Relian120m shares issued to promoters for US$3.6bn; Retain Buy

Reliance Industries (RIL) has issued 120m shares to its promoters at

Rs1,402/share. The shares were issued on the exercise of options attached to the

120m warrants issued preferentially to the promoters in April 2007. The promoters

had paid US$400m, 10% of the total consideration, in April 2007. The balance

US$3.2bn was to be paid on the issue of shares. We had already factored in

consequent equity dilution in our earnings and valuation. We retain Buy on RIL.

Promoters’ stake 42.4%; 54.99% including treasury shares

RIL’s outstanding shares are up to 1,574m shares. The promoter’s stake in RIL is

now up to 42.4% from 37.6% after issue of 120m shares. Another 12.6% of

treasury shares are controlled by RIL management and held for benefit of all

shareholders. Including treasury shares the stake controlled by promoters is up to

54.99% from 51.28% before issue of 120m shares.

0.1% stake sale prevents promoter’s stake rising to 55.07%

RIL’s quarterly share holding statement dated September 30, 2008 shows that

promoters have sold 1.26m shares, which is 0.1% of RIL’s equity. If promoters

had not sold their stake in RIL, their stake including treasury shares, would have

been up to 55.07% on the issue of the 120m shares.

SEBI requires open offer for 20% stake if it goes over 55%

The reason for the small stake sale in July-September 2008 appears to be to

prevent the promoter’s stake including treasury shares from rising to over 55%.

As per regulations of market regulator SEBI, an open offer to acquire another

20% needs to be made if stake rises over 55%.

Company Description

India's largest petchem and second largest refining

company, Reliance, owns a 660kbpd refinery. Along

with RPL, its total refining capacity would be

1.2mbpd by 2009. It also has a 900ktpa cracker,

1mtpa polyester, 1.9mtpa polymer and over 3mtpa

of fibre intermediate capacities. Refining contributes

55% to revenues with petchem contributing 43%.

The company has discovered gas with initial inplace

r eserves of over 40tcf on the East Coast.

Investment Thesis

Share price drivers are (1) two-year EPS CAGR of

45pct to FY10E, (2) large reserve accretion

potential, and (3) upside to valuation on

diversification into organized retail (valued at

Rs102/share) and SEZ (not valued). RIL's 2P

reserves and resources of 4.7bn boe are from

exploration of just 5pct of its Indian acreage. It is

embarking on a US$4bn exploration program of its

highly prospective acreage and we believe positive

news flow by way of more discoveries and reserve

a ccretion will continue.

Stock Data

Shares / GDR 2.00

P rice to Book Value 2.6x

Promoters stake in RIL up to 42.4%

120m shares issued to promoters

Exercise of 120m warrants issued to promoter in April 2007

On October 3, RIL issued a press release that 120m shares had been issued to

the promoters. These shares were issued on the exercise of options attached to

the 120m warrants issued preferentially to the promoters in April 2007. The last

date for exercise was in October 2008.

US$3.2bn paid now; US$400m paid in April 2007

Exercise price of Rs1,402/share is 20% discount to market price

The 120m shares were issued at a price Rs1,402/share, which is at 20% discount

to RIL’s closing market price of Rs1,750/share. The issue price was fixed at the

time of the issue of the warrants in line with guidelines of regulator SEBI for

preferential issue of shares.

Rs168bn (US$3.6bn) is the cost of 120m shares at Rs1,402/share. As required

by SEBI regulations Rs16.8bn (US$400m), which is 10% of the amount, was

already paid on the allotment of warrants in April 2007. The balance Rs151bn

(US$3.2bn) must have been paid now when the 120m shares were issued.

8.3% equity dilution; outstanding shares up to 1,574m

Dilution already reflected in our forecast

Following the issue of 120m shares RIL's outstanding shares are up by 8.3% to

1,574m. We are already assuming outstanding shares rising to 1,574m in our

earnings forecast.

Promoter’s stake up to 42.4% from 37.6%

RIL management also controls treasury shares, which is 12.6% of equity

The promoter’s equity stake in RIL is now up to 42.4% from 37.6% with the issue

of 120m shares. The RIL management also controls another 199m shares, which

are treasury shares created at the time of merger of erstwhile Reliance Petroleum

(RPL) and IPCL with RIL. These 199m treasury shares are 12.6% of RIL’s equity.Ltd.

Promoters’ stake including treasury shares is 54.99%

Promoters’ stake including treasury shares up from 51.28%

The treasury shares are held by the RIL management for the benefit of all

shareholders of RIL. Including 12.6% of treasury shares the stake controlled by

promoters is up to 54.99% from 51.28% before issue of 120m shares on

October 3, 2008.

Promoters sold 1.26m shares (just 0.1%) in Jul-Sept'08

RIL’s quarterly share holding statement dated September 30, 2008 shows that

promoters have sold 1.26m shares. The promoters’ stake has consequently

declined from 37.7% as of June 30, 2008 to 37.6% as of September 2008. The

promoters thus sold 0.1% of RIL’s equity in July-September 2008.

