Case of Reliance Petroleum TOCD Issue in 1993

The case Reliance Petroleum's TOCD issue (B) analyzes the new

option provided to the TOCD holders after an extra ordinary general

meeting of RPL held in April 1998. It provides a detailed explanation

of the alternatives and the options available to the investor, which

were evaluated on the basis of their yield to maturity. The case is

designed to help students critically analyze alternative options

available to an investor at the time of exercising an option for

conversion. Analyzing various options of conversion available to the

investors of RPL TOCD on the basis of yield to maturity and drawing

suitable conclusions. To gain an understanding in the mechanics of

financial analysis and develop skills in making suitable decisions

based on the returns earned on an investment.

Reliance Petroleum Limited (RPL), a part of the Reliance

Group1 came up with an initial public offering (IPO) in September

1993 to partly finance its Rs 51.42 billion refinery project. The total

public issue was of Rs. 21.72 billion while the net offer to the Indian

public was Rs. 8.62 billion.

The issue was the largest during that time in India and was made

available to the public through an innovative financial instrument in

the form of Triple Option Convertible Debentures (TOCDs). The

TOCD was not structured as a conventional debt instrument. Each

TOCD was issued for a face value of Rs.60. This included two equity

shares allotted to the investors at a face value for Rs 10 each. The

remaining Rs 40 comprised of a non-convertible accompanied by

two detachable warrants. The TOCD holders could exercise the

option to convert their instrument into equity shares in September

1997 that is, between the 47th and 49th months from the date on

which the TOCD was issued (Refer Exhibit I for complete details of

the TOCD issue).

Some market observers expressed doubts as to whether this mega

scheme would be fully subscribed to given the depressed condition

of the stock market at that time. Belying these fears, RPL's issuing

of TOCD was successful. However, despite the success in obtaining

the required finances, the RPL project could not be commenced

start as scheduled

The delay was caused by the were mainly due to the scaling up of

the proposed capacity from the initial nine million to 18 million tons

and eventually to 27 million tons. With this increase in capacity, RPL

became the world's largest grass root refinery and seventh largest

operating refinery in the world. The project commenced with the

acquisition of land, which happened in December 1994. The

construction commenced only in the year 1996, with the leveling of

land and laying of equipment foundations. The increase in the

plant's capacity from 9 million tons to 18 million tons was officially

announced in April 1998, followed by a further increase in capacity

in December 1998 to 27 million tons. The project was eventually

commissioned in the financial year 1999-2000.

It started commercial production in April 2000. RPL completed its

first full year of commercial operations in March 2001, during which

it emerged as the largest private sector company in terms of

revenues, with sales worth more than Rs 300 billion. The plant

utilized 100% of its capacity initially during the initial years and was

expected to increase it to 115%. By 2002, RPL had emerged as one

of the most modern refineries in the world, using the latest

technology, and had the ability to use almost any kind of crude oil.

The refinery had the capacity to process 80,000 tons of crude oil per

day and its capital cost per ton was about 40% lower than existing

refineries in India. This translated into substantial cost

competitiveness. Some of the products like naphtha, reformate and

propylene produced by RPL were captively consumed by Reliance

Industries Limited4 ensuring sufficient offtake and substantial

savings in handling and storage costs. Captive consumption by

group companies accounted for approximately 25%-30% of RPL's

production. The main products of the company were liquid

petroleum gas (LPG), motor spirit/gasoline (MS), naphtha, high-

speed diesel (HSD), superior kerosene oil (SKO) & aviation turbine

fuel (ATF), fuel oil (FO), coke and sulphur...

The Need for an Alternative

The holders of the RPL's TOCD issued in 1993 were not allowed to

exercise the option of converting TOCD in September 1997, as was

promised in the IPO document. This was postponed till May 1998 in

order to provide the investors with a new conversion option.

Analysts commented that the need to come up with the new option

was prompted by the fact that the non- convertible debenture was

trading at around Rs. 48 (Refer Table I) and the two warrants could

be sold for Rs 5 each in the market between September 1997 and

April 1998, as against shares worth Rs 40 that would be received if

the same were to be surrendered. Moreover, RPL's stock price was

Rs. 22 (Refer Table II). This meant that the market value of the

shares held by an investor opting for conversion in accordance with

the initial offer (Refer Exhibit I) in September 1997 was Rs. 44 which

was much lower than the combined market value of the non-

convertible debenture and the detachable warrants...

The New Option

On April 15, 1998, RPL convened an extraordinary general meeting

(EGM) to seek shareholders' approval to hike its authorized share

capital from Rs 50 billion to Rs 70 billion.

The purpose was to enable investors to use the new conversion

option, which involved phased allotment of three equity shares with

a face value of Rs 10 each, in lieu of Rs 40 paid-up non-convertible

debentures along with the detachable warrants. As per the option,

the first equity share at par would be allotted in November 1999

(the 6th year), followed by two equity shares at a premium of Rs 5

each in November 2000 (the 7th year) and November 2001 (the 8th

year). The period from May 1998 to June 1998 was the period during

which the conversion offer would operate. In case the TOCD holders

did not want to opt for the new option, they could get the non-

convertible portion of the TOCD redeemed in three installments...

RPL - Investor Returns?

The Reliance Group had always prided itself in creating value for its

investors. This was visible through the RPL share prices from the

very first year when it began operating.

The share price witnessed a sharp rise from around Rs.22 at the

beginning of the financial year 1999 to about Rs.60 by the end of it.

RPL's financial performance over the next two financial years had

been impressive with a net profit worth Rs 14.64 billion in 2000-

2001 and Rs 16.74 billion in 2001-2002 on revenues amounting to

Rs 309.63 billion and Rs.331.17 billion respectively. However, during

September 2002, the share price of RPL stood at around Rs.23. The

earnings per share (EPS) of the RPL stock remained at three, but

there had been a sharp decline in its P/E multiple from 18 in 2001 to

only 8 in 2002. There was a delay in dismantling the administrative

pricing mechanism, which was expected to benefit RPL profits

significantly...