>RELIANCE CAPITAL: Recent stake sale in life (NIPPON) insurance and asset management businesses

Recent deals ease pressure on capitalization, accounting practices overhang persists.
Reliance Capital made capital gains of Rs34 bn from the recent stake sale in life insurance and asset management businesses. The significant capital increase (42% of FY2011 net worth) due to these transactions eases its leverage. Revaluation of its existing investment in the life insurance business boosted the reported net worth by an additional 28% (Rs22 bn). We are not comfortable with the accounting practice of boosting net worth through asset revaluation; expect stock performance to remain muted despite inexpensive valuations and successful completion of these deals.

Leverage under control after recent deals though accounting practices concern continues
High leverage at Reliance Capital (RCAP) has been a cause for concern in the past though recent deals with Nippon Life provide solace. We are, however, not comfortable with the recent revaluation of its investments in the life insurance business which boosted FY2011 net worth by 28%, i.e. Rs22 bn. The loan book of the NBFC business (operated from the balance sheet of the parent company) increased by 23% yoy and had an effective leverage (after adding the realized capital gains) of 5X as of March 2012.


Investments exceed net worth in 2011
In March 2011, RCAP’s equity investments (and NCD/ preference share exposures to group companies) exceeded its reported net worth. Thus, the residual economic capital (available to the NBFC business, had this been a separate subsidiary) was negative. We note that some of the investments in group companies are made through preference shares or convertibles and can hence be considered as quasi equity.


As of March 2011, RCAP’s reported investments stand at Rs122 bn of which the aforesaid (equity/group company) investments were Rs82 bn—higher than the consolidated net worth of Rs78 bn. In addition, RCAP’s NBFC business had a loan book of Rs123 bn which effectively did not have any equity support (had the NBFC been a separate company).


In the past, RCAP had carved out the NBFC businesses in distinct subsidiaries. Notably, over the past 4-5 quarters, RCAP has merged the NBFC businesses back into the parent company.


Strong brand name and strength of the Reliance group provided comfort to rating agencies even as effective leverage was high. Currently, the bonds of RCAP carry AAA and AA+ ratings.


Leverage reduces post recent stake sale
We calculate capital gains (not factoring tax liability) of Rs34 bn for Reliance Capital from recent deals with Nippon Life:


􀁠 RCAP made capital gains of Rs19 bn in the recent 26% stake sale in Reliance Life. 


􀁠 RCAP will also make capital gains of Rs14.5 bn by selling 5% stake in Reliance AMC; the transaction was approved by the regulators last week.


After adjusting these transactions, we estimate consolidated net worth of RCAP at Rs112 bn.
After reducing the adjusted investments of Rs82 bn, the core residual capital is Rs30 bn. As of March 2012, RCAP’s NBFC business had a loan book (including loans securitized) of Rs151 bn. Thus, the NBFC business already has asset to adjusted equity ratio of 5X (4.5X if we exclude securitized loans). We are not considering RCAP’s other debt investments and loans in our leverage calculation. In the past, the management had highlighted these are non-core debt investments and can be divested to fund its core business.


Recent accounting of merger boosted reported net worth
Prior to the stake sale to Nippon Life, RCAP had 100% economic interest in the life insurance business though about 84% stake in the life insurance was held by two of its affiliate companies (Viscount Management Services and Viscount Management Alpha Services).


While selling stake to Nippon Life, Viscount Management Alpha Services’ investments (48% in Reliance Life) were revalued upwards. In 4QFY12, Reliance Life itself realized the gain made by Viscount Management Alpha Services. Thus, RCAP’s consolidated net worth increased by Rs41 bn as compared to capital gains of Rs19 bn from the transaction, thereby boosting its net worth by Rs22 bn.

RISH TRADER