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Monday, July 11, 2011

Why is Reliance Infrastructure undervalued?

 During the May-11 conference call discussing the FY11 audited results, the RInfra MD boasted of a solid balance sheet and net worth stating that Our net debt is zero. Our total net worth on a consolidated basis at the end of FY11 is Rs 23,965 crores which gives us a book value per share on a consol basis of Rs. 958.

Yet, the share price is just Rs 580, implying a P/BV of just 0.4, at a market capitalization of Rs 15,518 Crores. Ok, granted that neither P/E nor P/BV are good metrics for an infrastructure company, which ideally should be valued on SOTP(sum of the parts basis). Still, Book Value is a conservative measure of company valuation for non financial companies, so it is surprising that the P/BV<1 for a self confessed 'solid company'. Various theories hold such as
  1. Bear attack on R-ADAG group:- Anil Ambani(chairman and promoter of the Reliance ADAG group cos including Rinfra) is no saint, but recently, ADAG stocks saw a concerted sell, from which they have not fully recovered. Whether this was informed trading or mere vindictive attack, is something which only time will tell
  2. Anil Ambani 'hex':- Though the public and capital face of Reliance Industries Ltd during the life time of his father Dhirubhai Ambani, Anil Ambani has not pleased investors equally. The RPower mega IPO inflicted mammoth losses on investors, which even bonus shares have not helped recoup. Old time investors in Reliance still idolize Anil's dad but not him. No wonder then, that even the best investor relations effort(like this presentation http://www.rinfra.com/pdf/RInfra-InvestorPresentation-May11.pdf) has left them unmoved. 
  3. Conglomerate discount:-Rinfra straddles the infrastructure spectrum with roads, metros, power, airports, EPC etc. Each has different valuation metrics-for example road projects can be valued on annuity basis, power projects/EPC can be valued using P/E. Non disclosure of adequate information may lead the market to assign conservative metrics. Maybe, spin off of subsidiaries OR accounting bifurcation with separate audited accounts, may reduce this
  4. Holding Company Discount:- RInfra holds 38% in RPower, worth around Rs 12579 crores, even at today's depressed prices, which would imply that 81% of RInfra's capitalization alone is due to its holding in RPower. Of course, this won't be divested anytime soon and so we apply 'holding company discount' of maybe 50%. If RPower was an independent company, this discount would not hold. 
 Considering that Rinfra has a decent size operation(Rs 1000 crore profits p.a) independent of RPiower(http://www.rinfra.com/pdf/quarter-fc/RInfra_Mar2011_Annual%20AuditedResults.pdf), it is quite illogical as to why it is valued LOWER in market cap than RPower. Every company feels that its shares are undervalued, but Rinfra is entitled to feel so.Unless of course RPower is overvalued, which is not discussed in this post, but certainly a possibility. But surely, the holding company discount for that 38% stake in RPower, should also be adequate to adjust for that.

One may raise concerns over the opacity of Reliance's earnings disclosure(like overuse of the 'Other Income' category while reporting quarterly revenues), balance sheet quality(due to pileup of regulatory assets which essentially represent tariffs recoverable in future from consumer), evasive behaviour during analyst conference calls(by directing some 'awkward' questions to be answered offline by some other company employee) and inadequate disclosure(on pending litigation, project wise cash flow break up).

Therefore, I would welcome comments from the readers, as to their ideas of why this difference is there. I picked RInfra because it has less debt(debt free on net cash basis), profitable on both standalone and consolidated basis, and has little execution/industry/regulation issues. Maybe this applies to other R-ADAG companies, about which I have lesser idea.

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