Is it Hep, Hype or Hope?

Will the investors exclaim ‘Jio’ after listing?

Reliance Industries had a footprint in the financial services sector but it moved to Anil Ambani as part of the demerger under the family split in 2006. After a gap of nearly two decades the parent Reliance Industries has re entered the space with the creation of the new entity with the indicated name of Jio Financial Services Ltd.

The subject has been hogging the headlines in the media and the process of setting up the business as a separate venture has been engineered through a demerger of the carved out financial services business effective from the close of the business hours on 31^st March 2023.

Reliance Industries Ltd has been the umbrella under which the entire spectrum of the ventures the group is engaged in is carried on. Some are within the legal entity of the main company and a few like the retail and telecom are housed in subsidiaries.

The segments primarily reported by the company has been refining, petrochemicals, oil and gas, retail and digital services. For the first time in the annual report of the year ended 31^st March 2020 financial services featured as a new segment.

The scheme of arrangement that constitutes the base document for the emergence of the financial services entity defines the financial services business as below-

"Financial Services Business" means the division of the Demerged Company engaged in investment and other financial services business including non-banking financial services, insurance broking, payments bank, payment aggregation, directly and through its subsidiaries and joint ventures other than the investments of the Demerged Company in Reliance Ventures Limited and Reliance Strategic Business Ventures Limited.

Investments in subsidiaries and joint ventures engaged in Financial Services Business including investments in Reliance Industrial Investments and Holdings Limited is part of the FS undertaking.

Further, as an integral part of the reorganization, Reliance Industrial Investments and Holdings Limited pursuant to a separate arrangement shall transfer its investment (in the form of shares) in its wholly owned subsidiaries namely, Reliance Retail Finance Limited, Reliance Payment Solutions Limited, Jio Information Aggregator Services Limited and Reliance Retail Insurance Broking Limited to the Resulting Company (FS entity).

The actual scope of the FS business and its outreach will become clear only when an independent accounts of the cluster of the companies featured in the above definition is made available in the public domain.

It is hoped that along with the first quarter result of the main company, the results of the new FS business would also be provided though the listing regulations may not apply to this currently.

Before making some dissection of the FS business of the company as presently reported, a few more aspects deserve some elucidation.

The scope of the FS undertaking (demerged undertaking) includes the investment the parent has in Reliance Industrial Investments and Holdings Limited. This investment has moved to the resulting company which is the vehicle for the FS business henceforth.

Reliance Industrial Investments and Holdings Limited has an interesting history. This entity had a significant investment in one of the ventures of the Reliance group set up for petroleum refining which had independently raised capital in the market like many other such ventures that the group spawned of in the 1980s and 1990s.

This off shoot entity was merged into the parent Reliance Industries sometime around 2002 and the scheme of merger provided that the shares to be allotted upon the merger would also be issued to Reliance Industrial Investments and Holdings Limited for its stake in the amalgamating entity.

The aspect to note is that Reliance Industrial Investments and Holdings Limited was itself a subsidiary of Reliance Industries Ltd and the shares of the parent that arose for issue on the merger was permitted by the court to be issued to the subsidiary as well.

Reliance Industrial Investments and Holdings Limited set up a trust by the name of Petroleum Trust to facilitate the holding of the shares of Reliance Industries Ltd. At that point in time the holding was around 7.5% of the parent’ capital, a substantial figure.

This arrangement has remained undisturbed for over two decades and the change in the company law in 2013 that prohibits such practices did not upset the old transaction.

The company has been treating the holding of the Petroleum Trust as a promoter holding. It appears that the current holding is only around 3.75% as against the original 7.5%. The possible reason is that when the company made a 1:1 bonus issue in 2017, due to the prohibition in law it may not have been possible to allot shares to its own subsidiary, thereby diluting the original stake.

All this should be independently verified by any reader and may require significant time to collate and correlate the details.

Be that as it may, as on date Reliance Industrial Investments and Holdings Limited holds a 3.75% stake in Reliance Industries Ltd through the Petroleum Trust and that holding also moves as part of the demerger to the FS entity.

This will create a cross holding, though minimal, between the FS entity and Reliance Industries Ltd while the avowed objective was to actually separate them.

This has also created some detriment to the promoters as the new shares arising on the demerger which the FS entity would issue to all the shareholders of Reliance Industries Ltd cannot be issued to Reliance Industrial Investments and Holdings Limited (Petroleum Trust) as it has now become a subsidiary of the FS entity!

Technically the promoter holding in the FS entity will not mirror their holding in the parent entity. They end up with a smaller percentage of 45.80 in the FS entity as compared to 49.11% in Reliance Industries Ltd.

The FS entity would issue one equity share as a swap to each share held in Reliance Industries Ltd. It is interesting to note from the data provided to the stock exchanges by the company that nearly 75% of the investors in Reliance Industries Ltd hold less than 100 shares each. Shareholders holding up to 15 shares each constitute 39.6% of the total shareholders.

The document submitted to the exchanges clarify that the swap ratio of 1:1 was principally to avoid fractional share issue problem that may have arisen if the ratio was anything reflecting the true size of the two entities.

The share exchange ratio in a demerger into an empty shell like what has been done in this case helps avoid the delicacy of a valuation that may raise multiple questions.

The FS entity would start with a base capital of Rs 6765.67cr, possibly the biggest among FS companies including banks; HDFC bank would be approximately a tenth of this before the new issue for the HDFC shareholders!

There is a major hype in the markets on the arrival of the record date (20^th July) to determine the eligible Reliance shareholders for receiving shares in the FS entity.

Hardly anyone I spoke with had a clue about the offspring and what it represented. Of course, the big investors may have done their homework. Surprisingly, little in terms of what the current state and size of the business being carved out featured in the media reports.

It would be essential to set out the details about the FS business for the benefit of those looking to make their fortune in this new listing in the market as and when it takes place.

The consolidated revenue of Reliance is almost Rs 10tn in FY2023 and the FS’ share is about 0.09%. The assets of FS being demerged is Rs100823cr and constitutes 5.88% of the total assets. The net worth of FS of Rs25851cr is a small fraction of the consolidated number of Rs416706cr.

The aspect that may need a deeper examination is whether the FS is an active lending business or primarily comprising of internal group investments. The reason to get this doubt is that the gross revenue of FS business in FY 2023 is 0.89% of its gross assets! The net worth of Rs25851 returned 1.9% based on the reported EBIT of Rs494cr; interest/taxes not known separately.

None of the data above will even set the driest nullah in the vicinity of Bandra on fire!

But so much effort may not have been taken to separate such a skeletal business when the group actually has much bigger business that can be separated like retail to unlock value for the investors.

Right now, the big part of the value of the FS entity may appear to be the indirect holding of 3.75% in RIL! But that is just arithmetic and may fail to capture the hep value of a shadow bank belonging to the biggest conglomerate in India with the added hype around fintech and a surging middle class as potential consumers of the retail business and the increasing culture to buy now and pay later!

The RIL shareholders get a gift coupon in the FS entity with no cost to them.  If the hype around the demerger turns into hope on listing, they will have no cribs and the cry of ‘JIO’ may bounce off the walls of the bourses!!

Should things flop, they can sell the new shares and book a capital loss as tax law allows a notional cost to the new shares!