Just Who Will Seal A Deal With Essar Oil?

M&A
Just Who Will Seal A
Deal With Essar Oil?

The Ruias are desperate and the financial institutions, frantic. But the BPCL-Essar Oil deal is still on a slippery track.

By Ranju Sarkar & R. Sriram

U. Sundarajan, CEO, BPCL: "We have undertaken a valuation exercise, after which we will take a decision" In June, 1999, even as Bharat Petroleum Corporation Ltd's (BPCL's) 56-year-old portly CEO, U. Sundararajan, was finalising a marketing alliance with Madras Refineries, he received feelers for an unexpected deal. From an unexpected quarter. As part of the restructuring of the Rs 3,726-crore Essar Group, its lead financial institution, ICICI, offered BPCL a 26 per cent stake in--and management control of--Essar Oil. Understandable, since the financial institutions together had an exposure of Rs 7,957 crore in the Essar Group, and Rs 3,000 crore in Essar Oil alone.

Given the trouble that the promoters, the Ruias, were in, the lending agencies chalked out a time-table for drastic financial surgery--including divestments to reduce the Group's debt by 60 per cent to Rs 3,192 crore. Since then, the competition to grab Essar Oil's 10.50-million tonnes per annum (tpa) refinery at Jamnagar (Gujarat), which has yet to be commissioned, has intensified.

While BPCL is trying to push down the price, other suitors are eyeing Essar Oil too. Says Indian Oil Corporation's (IOC) Chairman, M.A. Pathan, 57: "We are also looking into it. Our decision will depend on the viability of the project." And, despite the denials by its spokesperson, Reliance Petroleum, whose 27-million tpa refinery is situated next to Essar Oil's, might just be interested. On the other hand, the Ruias are now trying to woo Oman Oil--which has already begun a due diligence exercise--to buy their stake.

Prashant Ruia, Director, Essar Oil The logic is obvious: the institutions have linked fresh loans of Rs 660 crore to Essar Oil to the restructuring. In fact, Essar Oil needs another Rs 1,210 crore--Rs 550 crore as equity, and the rest as debt--to complete the refinery, whose cost has been appraised by ICICI at Rs 6,925 crore in September, 1999. To hasten the process, Ravi Ruia, Vice-Chairman, Essar Oil, wrote a letter on July 8, 1999, to the Union Minister For Petroleum & Natural Gas, V.K. Ramamurthy, stating: "It is essential for BPCL to consider the proposal expeditiously We, therefore, seek your support to resolve these matters." Adds Shishir Agarwal, 42, CFO, Essar Oil: "BPCL will bring in strategic value in terms of operational management, equity partnership, and marketing expertise."

There are issues that could stall the deal. For one, the parties have not decided the price yet. Essar, which had commissioned PricewaterhouseCoopers to conduct a valuation of the refinery, expects a price per share (face value: Rs 10) of more than Rs 45.70. Or, Rs 420 crore for a 26 per cent stake. In addition, the Ruias contend that 70 per cent of the project has been completed, and that the refinery is viable despite the cost-escalations. While Essar Oil's project cost per million tonne, at Rs 660 crore, stands higher than Reliance's Rs 528 crore, it is much lower than Mangalore Refinery's Rs 710 crore and Bharat Oman Oil Refinery's Rs 867 crore.

Yet, a number of analysts that BT spoke to contend that Essar is demanding too high a price. They reckon that a fair price would be in the region of Rs 18 to Rs 20 per share--or, a maximum of Rs 185 crore for a 26 per cent stake--which is still more than one-and-a-half times the current scrip-price of Rs 12.90 (on September 15, 1999). Says Sundararajan: "We have undertaken a due-diligence and valuation exercise after which we will take a decision."

Moreover, while the Ruias insist that the project will be on-stream by the last quarter of 2000, BPCL estimates that it won't be ready before end-2001, or even early 2002. Such a delay will push up the project-cost by at least Rs 1,000 crore. In addition, BPCL has asked the financial institutions to waive the interest-cost of Rs 300 crore due to the current delays, and has also put forth a condition that the cost overruns should be financed by the financial institutions and the Ruias--not BPCL.

