EXPLAINED: LUCRATIVE SWAP RATIOS IN THE RELIANCE-FUTURE DEAL MIGHT BE DECEPTIVE!
It has been reported in the media for quite some time and so it didn’t come as a surprise. The high-debt burden forced Mr. Kishore Biyani to sell his most prized assets to Mr. Mukesh Ambani who has been on a deal-making spree.
What is Mr. Biyani selling?
- Retail & Wholesale Business [FLFL -Future Lifestyle Fashions Ltd and FRL -Future Retail Ltd]
- Logistics & Warehousing Business [FSCSL -Future Supply Chain Solutions Ltd]
In other words, Reliance Retail will now own all of Future Enterprises’ stores by way of a ‘slump sale’ – Big Bazaar, fbb, Foodhall, Easyday, Nilgiris, Central and Brand Factory. Reliance will also take over Future’s logistics and warehouse business.
What will remain with Mr. Biyani?
- Manufacturing and sourcing of fashion products (garments)
- Manufacturing, sourcing, branding and distribution of FMCG products
- Investment in JVs with Generali – Future Generali Life Insurance and General Insurance
- Investment in JV with NTC Mills (Textiles)
Where will Future group sell the FMCG products and garments that it will manufacture?
A Strategic supply agreement has been agreed upon between Future group and Reliance. This will give Future group the opportunity to sell its FMCG and fashion products in:
Existing Future group stores (even after being taken over by Reliance)
+ Existing Reliance stores
+ Upcoming JioMart platform.
Now, coming to the numbers part…
Let’s break it down into 2 parts. The first part is obvious and this is what has got many people excited.
Future Group runs its various businesses through subsidiaries. It is going to merge all of these subsidiaries with Future Enterprises Limited [FEL]. So, every shareholder in the subsidiary will get shares of FEL in lieu of the shares it holds in the subsidiary company. This is what we call a “Share Swap”. You are issued shares in one company against the shares you hold in another company.
Once, all the businesses are under one company, Reliance will buy the above mentioned wholesale, retail, warehouse and logistics business from FEL for 24,713 crores. This money will first be used for payment of debts and liabilities and only ~Rs 5,700 crores will be received by the company.
Reliance will acquire a stake of 13.14% in FEL for a total of Rs 2,800 cr via shares and warrants at a price of Rs. 17.65 post the transaction. This money will go to the company.
Now, let’s look at one example in detail so we understand the mathematics clearly.
A shareholder who holds 10 shares in Future Lifestyle Fashions Ltd will get 116 shares of FEL.
*CMP – Current Market Price [CMP] as of Friday market close.
On first glance, it seems there is a sure-shot fortune to be made. You buy 10 shares of FLFL by paying Rs 1,450/- and you get 116 shares of FEL worth Rs. 2,332!!
And it’s not just FLFL, all swap ratios seem stacked in favour of the subsidiaries in the Reliance-Future Deal.
What’s the catch? This is the 2nd part which is more interesting.
Remember, the shareholder of the subsidiary is not getting this money in cash. It’s in the form of shares in FEL. The biggest variable here is the share price of FEL. What if FEL shares are worth much less by the time the merger transaction is completed?
Let’s try to figure out how FEL will look like once the merger is done.
These are the P&L figures for FY 19-20 for the segments which will be retained by FEL.
Pro-forma balance sheet after the all above mentioned transactions are completed (Post merger and slump sale to Reliance):
Net worth of FEL is expected to be Rs 3,290 crore. What is the net-worth per share, also known as book value per share? [Networth divided by the total number of shares]
As of now, the total number of shares is 45.49 crores. That’s a book-value of Rs 72 per share. Wow!
Wait a minute, remember the share swap?
New shares will be issued to shareholders of subsidiary companies.
What’s the number of shares issued for the swap?
1022.43 crore shares. The adjusted book value is Rs 3 per share! [3290 / (1022.43+45.49)]
This is what dilution does to share prices. That’s why the old saying “Raise Capital Only When You Need It.”
[We have not considered the 13.14% stake that Reliance will buy at 17.65 per share. That’s another 158 crore shares. Let’s not get into that to keep things simple.]
That’s a very broad range – BV of Rs 3 and Reliance acquisition price of Rs 17.65. The market price will settle somewhere in between. But you need to remember this, FEL price should settle above Rs ~13 per share to ensure that swap ratio is not detrimental to the shareholders of the subsidiaries.
In other words, if you buy the shares of subsidiaries at their CMP, you will have to hope that FEL price does not fall below Rs ~13, otherwise you will end up making a loss.
Is Rs 13 per share fair price for the new (post the transaction) FEL?
Let’s look at some available ratios:
Price/Book ratio: Adjusted book value is Rs 3. Thus, Price/Book ratio will be > 4x [13 divided by 3].
Price/EBITDA ratio: (Since, net earnings is not available we are using EBITDA as a substitute). FY20 EBITDA is Rs 433 crores and EBITDA per share is Rs 0.41. Thus, this ratio will be 32x the FY20 EBITDA [13 divided by 0.41].
These valuations are very expensive but they are not unprecedented. However, they are reserved for companies with very high growth potential. So, there may be a trading opportunity in the short-term but this is not a long-term investment opportunity. If you are looking to trade this, keep one foot at the door so you can exit quickly if the trade doesn’t go in your favour.
#RelianceTakesOverFuture #AmbaniBiyaniDeal #Markets
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Link for sources:
Future Group Press release and PPT – https://www.bseindia.com/stock-share-price/future-enterprises-ltd/fel/523574/corp-announements/
Reliance press release –https://www.bseindia.com/stock-share-price/reliance-industries-ltd/reliance/500325/corp-announements/