NTM193305003007. E010901
V.- ANÁLISIS SEMÁNTICO DE LA TERMINOLOGÍA UTILIZADA
V.II. - ESTRUCTURA EN ÁRBOL E ÍNDICE DE MATERIAS
127 FREE CASH FLOW TO EQUITY
Free Cash Flow to Equity (FCFE) means a measure of how much amount of cash can be paid to the equity shareholders of the company after the payment of all the expenses, reinvestment and debt repayment.
It is calculated as:
FCFE is many a times used by analysts to determine the value of a company.
In the valuation of RIL, the two stage FCFE model has been used. According to this model, the value of a stock is the present value of the FCFE per year for the extraordinary growth period plus the present value of the terminal price at the end of the period. It can be written as:
Where,
FCFE (t) = Free Cash flow to Equity in year t
Pn= Price at the end of the extraordinary growth period r = required rate of return to equity investors in the firm
The terminal price is generally calculated using the infinite growth rate model,
Where, gn= Growth rate after the terminal year forever.
In the case of RIL for the current period:
Current Earnings per share= 133.86 (Capital Spending - Depreciation)*(1-DR) 1.2 Change in Working Capital * (1-DR) 59.87
Current FCFE 75.19
128 And in the case of RPL,
Current Earnings per share= 0.19 (Capital Spending - Depreciation)*(1-DR) -0.14 Change in Working Capital * (1-DR) 1.4
Current FCFE -1.06
It has been assumed that the growth rate would be 9% for all the periods for which the calculation has been shown. Moreover, it has also been assumed that the beta (β) for the company will be stable for the period i.e., it would not change. The working capital as a percent of the revenues is 14% for RIL and 15% for RPL. The return on equity in the stable growth period is 17.48% for RIL and 16.10% for RPL.
The depreciation/amortization is added back to the cash flows because free cash flow is meant to measure money being spent right now and the not transactions that happened in the past. This makes FCFE a useful instrument for identifying growing companies with high up-front costs, which may eat into earnings now but have the potential to pay off later.
Through FCFE we can find out the total amount that the co mpany could have paid in the previous years. The Free Cash flow to Equity (FCFE) is a measure of how much cash is left in the business after non-equity holders (debt and preference shareholder) have been paid, and after any reinvestment needed to sustain the firm‟s assets and future growth.
If FCFE>Dividends, this means that company is paying too less to its shareholders. But when FCFE<Dividends then company is paying too much to its shareholders.
In case of RIL, the dividend per share for the current period is 13. From the above given figures, it can be seen that the dividend paid by the company is less than FCFE. Hence management is in pressure to pay more to its shareholders. But it is also because the company has invested the earnings for the expansion and further investments which help the company to increase the shareholders wealth in the long run.
The future plans of action for the company are:
1. Basic studies of new material development in Hazira.
2. Treatment of plant waste water streams for re-use.
129 3. Development of nano metal/metal oxides composites of polyolefin.
4. High shrinkage fiber development in Dhenkanal.
5. Nano structured catalysts for hydrogenation and dehydrogenation processes in Vadodara.
6. Nano structured adsorbents for purification and recovery of monometers.
7. Installation of SSM air texturing pilot machine in Silvassa.
8. PFF silicon finish oil consumption to be reduced by 0.5 Kg/MT in Hoshiarpur.
In the case of RPL, the company has not been paying any dividends because RPL is yet to fully commission its refinery and generate the revenues which can be distributed to the shareholders.
Though the figure for the FCFE is negative, it does not mean that financially the company is not sound. It is negative because the company has only recently started production (only 15 days of production till March 2008).
The estimations for both the companies can give a better view about the future of the company.
The estimations for the next four years for RIL are:
Particulars 1 2 3 4 Terminal Year
130 FREE CASH FLOW TO THE FIRM
Free cash flow for the firm (FCFF) is a measure of a company's profits after it has laid out money for all expenses and reinvestments. FCFF means a measure of financial performance that expresses the net amount of cash that is generated for the firm, consisting of expenses, taxes and changes in net working capital and investments. It is calculated as:
This is a measurement of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial health.
