RIL, RPL and some questions on transparency

An investor cannot be blamed for taking some profits when stock prices surge, even if the quantity offloaded is large. But, what if the seller holds a majority stake and has management control of the company whose stock was dumped? That will obviously raise questions as to why the offloading happened, especially when the seller has full knowledge of what is going on.

Reliance Petroleum (RPL) has been a stellar performer this year. When the company offered shares at Rs60 apiece at its IPO last year, many analysts were dead sure that the stock will settle down at close to double that price on listing. But, that was not to be. As the initial euphoria died down, the stock slipped and stayed close to its issue price for many months.

Then the RPL mania started. Helped by soaring crude oil prices, which will supposedly help refining margins – though the recent results of some of the largest global oil companies do not support this view, the stock started a gravity-defying up-move. As valuations became indefensible, various 'theories' and 'market talk' started to flow – which pushed the stock even higher. Soon, the market value of the company which will spend just Rs27,000 crore to set up its refinery was nearly four times that figure.

Then, without warning, Reliance Industries (RIL) – the promoter and majority shareholder of RPL – started selling the stock in the secondary market. RIL sold 4 per cent of RPL for over Rs4,000 crore. A stake sale like this usually happens either when the seller is in need of cash or when the market valuation is considered unsustainable. But, RIL generates sufficient cash from its operations to meet most of its investment needs, doesn't it?

Then, there is this new theory that Chevron – which has a 5 per cent stake in RPL and has the option to buy another 25 per cent – maybe planning an exit. That makes sense; with the money required for 25 per cent in RPL, Chevron can set up another refinery! If Chevron decides to exit, RIL is said to have the right to acquire its current 5 per cent holding at close to the issue price of Rs60 per share. So, this new theory says RIL sold the stake in RPL as it can anyway build it back above 75 per cent by buying out Chevron. Ironically, one of the earlier theories which fuelled the big surge in RPL share price was that Chevron is very excited about the refinery's prospects and is willing to pay more than $6 billion for the 25 per cent additional stake! So much for market rumours!

The stake sale has kept the RPL stock depressed. So, was it in the best interests of minority shareholders of RPL? Was it in the best interests of RIL shareholders, as the value of its stake in RPL has come down with the price correction? Should RIL have made an announcement before selling? Maybe, the stock price would not have corrected as much if the company was more transparent.

RIL's holding in RPL is not a treasury investment, wherein companies invest surplus cash in the stock market and can move in and out of individual stocks as they please. There was no indication from RIL that it would sell RPL shares in the open market if the stock price rises above a certain level. Even if there was a management decision or policy like that, it was never disclosed to RIL or RPL shareholders.

Now, having decided to sell RPL shares, did RIL ensure that it received the best price? RIL sold 18.04 crore shares of RPL for a total consideration of Rs4,023 crore – which translates to an average price of Rs223 per share against the stock's lifetime high of Rs295. Would RIL have received a better price, if the sale was made through an open tender or a negotiated deal with one or more large institutional investors?

The initial trigger for the correction in RPL stock price was its temporary suspension from the derivatives segment as positions in the counter hit market-wide limits. But before the suspension became effective, it is rumoured that a group of traders were actively selling the stock in the derivatives segment. Did they have any prior information about RIL's stake sale which made them confident enough to short the stock? The exchanges have remained silent but SEBI is rumoured to have initiated an investigation. Can't the exchanges or SEBI upgrade the market monitoring systems to discourage such trading on a proactive basis, rather than doing post-event investigations that fail to deter future events?

There is a new controversy surrounding this stake sale, with a newspaper report claiming that RPL's volume data from the exchanges do not match with the volume and dates mentioned by RIL. The stake sale happened between November 14 and 23, but the combined traded volume of RPL shares on BSE and NSE do not ad up to the 18.04 crore shares RIL says it sold – the report says.

RIL says it offloaded RPL shares to increase the floating stock, and thereby curb volatility in stock price. The free float will increase by a fifth and that should ideally bring down volatility. But, in our markets, volatility in large caps is closely correlated to activity in the derivatives segment. Traders in our nascent derivative market usually show a herd mentality and move together in one direction or the other. This behaviour leads to sustained up-moves and sharp slides in stock prices. The market-wide limit, defined as 20 per cent of free float, is the only constraint determining the quantum of positions. As free float increases, market-wide limits in the derivatives segment will go up and the build up in positions can be even larger. Won't that lead to even higher volatility in stock price, and if so, what was the real reason behind the stake sale by RIL?

RIL may not be the first company to do this kind of transactions and may not be the least transparent of large Indian companies either. But, being the biggest and most valuable company in the country, it will always face more scrutiny from the media and regulators. In the interests of the long term development of our capital markets, leading companies like RIL must set for themselves very high standards of transparency and corporate governance.