Finally, BT learns that the public sector oil major also wants Essar Oil to bring back the key facilities like the single-buoy mooring, terminals, and the product jetty--which are, usually, part of any refinery project--that the latter had hived off into separate ventures 3 years ago. Explains Ashok Sinha, 42, Director (Finance), BPCL: "We are looking at what would be required to operate the refinery." Denies Essar's Agarwal: "Until now, BPCL has not put forth any conditions, but we will address all their concerns."

In fact, R.K. Sukhdevsinhji, 64, Managing Director, Essar Oil, feels that BPCL should not have any problems since the company "has a terminal, a power plant, and other facilities from the joint ventures for 30 years." But BPCL is likely to use these issues to drive down the cost, especially since SBI Caps has dissuaded BPCL from purchasing the stake. In the end, it may be politics that will decide the fate of the deal. Initially, the Ruias were lobbying with the Union Ministries of Finance and Petroleum to push through the deal with BPCL. Now, with other heavyweights in the fray, the decision could swing any way.

What will these suitors gain from a stake in Essar Oil? There are no doubts that BPCL, which has only one refinery (8.96 million tpa, Mumbai), needs access to petro-products that it can push through its distribution network of 4,400 petrol-stations, 960 kerosene-dealers, and 1,180 LPG-distributors. In 1998-99, despite its lower refining-capacity, BPCL sold 17.50 million tonnes of products, mainly canalised imports allocated to the public sector oil companies for distribution as per their marketshares. But, post-2002, in the decontrolled era, the PSUs will need to source products to fuel their marketing networks.

According to projections made by Goldman Sachs Kotak Securities, while the domestic supply of petro-products will touch 124.32 million tonnes in 2002, the demand will be only 110.76 million tonnes. That will force BPCL to either strike marketing alliances with refineries, or expand its refining-capacities to retain marketshare. Agrees BPCL's Sinha: "We need to enhance product-availability, especially in North India." Already, its tie-ups with the 6.50-million tpa Madras Refineries, the 27-million tpa Reliance Petroleum Refinery--BPCL will lift 25 per cent of its output--and the 2.65-million tpa Numaligarh Refinery for 1 million tpa will assure BPCL of 23 million tonnes of products every year.

These alliances are, however, valid for only 5 years. In addition, BPCL's proposed refineries are under a cloud. While Shell, one of the partners, has withdrawn from the 7 million tpa Central India Refinery at Sultanpur (Uttar Pradesh), the 26:26 joint venture with Oman Oil at Bina (6 million tpa, Madhya Pradesh) has not received environmental clearances from the Gujarat state government, and cannot be commissioned before 2004. Obviously, a strategic stake in Essar Oil will ensure a refinery which will commence production earlier--and be cheaper too.

In fact, BPCL's equity infusion into the Bina Refinery would have been around Rs 1,000 crore--two-and-a-half times the price being demanded by the Ruias for the 26 per cent stake in Essar Oil. The flip side: problems relating to distribution logistics. Although the capacity of the Kandla-Bhatinda pipeline will expand from 7 to 12 million tpa by 2002, it still won't be able to service Essar Oil's output. That would not matter if the proposed Central India Pipeline is ready by 2002. Otherwise, BPCL will have to transport the products by rail, which costs twice as much as moving them through pipelines. For instance, the cost of transporting products by rail from Kandla to Bhatinda is Rs 1,837 per tonne compared to Rs 841 per tonne through the pipeline.

Other suitors too can derive other synergies. It would help Reliance increase its refinery-capacity from 27 to 37.50 million tpa. An expansion of their refinery would cost the Ambanis Rs 3,020 crore while a stake in Essar Oil would entail an outflow of less than Rs 500 crore. Ditto for IOC, which has forged marketing alliances with Reliance to market 50 per cent of its output, and Cochin Refineries (7.50 million tpa). While Oman Oil is optimistic about the potential of the Indian market, given the delays in the commissioning of the Bina Refinery, it is scouting for alternative routes to gain an entry.

For the Ruias, BPCL is their best bet--yet. The reason: Reliance is an arch-rival, IOC is a giant for whom Essar Oil will be just one of 7 refineries, and Oman Oil may offer rock-bottom prices. No wonder the Ruias are trying to iron out all the glitches to strike the deal with BPCL. Because this is not just any old deal; it's the one that may re(de)fine the future of Essar.

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