SWAMINOMICS

RIL should bid to take over BP

S A Aiyar
11 July 2010, 01:04 AM IST

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The share price of British Petroleum, the fourth largest company in the world, has halved after causing the greatest environmental disaster in history. Its out-of-control Macondo well is spewing thousands of barrels of oil daily into the Gulf of Mexico, killing birds and sea life and ruining tourist beaches and the livelihoods of fishermen. It has been obliged to suspend dividends and put $20 billion into an escrow account from which damages will be paid.

But disaster for some means opportunity for others. Mukesh Ambani suddenly has an opportunity to take over the fourth largest company in the world. Reliance is small compared with the global oil majors. Yet the stock market has driven down BP's market value to just $100 billion, not far above Reliance's $80 billion.

Mukesh could offer a merger in which two Reliance shares would be exchanged for every BP share, giving BP shareholders a substantial premium over their current market value. This would, however, carry the risk of sinking Reliance if BP itself is driven into bankruptcy by a failure to plug the Macondo well.

So Mukesh can explore a less risky option. BP seeks a big investment in its shares to lift market confidence, and has approached sovereign wealth funds and rich Arabs. But these investors burned their fingers when they bought into distressed US banks (notably Citibank) in 2008, and then suffered huge losses when the banks plunged into near-bankruptcy. Once bitten, twice shy.

Mukesh is not a passive investor. He wants control. So, he could buy a 10% to 15 % stake in BP, which at current prices would cost between $10 billion and $15 billion. This will give Mukesh a Board seat, not total control of BP. But he can increase his stake later and acquire control once the Macondo well is capped, limiting the damages BP will have to pay.

Borrowing $10 billion to $15 billion for this strategy will be easy for a company with a market value of $80 billion. Borrowing this sum will still leave Reliance with a very respectable debt-equity ratio of less than one. It has a strong balance sheet, with cash in hand of $5 billion. It will not suffer the mountainous debt-equity ratios that burdened Tata Steel in taking over Corus, or Hindalco in taking over Novellis.

BP is well worth taking over, despite the risk. If the disaster costs BP $20 billion in damages, this will be paid out over several years, and will be well within the capacity of a company with a net profit of $21 billion in 2009. Even if damages ultimately cost between $40 billion and $50 billion, that will be affordable if spread over five to ten years, which is likely. President Obama has no desire to drive BP into bankruptcy; he wants it to remain viable and pay the damages.

Buying into BP carries risks, but is justified by the bargain share price. BP trades today at a price-earnings ratio of just 5.1, compared to 13.4 for Exxon-Mobil and 12.56 for Conoco-Philips, its two main US rivals. There remains some uncertainty whether BP will succeed in plugging the Macondo well. It is drilling two relief wells, giving itself two chances to drill into the cursed well and kill it. The technology is well-tested, and should work.

Reliance is not famous for taking big risks abroad. It has long had a rule of thumb: all its projects in India should promise a return of at least 20%, and all foreign ventures should promise at least 30% (to compensate for higher risks abroad). Reliance's great comparative advantage in India has always been its ability to influence government policy, an advantage it lacks abroad. That is one reason why its foreign ventures to date have been so modest. It has gone for small oil exploration projects in Yemen, Iraq, Oman, Colombia and East Timor. It acquired Hoechst's polyester plant in Germany, but that failed and had to be closed. This showed how much more difficult operations were abroad.

What would Dhirubhai Ambani have done had he been alive? Some regard him as simply a master manipulator, but he was also a visionary. His vision of making telephone calls cheaper than postcards was achieved. His vision of building the largest oil refinery in the world was also achieved. I think Dhirubhai would have gone all out to take over BP. This is the fourth-largest company in the world. Along with Reliance's own sales, a BP takeover would put his company in a strong position to become world number one. That's the sort of goal Dhirubhai would have gone for.

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Shabha says:

July 11,2010 at 04:54 AM IST

The idea is practical that Mr Mukesh acquire sufficient shares to earn a board member seat in BP and later take control when the Macondo oil well is capped, damages paid.

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