Will RIL become holding company post arm listings? Kotak looks at key scenarios

Everytime around Reliance Industries' AGM, there are hopes that the oil-to-telecom major would announce listing plans of its key businesses namely telecom and retail. Last month was no different.

Kotak Institutional Equities, which sees arm listings in the next 2-3 years, said this is among issues that the group will have to grapple with over the next 1-2 years as it prepares to list its retailing and telecommunications subsidiaries and induct members of the third generation of the founding family into more prominent roles in the group.

Kotak said the Reliance Industries management and shareholders may consider a reorganisation of the company to achieve three mutually-linked objectives of structure, succession and segregation.

It said one option could be to reorganise RIL into three independent listed entities i.e. Reliance Industries and two listed subsidiaries in communications and retailing. This would avoid potential holding company discount, the fate of most holding-cum-operating companies in India.

"Various smaller entities may be ‘clubbed’ into one of the appropriate verticals to ensure limited overlaps post the restructuring," it said.
As a second option, Reliance Industries can continue with its current structure with RIL as a holding-cum-operating company. In that case, there could be four listed entities. They would include Reliance Industries and three listed subsidiaries in communications, energy and retailing.

"In our view, the current structure may not be ideal given possible issues — likely holding company discount as and when the retailing and telecommunications subsidiaries were to list, possible conflicts from ‘overlapping’ roles of next-generation founding family members as managers and owners both and continued large-interlinkages and related-party transactions between various listed entities within RIL group," it said.
Kotak said almost all holding or holding-cum-operating companies in India have traded at meaningful discounts to the fair value of their underlying businesses in the parent entity (holding company) or in subsidiaries.

"We have never fully understood the reasons for the large holding company discount. However, that’s been the historical experience for the past two decades and we are not sure whether this will change soon. Bajaj Finserv, HDFC, L&T and M&M are a few prominent examples of such operating-cum-holding companies, whose stocks have traded at meaningful discounts to the fair value of their businesses," it said.

Kotak said it has been seen that the holding company discount increases as and when the unlisted subsidiaries of holding companies list.

HDFC is a good case study in hand, it said, adding that HDFC's holding company discount widened when its various subsidiaries (asset management, life insurance) listed.

"It is possible that RIL may have four (or more) listed entities eventually assuming it was to continue to operate under the current structure. RIL may look to demerge the energy vertical out of RIL or list its ‘new’ energy business separately. If RIL was to demerge the energy business into a separate listed entity, RIL would largely become a holding company. This would be even worse from a stock market perspective as pure holding companies trade at even larger discounts to the underlying value of their holdings in various subsidiaries compared to the holding-cum-operating companies," Kotak said.

In fact, such companies tend to be largely ignored by investors, Kotak said. Bombay Burmah and Godrej Industries are prominent examples of holding companies that trade at massive discounts to the fair value of their assets and investments, Kotak added.

Summary
Kotak said three independent listed entities for RIL in the areas of energy, retailing and telecommunications may help achieve several objectives prevent holding company discount, prepare RIL for the future given inevitable management changes and preclude unnecessary inter-linkages as and when each of RIL’s major subsidiaries were to list over the next 2-3 years.

It said that the RIL promoter family may prefer the current structure of RIL group from a control perspective, but the structure may result in potential large loss of value.

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