Deleveraging To Boost Stocks

By the time you read this, Reliance Jio’s rollout of fixed line broadband commercial services will have started.  Offerings of fast fibre-based home broadband will be backed up by bundled set-top boxes and LED TVs. In addition, Jio will offer cloud-based services to businesses, by partnering with Microsoft. It is also entering the Internet of Things (IoT) segment.

This is coupled with various measures for reducing the Rs1.54 trillion debt on Reliance Industries Limited’s (RIL) balance sheet. RIL intends to go debt-free in the next 18 months. It also intends to list Reliance Jio Infocomm and Reliance Retail as separate companies within the next five years.

One key move is to try and sell a stake to Saudi Aramco, one of the world’s largest crude and gas producers, for $15 bn. This involves RIL hiving off the Oils-to-Chemicals division (by far, the largest business segment of RIL) into a separate company.  In addition, British Petroleum (BP) will take a stake in another Reliance subsidiary (marketing petro-products for around $1 bn)

Aramco plus BP adds up to `1.15 trillion (assuming $1 = roughly `70) cutting debt substantially. Plus, RIL has hived off towers and fibre assets into an Infrastructure Investment Trust. It can sell stakes in that too.

Assume all this happens as planned. Five years later, RIL will be a holding company, operating only its exploration and production business, while holding stakes in listed entities like Jio, retail, oil and chemicals business.

Jio will target 500 million mobile subscribers, 18-20 million home broadband subscribers, and 15 million business clients. IoT and cloud services will provide new revenue streams.  The entertainment and media division will piggyback Jio operations while retail will also benefit from online-offline play.

This sounds good for the group. Investors must be optimistic and assume that the game plan will eventually come to pass, though timelines may be extended. Apart from higher dividends, investors can hope to be given stakes when these arms are listed. Any standalone business tends to get better valuations than a conglomerate, so the break up into multiple companies should automatically lead to capital gains.

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So there is an upside to holding Reliance Industries. Even if you do not directly own RIL, the company has a huge weight in Nifty and Sensex, because of its huge shareholder base.  RIL stock has been an underperformer precisely because many investors are worried about its large debt-pile. This perception will change.

One thing worth considering is, the two other telecom service companies still in business (ignoring the bankrupted MTNL and BSNL), Vodafone-Idea and Airtel may have to respond in some way, or another,  to the rollout.

Vodafone has zero presence in fixed broadband. Airtel has some. Can either of them fund the investments required to survive another price war? Or do they cede this space completely? Can they figure out how to match Jio in terms of entertainment options, and what do they do on the cloud and IoT front?  It is not good for any industry to turn into a monopoly.  If it happens in telecom, which is a massive enabler for other industries, the lack of competition would be bad for the  economy as a whole.

The second consideration is even broader. Reliance has been singlehandedly responsible for a huge chunk of private sector investment in the past six years. It has invested over Rs5.5 trillion since 2013, with close to half of that going into setting up Jio.

Now Ambani says, the investment cycle is nearly over for Jio. Reliance is clearly looking to pull back on future investments by cutting debt, rather than borrowing to continue investing.  Unless other companies take up the slack, overall private investment could fall over the next 18 months, as Reliance eases off the accelerator.

Private investment is a key precondition for strong economic growth. This tapering off on the part of RIL could have negative implications. It will hit the financial industry for example, since there will be less demand for funds. This is worth bearing in mind as well.

The author tracks economic, behavioural and corporate trends, hoping to gauge good avenues of returns