Stake sale helped keep stake including treasury below 55%

Promoters’ stake including treasury shares 55.07% if not for stake sale

If the promoters had not sold their stake in RIL, their stake including treasury

shares, would have been up to 55.07% on issue of 120m shares. The 0.1% stake

sale in July-September 2008 helped keep promoters’ stake including treasury

shares at 54.99% on exercise of 120m warrants.

SEBI regulations - open offer for 20% if stake over 55%

Small stake sale appears to be to prevent open offer for 20% stake

As per SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,

1997 open offer to acquire another 20% equity stake needs to be made if stake

rises over 55%.

The reason for the small stake sale in July-September 2008 thus appears to be to

prevent promoter’s stake including treasury shares from rising to over 55%. The

issue of 120m shares against warrants would have taken the promoters’ stake

including treasury shares over 55%. It would have required the promoters to

make open offer to acquire another 20% stake from minority shareholders.

Thus the small stake sale appears to have been done to ensure promoters' stake

remains below 55% and thereby no open offer has to be made for additional 20%

stake.

Press reports indicating 6.6% promoter stake sale incorrect

Stake held by subsidiaries in RIL reclassified as held by “others”

Some press reports suggest that promoters' holding in RIL has dropped from

51.37% as reported on June 30, 2008 to 44.8% as reported on Sept 30, 2008.

This suggests promoters have offloaded 6.6% stake in RIL. However this is

entirely incorrect.

RIL group companies, which held 6.5% stake in RIL, have now become its

subsidiaries. These group companies held shares in erstwhile RPL and IPCL and

got RIL shares in lieu of RPL and IPCL shares when they were merged with RIL.

In case of group companies holding RPL shares before merger, RIL held

optionally fully convertible debentures. These debentures appear to have been

converted thereby making these companies RIL’s subsidiaries.

The stake held in RIL by the group companies was being classified as promoters'

stake until June 2008. It has been shown as shares held by "Others" in

shareholding pattern as of September 2008. It has been specified as "Shares

held by Subsidiary Companies on which no voting rights are exercisable" in the

September 2008 shareholding pattern on BSE website.

We retain Buy on RIL

2-year EPS CAGR of 40%; attractive valuation

We expect 2-year EPS CAGR in FY08-FY10E) to be 40%. RIL has one of the

strongest earnings growth in our global universe. KG D6 oil and gas (0.6m boepd

of output at peak) and RPL refinery (0.58m bpd) will be main earnings drivers.

RIL’s valuation is compelling now at 8.5x on FY10E EPS and PEG of 0.21x.

Positive news flow on E&P to continue

Positive news flow on E&P in terms of discoveries and reserves accretion is likely

to continue. RIL is scheduled to drill in at least 3 highly prospective blocks (KG

D6, KG D9 and Mahanadi D4) in the next 12 months.

Strong growth prospects beyond FY10E, too

We believe RIL has strong growth prospects even beyond FY10E. Prospects

beyond FY10E will be driven by (i) 2 large petrochemical projects (ii) rise in gas

reserves and production (iii) organized retail (iv) SEZ

Some main risks also appear to be receding

There are indications that some of the main risks like no tax holiday for gas

production and windfall tax are receding.

We retain Buy on RIL.

Price objective basis & risk

Reliance Inds (XRELF / RLNIY)

Our PO of Rs2,910 (GDR US$149.23) is based on an SOTP valuation. The value

of the core refining and petrochemical business has been calculated on DCF

using WACC of 11.8pct. The value of its investment in Reliance Petroleum (RPL)

is calculated by applying the DCF value of RPL to RIL's holding in RPL. We have

a scenario-based valuation approach for valuing stake in RPL, with equal

weighting being given to each of the four scenarios assumed. Oil and gas

reserves and resources, as well as its retail business, are also valued on a DCF

basis. Refining and marketing, including investment in RPL, is 31pct of PO, E&P

valuation (Rs1,397) 48pct, petrochemicals 18pct and organized retail 4pct. At our

PO FY09E PE is 25.2x, which may appear expensive. However, RIL offers 40pct

EPS CAGR during FY08E-10E, which is far higher than peers. It is the cheapest

among its peer group on a PEG basis. Risks are (1) Decline in refining and

petrochemical margins being steeper than expected, (2) huge disappointments on

the E&P front as we have valued even resources and exploration upside,

(3) failure in the retail business, and (4) changes in government policies (eg,

withdrawal of the tax holiday) which may have a direct impact on the business,

cashflow and profit.

Analyst Certification

I, Vidyadhar Ginde, hereby certify that the views expressed in this research report

accurately reflect my personal views about the subject securities and issuers.

I also certify that no part of my compensation was, is, or will be, directly or

indirectly, related to the specific recommendations or view expressed in this

research report.

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