GAIL stake sale proposal is a win-win for all

Synergies for the companies

IOC and BPCL are the two largest oil refining and marketing companies in India and have been eyeing expansion in the gas downstream market for some time.

IOC has already entered the gas market with city gas distribution projects and liquefied natural gas pipelines (under development) and a stake purchase in GAIL would complement the growth of this segment.

BPCL on the other hand has been keen on entering the gas market and the GAIL’s stake would enable it to quickly cater to this ambition. The purchase would give the company access to GAIL’s huge ready-made gas distribution network in the form of over 11,000 km of gas pipelines and over 850 CNG stations across the country.

Overall a stake in GAIL will help both the companies to add and expand the natural gas transportation and marketing business. It would facilitate their rapid expansion in the retail gas market, which is much needed given the changing oil marketing landscape in the country, increased competition with the entry of foreign players and anticipated growth in consumption of cleaner fuels in the coming years.

The government’s side

The proposed deal should fulfill government’s desire of consolidating the oil sector and form integrated oil companies with better bargaining and competitive powers with an enhanced global standing. It would enable the government to monetise its stake in GAIL without much dilution of the control as the government would still enjoy a controlling stake through its majority holding in IOC and BPCL.

The deal at a rough value of Rs 41,000 crore forms approximately 51 percent of the targeted Rs 80,000 crore divestment for 2018-19E, which will provide much relief to the government given the slightly subdued sentiment in the capital market.

The impact on financials

Although the proposal has not been approved and contours of the deal have not been finalised but assuming that the deal is funded through debt, the purchase would mean significant addition to the finance cost for the acquiring companies. It would escalate the finance costs by around Rs 400-500 crore each for the two companies. This is around 2.5 percent of net earnings for FY17 for IOC and around 5 percent of net earnings of FY17 for BPCL.

The additional debt would also considerably increase the leverage in these companies, pushing up the debt equity ratio to 0.8x in IOC and 1.7x in BPCL. As far as GAIL is concerned, the deal would only mean a change in the ownership profile and we do not see much direct benefit prima facie.

Outlook

Overall, the deal brings about significant synergies for IOC and BPCL and would facilitate their strong and rapid expansion in the retail segment, though there could be short-term surge in the finance cost.

While IOC is better positioned to absorb the cost for the deal, BPCL would see significant increase in leverage. Further deal details are not finalised yet and feasibility of the deal would depend on the valuations. The government stands as a strong beneficiary and the deal would be a quick fix in achieving its tall divestment targets.

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