RIL-BP Deal: Analysts may de-rate RIL if value lower than expected

On the face of it, the decision of Reliance Industries to sell a 30% stake in its 23 exploration blocks in India to BP appears to be a great value-unlocking proposition. However, the implied valuation of these exploration blocks appears to be lower than what analysts had assigned to them earlier. If this really turns out to be the case, there is every possibility that analysts could de-rate the company in the near term. Reliance Industries controls 29 exploration & production or E&P blocks in India. The latest research reports put out by leading brokerages have pegged the net value of the domestic exploration portfolio at somewhere between Rs 450 - Rs 500 per share. However, the current deal values 80% of these assets at close to Rs 295 per share.

A report by Goldman Sachs dated Jan 17, 2011 has assigned a value of Rs 509 per share for RIL's exploration portfolio excluding the CBM and shale gas assets. In fact, the KG Basin D6 block alone is valued at Rs 250 per share. In its 21st January 2011 report on the company, brokerage firm Edelweiss assigned Rs 495 per share as value of its firm reserves and exploration upside.

The latest research report by HSBC on RIL is somewhat more conservative. It values the producing KG-D6 block at Rs 203 per share, other E&P blocks at Rs 68 and exploration upside at Rs 111, totalling at Rs 382 per share for assets excluding PMT and shale gas.

Analysts are miffed over the lower valuations, but are unable to explain further, as it was not immediately clear which 23 out of 29 blocks were part of the deal. So the 23 blocks could be predominantly exploratory, rather than in the development phase. Alternatively, the discount could be extended for gaining access to BP's technical expertise.

RIL had cash equivalent of nearly $7.1 billion on its books at the end of December 2010. When adjusted for cash, its net debt was close to $2.6 billion. The company's scrip, which gained 2.5% before this announcement was made, has been underperforming the broader markets for last several months. Since last February, RIL's scrip has lost around 2%, against a 13% gain in BSE Sensex

The deal, no doubt, unlocks a lot of value for the company by bringing in a chunk of cash towards future profits. However, investors should keep in mind the fact that this in itself may not prove to be a positive trigger for the company's scrip. Taken as a benchmark, this deal could lead to analysts lowering the value of the firm's exploration business as well as price targets.