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Why Reliance is raising more $ loans even as it sits on a huge hoard of cash

Discussion in 'World Economy' started by layman, Feb 20, 2014.

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  1. layman

    layman Aurignacian STAR MEMBER

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    If you were sitting on loads of cash, would you buy a new car by: a) taking a loan on interest; or b) paying cash by breaking an interest-bearing fixed deposit (FDs).

    Most people would probably choose option ‘b’ if the cost of the car loan is higher than the interest earned on the fixed deposit. Many people would probably choose ‘a’ if it is the reverse – that is the interest on the loan is lower than the earnings on the FD.

    Mukesh Ambani is doing more of the former: sitting on the FDs and raising loans.

    Business Standard reports today (20 February) that Reliance Industries Ltd (RIL), which was sitting on cash, bank balances and cash-equivalent investments of Rs 88,704 crore ($14.4 billion) as on 31 December 2013, is raising over $1 billion (around Rs 6,200 crore) as foreign loans from export credit agencies. This, says the paper, is part of the $13 billion plan for expanding its petrochemical and gasification projects at its refinery in Jamnagar.

    In theory, Reliance can finance the entire expansion with its own cash (which is $14.4 billion) or through loans. But it is opting for debt. Is this the right strategy?

    Reliance has always loved the idea of raising cash for as long as one can remember. In fact, the management is continually raising and allocating cash to its various businesses even as these businesses generate cash surpluses of their own that go into FDs and other investments. What seems to be the idea behind loading up on debt at one end even while banking the cash at the other?

    Five reasons seem to provide the logic, some of it unique to Reliance.

    First, since debt can be set off against profits and lower taxation, it provides a tax shield.

    Second, thanks to the global financial crisis of 2008, interest rates have never been lower in the west. This is an additional reason for tanking up on dollar debt and investing it in rupee deposits.

    Third, as a huge exporter of petro-products – Reliance gets nearly two-thirds of its turnover from exports – the company can theoretically raise dollar debt with zero exchange cover. As its earnings are two-thirds in dollars, it has a natural hedge. Thus, while other borrowers would end up paying 9-10 percent (borrowing cost in dollars plus the forward cover), which is not much cheaper than taking a domestic loan, Reliance probably borrows in dollars at less than half that rate. The rest is money for jam if invested at home in an FD.

    While Reliance is also a huge importer of crude for its oil refinery, it is a bigger exporter than importer - and being on both the buy and sell sides of the dollar market allows it to play the hedging game - to the extent it wants to play it - on both sides.

    Fourth, keeping cash in the bank even while raising debt gives the company the ability to wangle softer rates from lenders and the ability to drive hard bargains on what it buys from vendors. For both lenders and suppliers, Reliance’s status as a net zero-debt company is a huge comfort.

    Fifth, raising debt is a form of business discipline. If you can make money after borrowing, it means your equity earns higher returns per share.

    However, there is one downside to having so much cash in the bank rather than in the business. It means shareholders are getting a lower return on their shareholding, as the earning on the company’s net worth is lower. Holding so much cash ultimately makes sense only if at some point it is going to earn even more margins from investment. Else, the cash is better returned to shareholders – which can get the same returns from bank FDs and bonds.

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  2. layman

    layman Aurignacian STAR MEMBER

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    A Business Practice i used to follow most of the times...

    :tup:
     
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