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The Reliance game plan

With the crash in oil prices, its structural decline as a commodity is a given. Excess global capacity and lower demand for oil-based products imply erosion of refining margins — GRMs of $11 per barrel is now history.

It is in this context that Reliance is co­nverting its debt to equity. This is an antithesis to its DNA — it has from 1977 followed a path of growth predominantly through high debt and financial engineering. Why? Because it was confident of free cash flows for debt repayments on a sustainable basis and in the process created enormous wealth for its shareholders through a leveraged play on the oil value chain.

Now, with its cash cow of the oil business threatened, the proposal to raise equity is an indication of the company’s lack of confidence in the existing businesses to consistently generate free cash flows to service debt. Apart from the dilution impact on existing shareholders, the cost of servicing equity is far more expensive especially in an environment of rising risk premiums for India among other emerging markets.

The hope, therefore, seems to be to transform itself to a giant tech play and now play the valuations game a la Amazon or Google vis-a-vis a cash-profit-driven game it has played thus far.

With shrinking valuation multiples inevitable over the next few years, shareholders will be subject to a potentially dangerous value dilutive game as Reliance goes net debt-free through this equity raise and the Jio IPO later. Who will be the sucker (relatively speaking) in this high-stakes gambit? The eternal greater fool theory will be at play again — albeit in a large conglomerate situation and not as is the model in most of the startup ecosystem.

The other side of this fascinating business transformation underway on a scale not witnessed thus far is the potential of what it can achieve with the investment from Facebook. Apart from the obvious benefit for a retail ecosystem play with WhatsApp (an FB entity), including in-chat JioMart interfaces within the messaging platform, in my view Mukesh Ambani and Mark Zuckerberg, true to their styles, are thinking of much bigger things.

It has recently been announced that FB has given up its plans for Libra, its ambitious global cryptocurrency project. This was a project by which FB would have potentially created the basis for an alternative non-US dollar global financial system leveraging its captive 2.5 billion global user base. It is therefore logical for it to develop instead a classical digital payment network like a Paypal.

India could well be the playground for it in partnership with a telecom operator with both political and financial muscle to navigate the system and regulatory hurdles that ultimately derailed FB’s ambitions. Incidentally, India has no super apps too primarily because these were not operator-backed but created by small internet service providers. This time it will be different. Interestingly, on April 28 a small footnote reported in one of the pink papers suggested that Reliance had expressed interest in obtaining a licence to operate a national payments network in competition to NPCI which runs the UPI platform, NFS, IMPS, etc.

China’s pioneering effort could well provide a blueprint. The People’s Bank of China (PBOC) has been quietly developing technology to introduce a sovereign digital cryptocurrency pegged to the yuan and is close to launching trials to formally commence one part of its five-pronged long-term strategy to formally challenge the supremacy of the US dollar as the global reserve currency.

The two largest platforms in China — Alipay, owned by Alibaba’s Ant Financial, and WeChat Pay, owned by Tencent — with a combined user base of two billion users, have helped create a vibrant and massive digital currency infrastructure, consumer culture and the technology backbone to enable PBOC to embark on its ambitious journey to launch the world’s first sovereign digital currency.

It is this pie which, I believe, is the ultimate objective. Reliance would be eager to rival NPCI in building its own proprietory payment systems. And once it reaches the stage to rival NPCI in the future, India could well be on its way to launching its own sovereign digital currency system for which RBI has recently shown preliminary interest. NPCI and Reliance would be the only two large platforms — our own WeChat Pay and Alipay equivalents — and will propel RBI to cross the chasm. Though from a user’s perspective not much will change, the central bank will move to a new paradigm in terms of supervision, future modes of financing, business and social governance, apart from transparency.

The possibilities would then be endless.

Which path Reliance takes will be interesting to watch and will determine the next phase of its journey. Mega value creation or dwindling valuations will merely be an outcome of the path it takes. The mere desire to generate wealth will not be enough to sustain this transformation — it will need the passion of Ambani, his next generation and Zuckerberg.

―Authored by Prabal Basu Roy, a Sloan Fellow from the London Business School, director and adviser to chairmen of corporate boards; formerly group CFO in various companies published in Business Standard

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