While most brokerages say that the deal will shift focus away from RIL’s hitherto underperforming E&P segment to refining and petrochem, questions remain over the company’s hurry to monetise these assets

On Tuesday, newspapers front-paged the $7.2 billion deal between BP and Reliance Industries (RIL) for a stake in 23 oil and gas blocks owned by Reliance, one of the biggest foreign direct investments in India so far.

BP agreed to buy a 30% stake in the oil and gas blocks that analysts believe would help RIL expand its deepsea exploration and development off the east coast and give it financial muscle to buy shale gas assets in the US.

BP could pay up to $1.8 billion more by way of performance payments for successful exploration that ends up in commercial discoveries. The two companies will also set up a 50:50 joint venture for sourcing and marketing gas. According to RIL, the payments and combined investment could amount to $20 billion.

List of RIL's 23 blocks

RIL chairman Mukesh Ambani said the talks between the two companies were going on for a couple of years now. RIL expects money from the deal to come into its books from FY12. BP is funding the deal from cash reserves and expects cash flows from sale of some non-strategic assets.

Oil secretary S Sundareshan has labeled the stake sale as a "farm out" arrangement and not a transfer of control, implying that approval for the deal should not be a problem, unlike in the case of the Cairn-Vedanta deal. BP is buying directly into the blocks instead of investing in RIL.

The best proof of what the market thinks about the deal is in the price. After making an initial 5% spurt, the stock price has steadied at Rs1,000. It was at around Rs950 just five sessions ago.

Most market watchers believe that the deal will secure for RIL the valuations of its exploration and production business (E&P) and that focus will shift from this venture, which has had less than expected production so far. Investors will now tend to focus on refining and petrochem, where margins are looking up.

Of course, not everyone is gung ho on the deal. Kotak says that it is "perplexed by the early monetization of the E&P assets by RIL at a modest premium" and that "BP's technical expertise seems to be the only plausible reason."

Today, RIL conducted an investor conference call on the BP deal, but not all doubts would have got clarified. A lot will get clearer over the next few days. Reliance did not comment about when it will get the $7.2 billion payment beyond reiterating that it will receive the funds in FY12.

It also clarified that the $1.8 billion contingent payment is linked to the filing of field development plans (FDPs)-this includes field development plans from discoveries already made. Therefore, the payment will be triggered even from a finalisation of NEC-25 and the KG-D6 satellite FDPs and is not limited to the success of future exploration work.

Since the nature of the deal is reasonably upfront and the clarification about the contingent payment indicates that the deal value is closer to the $9 billion, CLSA has upped its estimate of the risked net present value of assets attributed to the transaction by Rs40/share to closer to Rs400/share. This is generally where most brokers value the assets.

Very importantly, RIL has clarified that there would be no tax incidence since it is disposing a block of assets where the book value is lower than the proceeds from sales. The company also confirmed it will offset proceeds from the transaction from its capitalised E&P asset base leading to a fall in E&P DD&A (depletion, depreciation and amortization).

CLSA estimates a drop from around $12.5/boe currently to about $9.5/boe. "The one-third fall in Ebitda (Rs17bn-Rs18bn for FY12-13) will be partly compensated by a proportionately higher fall in depreciation allowing E&P Ebit to fall by just Rs6 bn-Rs8 bn. Higher other income on the cash inflow would result in a Rs0.5-Rs3.5/sh upgrade to FY12-13 EPS."

Niko has announced that it has the right to increase its stake in KG-D6 (10%), NEC-25 (10%) and MN-D4 (15%) by 30%. Reliance has clarified that this is off Niko's existing base.

RIL will turn a near-zero debt company by the end of FY12. Its existing cash levels of around $7 billion would have risen to around $14 billion once the deal is complete. It declined to comment on the question of use of cash. There have been worries in the market that RIL will end up wasting its cash on unrelated and unsuccessful diversifications such as telecoms, sports, hotels. In the past its retail diversification has not been successful.

Incidentally, Kotak pointed out in a research report yesterday that assets transferred under the proposed transaction are governed by the terms of the production-sharing contracts (PSC) signed under NELP (New Exploration Licensing Policy). Article 28.1 of the model PSC states, "Subject to the terms of this Article and other terms of this Contract, any Party comprising the Contractor may assign, or transfer, a part or all of its Participating Interest, with the prior written consent of the Government, which consent shall not be unreasonably withheld." Article 28.6 of the model PSC also states, "In the event that the Government does not give its consent or does not respond to a request for assignment or transfer by a Party comprising the Contractor within one hundred and twenty (120) days of such request and receipt of all information referred to in Article 28.3, consent shall be deemed to have been given by the Government."