
a. Attractive asset price: Global economic slowdown and the decline in margins in the petrochemical segment, has resulted in steep decline in replacement cost and asset value. Hence, the timing of the deal seems fair from a valuation perspective as RIL is looking for an attractive bargain. The possible acquisition attempt could turn out be a cheap asset acquisition for the company.
b. Global footprint and distribution network: The acquisition of LB is to increase RIL's global footprint in the petrochemical and refining industry. LyondellBasell has operations in more than 19 countries providing RIL with an opportunity to leverage the markets and the client base of LyondellBasell. Moreover, it provides a platform for RIL to market its refined crude oil products.
c. Technological benefits: LB is the global technological leader in polyolefins and has licensed its process technologies to polyolefins manufacturers representing 50% of the global polyolefins capacity.
Moreover, around 40% of the global installed polypropylene capacities use LB’s licensed process technologies. Similarly, LB is the technology leader in the manufacture of propylene oxide. Thus, the acquisition would enhance the technological advancement of RIL for its domestic capacities.
d. Maintain growth rate: With growth and scale in the domestic businesses already captured by RIL, the transition of the business from the domestic-oriented business to an MNC is a much required task in order to maintain its growth rate. Hence, growth beyond its domestic boundaries provides a diversification opportunity and broadens the product portfolio for RIL
RIL to become a major player in the biggest petrochemical markets: The acquisition, made at the right price has the potential to catapult RIL to become one of the largest petrochemical company in the world, with world class scale, size and a foothold in the highly lucrative and niche technology licensing business, where LyondellBasell is one of the largest players. The acquisition provides access to a market share of 13% in Polyethylene and 18% in Polypropylene in North America, while the respective shares in Europe are 15% and 25% respectively.
This would make RIL a major player in the biggest petrochemical markets in the world. The move also provides synergies in terms of access to new geographies (North America & Western Europe) as well as new technologies (Lyondell is the biggest player in Petrochemical technology licensing worldwide).
Acquisition to strengthen RIL’s refining operation: The acquisition will also strengthen their refining operations, taking total capacity to over 1.6mmbblpd from 1.24 mmbblpd. Analyst anticipates that downturn in refining business is close to the bottom of the cycle. Margins should start to improve by 2011/12 when supply/demand re-tightens on the back of an economic recovery. Further, RIL seems to be best placed to maximize the potential synergies on crude purchases and logistic which will further enhance the deal value.
RIL to save substantially on account of synergy in operation: The acquisition will enable RIL to optimize its product transportation logistics, storage and crude purchasing which will unlock further value in the deal. While the majority of RIL’s current asset base is in India and the majority (60%) of their revenues is generated outside of India, primarily in Europe and the US through exports. Given LB's assets are based in Europe and the US, transportation synergies from logistics optimization could be $300mm per year, assuming a saving of $10 per ton of products shipped.
Furthermore, there will be synergies on crude purchasing given the higher purchasing power following the acquisition. Assuming a saving of 20 cents per barrel, total savings could be amounted to $120mm per year. On storage, an annual saving of $50mm is achievable. Taken together, it is estimated that RIL can save total of $470mm in cost on account of synergy in the operations.
Funding the bid is not an issue for RIL: RIL has cash worth about $5bn and could potentially raise another $7-8bn from the sale of 183m treasury shares. RIL has already sold treasury stocks worth over $2bn during last few weeks. RIL could still raise enough debt for other acquisitions or investments as it has a comfortable debt-equity ratio of 0.42x.
Risk: However, the risk for RIL is that their balance sheet gets stretched to the extent it triggers a credit rating downgrade on their debts. The acquisition will result in RIL gearing rising from 36% to over 50%. Given RIL's strong operating cash flow however, it is believed that they should be able to avoid a credit rating downgrade as their balance sheet position improves next year.
RIL to go-ahead only if the acquisition is value-accretive: RIL has a track record of being conservative and in the past, it has bought good-quality distressed assets at attractive valuations. RIL is likely to go ahead with the acquisition of LB only if it is value-accretive. If RIL eventually end up acquiring LB, it is likely to be earnings- and valuation-accretive.
Deal positive in long-run: Given that LB is in distress, and timelines are very compressed, RIL may get a very attractive deal, and if the deal happens at a valuation of $10bn-13.5bn, it should be positive over long term. In its reorganization plan, LB estimated the average EBITDA (excluding restructuring costs) of $1.9bn in 2009, $1.6bn in 2010 and $2.0bn in 2011. The average EBITDA for these three years at US$1.8bn is significantly lower than pro-forma combined EBITDA of $4.8bn of Basel & Lyondell in 2007. Even at these trough levels, the implied valuation multiples of 5.5-7.5x would be attractive.
However, in short term there could be several challenges: Given the size of LB ($50bn revenue in 2008), compared with RIL ($29bn), acquiring the company may be a very challenging task. Most of LB’s assets are in petrochemicals (the business is likely to endure difficult times in the near to medium term) and moreover most of plants are in high-cost regions like NA & EU. Several plants have already been shut down, and many more would need to shut over coming months/quarters. It also has two refineries (one in the US of 268 kbpd and another in EU of 105 kbpd). The refining business is going through challenging times. Also, with RIL already engaged in several issues in India (gas litigation, ramping up production in KG-D6, plans in SEZ and retail, etc), acquiring a company of LB's size will open another challenging front.
Ultimately, a new acquisition requires a lot of management time and attention. RIL has a fairly strong balance sheet with about $5bn in cash and large treasury stocks with a current value of over $8bn. Also, with a comfortable debt-to-equity ratio of 0.42x, the company should also not have problems in raising debt. However, raising a large amount of cash could put some pressure on financials in the near term.
Finally, and perhaps most importantly, cultural issues could be the clincher. RIL has had a very successful track-record of acquiring companies/assets in India and turning those around. These have included several small polyester groups in the late 1990s and early this decade (such as Recron Synthetics, Silvasa Industries, Central India Polyfibers, Orissa Polyfibers and Apollo Fibres).
Acquisitions in petrochemicals, such as IPCL, and the assets of NOCIL and SM Dyechem have also been a success. However, RIL’s only major acquisition in the developed world was Trevira, which did materlize well as anticipated and Trevira filed for bankruptcy early in 2009. LB is much bigger in size than any of earlier acquisition with nearly 60 plants in 19 countries and over 17,000 employees. The acquisition process could be long while post-acquisition it could take time to integrate the two large companies across several geographies.
Valuation of LB key for acquisition: The potential valuation is likely to be the key for any value-accretion for RIL. One of the challenges for RIL would be to enhance LyondellBasell's margins. LyondellBasell and its competitors in the region are likely to face stiff competition, as low cost assets come online in other regions. LyondellBasell's plants use oil-based feedstock instead of the cheaper natural gas, and could face competition from regions such as the Middle East, where oil-based facilities are cheaper.
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