It is one of the most important criteria to check the financial condition of a company. A positive value would indicate that the firm has cash left after expenses. A negative value, on the other hand, would indicate that the firm has not generated enough revenue to cover its costs and investment activities. It indicates bad financial health of the company.
In the valuation of RIL, the two stage FCFE model has been used and t his model is designed to value the equity in a firm, with two stages of growth, an initial period of higher growth and a subsequent period of stable growth.
In case of RIL,
Current EBIT * (1 - tax rate) = 24468.28 - (Capital Spending - Depreciation) 150.81 - Change in Working Capital 7512.8
Current FCFF 17106.29
And in case of RPL:
Current EBIT * (1 - tax rate) = 248.05 - (Capital Spending - Depreciation) -64.77 - Change in Working Capital 627.82
Current FCFF -315.01
131 It has been assumed that the growth rate would be 9% for all the periods for which the calculation has been shown. Moreover, it has also been assumed that the beta (β) for the company will be stable for the period i.e., it would not change. The working capital as a percent of the revenues is 14% for RIL and 15% for RPL. The return on equity in the stable growth period is 17.48% for RIL and 16.10% for RPL.
The shareholders generally don‟t prefer negative cash flows for the company in any year until they get good returns. Negative cash flow does not necessarily mean loss, and it may be due only to a mismatch of expenditure and income. Having positive FCFF implies that the company has free cash flows, which is good news for the investors. Therefore, before investing in any company, the investors should also have a look at the FCFF of the company.
The value of FCFF for RIL is positive, which implies that company has a sound financial health.
In case of RPL, the value is negative but it does not imply that the company‟s financial health is low. It is negative because the company has only recently started production (only 15 days of production till March 2008). The estimations for the future can give a better picture of the company‟s financial position.
The estimations for the next 4 years are given as under:
Particulars 1 2 3 4 Terminal Year
EBIT * (1 - tax rate) 28,391.43 32943.59 38225.62 44354.56 56098.14 - (Cap Ex-Depreciation) -174.99 -203.05 -235.60 -273.38 -11112.98 -Chg. Working Capital 3121.97 3506.50 4068.72 4721.08 0 Free Cash flow to Firm 25544.45 29640.14 34392.51 39906.86 67211.12 Present Value 2250.32 23017.09 23535.28 24065.12
Similarly, the estimations for RPL for the 4 years are as follows (these figures are only 15 days figures):
132
FINDINGS
1. The financial ratios of RIL reveal a good financial health of the company, as the company has an increasing book value in last five years. The company has strong payout and liquidity ratios.
2. The stocks of RPL are more stable when compared to RIL. Thus, the volatility of RPL stock (0.48) is lesser than RIL‟s stock (0.54)
3. Weighted average cost of capital (WACC) of Reliance Industries Limited (13.48%) is more than Reliance Petroleum Limited (11.15 %). This is because RPL is better leveraged than RIL.
4. In case of RIL, the dividend paid by the company is less than FCFE but it is so because the company has invested the earnings for the expansion and further investments which help the company to increase the shareholders wealth in the long run. While in the case of RPL, the company has not been paying any dividends because it has not yet become due to the investors.
5. The positive value of FCFF for RIL implies that company has a sound financial health. In case of RPL, the value is negative because the company has only recently started production (only 15 days of production till March 2009).
133
CONCLUSION
The capital cost of RPL‟s project was estimated at Rs. 270 billion. The project was funded through debt (Rs. 157.5 billion) and equity (Rs 112.5 billion).
RPL went for an Initial Public Offer (IPO) through the book building process and it fulfilled certain guidelines issued by SEBI called Disclosure and Investor Protection Guidelines (DIP) and to raise funds through debt, guidelines of the Reserve Bank of India for External Commercial Borrowings were complied with.
Also software using the functions of Microsoft Excel 2007 called the Portfolio Tracker was created which helps in calculating the gain or loss on the stocks of a portfolio.
