>RELIANCE POWER: Merger of necessity? (MACQUARIE RESEARCH)

Event
■ On Sunday, 4 July, the Boards of RPWR and Reliance Natural Resources Limited (RNRL, NR) approved a scheme of amalgamation of the companies in a 4 (RNRL) for 1 (RPWR) share swap. Our initial thought is that this transaction is done out of necessity rather than value creation. An investor call is being held before market tomorrow. We retain our Underperform.

Impact
■ Look like a defensive move, rather than value creation: The recent RNRLRIL Supreme Court decision highlighted that the Government has ultimate control of how gas supply in India is allocated. RNRL itself has no power projects of its own – it’s essentially trading the gas – against the Government’s desire to allocate gas to end users and not traders. Therefore in our view, the absence of any gas assets in RNRL meant that this transaction was done as a necessary step to ensure gas allocation, rather than for value creation.

■ Pro forma accounts – RPWR still expensive: We provide a snapshot of pro-forma accounts of the transaction. The Price/Book Value (P/BV) after adjusting for the potential goodwill created from the transaction, sees the metric worsen to around 3.2x P/BV. Stripping out cash + investments implies a P/BV of 11.8x highlighting the early stage of the execution cycle for the combined RPWR-RNRL entity.

■ Other RNRL assets more speculative: The only real fundamental value that RNRL could bring to RPWR shareholders, in our view, is the undeveloped gas assets. Again, it seems that RPWR has paid an enterprise value of ~US$1.4bn for this more speculative upside. We need to do more valuation work around these assets.

■ Finer details on conference call tomorrow morning: at 8:15am (India time) to discuss the transaction. Call details within the note.

Earnings and target price revision
■ No change.

Price catalyst
■ 12-month price target: Rs107.00 based on a DCF methodology.
■ Catalyst: Details of gas pact between RIL-RNRL within the next month.

Action and recommendation
■ Underperform, with the stock trading at approximately a 40% premium to our valuation. With financial closure only achieved for 17% of its project pipeline, we believe there is still a long way to go regarding project execution.

To read the full report: RELIANCE POWER