By analyzing the merger of RPL with RIL, it can be concluded that the swap ratio for the merger which is 1:16 would mean that there will be a dilution of 4.4% of fully diluted RIL equity is in favor of the shareholders of RPL.
The deal is believed to be a win-win situation for the shareholders of both the companies. This can be attributed to the fact that post merger RIL will have improved Cash Flows and Balance Sheet along with a lower cost of capital. Moreover, the merger will help in unlocking the operational and financial synergies that exist between the two companies.
The financial ratios and free cash flows of RIL state that the company is in good financial health.
RPL has started its operation on 15th March, 2009. Hence only 15 days operational data has been made public. Currently the company has been highly leveraged as D/E Ratio for the company is 0.95:1 because RPL is a new project and requires heavy machinery.
The weighted average cost of capital (WACC) for RIL is higher than RPL and hence the valuation of RPL is better when compared to RIL (in respect of WACC).
But considering the fact that RPL is a new project and the estimations of the company statistics may show high variations from the actual results, RIL seems to be a good investment option.
This is because the Reliance Industries Limited has managed to be a profit generating company
134 since last 30 years. Thus, past data suggests that though RPL is a relatively stable stock option for investment, RIL‟s past data promises to increase the shareholders wealth.
We can also conclude that buying the shares of RIL will yield better results for the shareholders even though RIL stocks are more volatile as compared to the shares of RPL. This is because the former has a record of sustained earnings since its inception.
135
RECOMENDATIOS
Based on the study, it can be said that the RPL shareholders would benefit in the long term from the merger with RIL and the stakeholders should not exit the market by selling their shares of RPL. This is because after the merger, RPL shareholders will be gaining from the upsides from RIL‟s petroleum business as the company will be gaining from the strong value accretion due to exploration of the large unexplored acreage in the highly prospective areas.
Also, a steady rise in RIL‟s earnings is more likely than in RPL‟s earnings. There has been a secular rise in RIL‟s earnings since its inception. Because there are a number of subsidiary companies under the group, any decline in earnings of one subsidiary is set off against the increase in the earnings of the other subsidiaries.
Moreover the downturn of the refining sector post global slowdown has increased risks for RPL as a standalone unit. Therefore, the merger with RIL would expose RPL shareholders towards a relatively stable exploration business, integrated refining and petro-chemical business and emerging retail business.
The swap ratio of 1:16 will put the RPL shareholders in the same position after the merger as the shareholders of RIL as they are in now. Thus, we can say that the merger will benefit t he shareholders in the both the long and the short run.
136
DECLARATION
The reports and notes on merger and valuation of the company is completely my work and it is as per my understanding. Same are not vetted or authorized by the Company.
137
REFERENCES
FROM PRINT MATERIAL
1. IM Pandey, 2008, Financial Management, Vikas Publishing House, 9th Edition, pp.432-434
2. IM Pandey, 2008, Financial Management, Vikas Publishing House, 9th Edition, pp.438-440
3. Taxman‟s SEBI Manual, Volume I, 12th Edition, June 2008
FROM WEB PAGES AND ONLINE BOOKS
8. http://en.wikipedia.org/wiki/IPO [Accessed on 8 March 2009]
9. http://www.bseindia.com/bookbuilding/about.asp [Accessed on 8 March 2009]
10. Morgan Stanley, “Strategy Chart book January 5, 2007” [online] retrieved from : http://d.scribd.com/docs/jvxdvo8wvndwl0jl1w6.pdf [Accessed on 15 March 2008]
11. http://www.financeweek.co.uk/item/5608 [Accessed on 18 March 2009]
12. http://www.investopedia.com/terms/a/arbitrage.asp [Accessed on 25 March 2009]
13. http://www.ril.com/html/aboutus/aboutus.html [Accessed on 27 March 2009]
14. http://www.rbi.org.in/scripts/ECBView.aspx [Accessed on 27 March 2009]
15. http://finmin.nic.in/the_ministry/dept_eco_affairs/budget/annual_report/9900ea5.PDF [Accessed on 27 March 2009]
16. http://www.dare.co.in/funding/banks- loans/complete- guide-to-debt- financing.htm [Accessed on 1 April 2009]
17. http://entrepreneurs.about.com/od/financing/a/debtfinancing.htm [Accessed on 1 April 2009]
138 18. http://finance.mapsofworld.com/finance-theory/term- financing/ [Accessed on 2 April
2009]
19. http://wiki.answers.com/Q/Long_Term_Sources_of_Finance_in_financial_management [Accessed on 2 April 2009]
20. http://www.nos.org/srsec319/319-19.pdf [Accessed on 2 April 2009]
21. http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=107378 9573 [Accessed on 3 April 2009]
22. http://www.investorglossary.com/equity.htm [Accessed on 3 April 2009]
23. http://en.wikipedia.org/wiki/Capital_market [Accessed on 4 April 2009]
24. http://www.businessdictionary.com/definition/capital- market.html [Accessed on 4 April 2009]
25. http://www.karvy.com/corporatefin/mbdhome.htm [Accessed on 5 April 2008]
26. http://www.investopedia.com/terms/u/underwriter.asp [Accessed on 5 April 2008]
27. http://www.sebi.gov.in/acts/act041.pdf [Accessed on 5 April 2008]
28. http://www.investopedia.com/terms/s/stockbroker.asp [Accessed on 5 April 2008]
29. http://www.corporateinformation.com/Company-Snapshot.aspx?cusip=C3561HB00 [Accessed on 10 April 2009]
30. http://money.rediff.com/ [Accessed on April 23 till April 29]
31. http://www.valuenotes.com/vnteam/vn_poll_10Mar09.asp?ArtCd=142852&Cat=C&Id=3 5 [Accessed on May 4]
32. http://www.scribd.com/doc/924997/Rilrpl-Merril- Lynch [Accessed on May 4]
33. http://www.zeenews.com/Business/Companies-Commodities/2009-03-02/511871news.html [Accessed on May 5]
34. http://www.worldenergysource.co m/articles/pdf/longwell_WE_v5n3.pdf [Accessed on May 5]
35. http://www.moneycontrol.com/india/news/business/rpl- merger-to-unlock-synergiescrude- sourcing-ril/387348 [Accessed on May 6]
36. http://www.hinduonnet.com/thehindu/holnus/006200903021937.htm [Accessed on May 6]
37. http://www.hinduonnet.com/businessline/blnus/02271910.htm [Accessed on May 7]
139 38. http://www.indianstocksnews.com/2009/02/ril- rpl- merger-what-should- investors-do.html
[Accessed on May 7]
39. http://www.thehindubusinessline.com/iw/2009/03/01/stories/2009030151040700.htm [Accessed on May 8]
40. http://www.financialexpress.com/news/RILRPL- merger-gets-shareholders- nod/444294/
[Accessed on May 8]
41. http://www.zenwealth.com/BusinessFinanceOnline/FF/PercentageOfSales.html [Accessed on May 8]
42. http://www1.economictimes.indiatimes.com/articleshow/4210317.cms [Accessed on May 11]
43. http://economictimes.indiatimes.com/RIL-RPL-Merger-Fate-of-treasury-stock- uncertain/articleshow/4203064.cms [Accessed on May 11]
44. http://economictimes.indiatimes.com/rssarticleshow/4211288.cms [Accessed on May 11]
FROM LEGAL MATERIALS
1. Reliance Petroleum Limited Prospectus April 28, 2006. S.I. 2006
2. GOVERNMENT OF INDIA. August 2005. Guidelines on External Commercial Borrowings Policies & Procedure. GOI Ministry of Finance. S.I. 2005
3. RELIANCE PETROLEUM LIMITED. 2007 -08. Annual Report. S.I. 2008 4. RELIANCE INDUSTRIES LIMITED. 2007-08. Annual Report. S.I. 2008 5. Other Internal Documents of the Company referred.