Reliance Petroleums Triple Option Convertible Debentures (A) (FINC06) Reliance Petroleum Limited (RPL) is a part of Reliance Group,

one of the most successful Indian business houses having diversified business interests in Oil, Textiles, and Chemicals. The Indian industrialist in Dhirubhai Ambani founded it in 1966. Reliance group is known to be introducing innovative financial instruments in the stock market and an investor friendly company. RPL had come with an Initial Public offering in 1993 to finance partly its Rs.51.42 Billion refinery project. This was the largest issue in India and rated by leading credit rating agencies like CRISIL and FITCH as BB+ (Safe to invest). The issues were made through Triple Option Convertible Debentures structured in an investor friendly manner while protecting the interests of the company. The case discusses the details of TOCD and how it benefits both the investors and the company. a. Subscribing to convertible securities limits the downside risk of investors and provides them with the option of converting debt into tradable securities. Discuss in detail the benefits of convertible securities for both the parties. An organization raise to fund for new diversification, expansion growth plans through public investors by issuing various financial instruments. They can be raised by issuing company shares or through debt instruments. Debt instruments can be classified into debentures and bonds. Debentures are fixed interest debt instruments with varying maturity periods while bond is a certificate to assure a specified sum at a specified time. Debentures can be classified into fully convertible, partly convertible and non convertible debentures based on whether these debentures can be converted in to company shares at a future date as decided by the company (Call) or by the investors (Put). These are called convertibles will give the holders the right to convert a given security into specified no, of equity share under stipulated conditions. These debentures can be sold in the secondary market for a premium or a discounted rate based on the company performance, interest rates, inflations and various other market conditions. Debentures carry the best of both the worlds when compared with pure equity and pure debt instruments. Hence they can be very attractive financial instruments for both the company and the investors. Benefits of Convertibles from the Company Point of View: Company when raising finance through the public looks at a hassle free, flexible, less risky instruments that can yield better returns. The following are the benefits of debentures from the point of view of company. 1. Debentures help the companies raise funds without risk of dilution of controls.

2. Debentures holders dont have the right to vote and hence the company need not worry group of investors voting against the company management. 3. Debentures carry pre-determined schedule of interest and principal payments. The information helps the company in planning for the cash flow, expansion/diversification and investment. 4. The amount of interest paid on the debentures are tax-deductible and post tax cost of debentures are far lower than the tax on dividends paid on preferential and common shares. 5. Convertibles provide the option of converting into equity shares of the company and in a good time the market pays for the shares and not the company. 6. Unlike conventional debt, debentures can be structured in a way to reduce the interest burden of the company. 7. Debentures can help company to maintain a healthy debt to equity ratio thus improving key performance ratios like Return on Equity, ROCE etc. to improve the valuation of the company. Benefits of Convertibles from the Investors Point of View: When people invest in markets they want risk free, higher return for their money. Convertibles offer medium risk-return portfolio for the people with option of converting it into a company share at a later point of time based on the company performance. Following are the benefits of convertible. 1. Through convertibles the investors are ensured of fixed interest payments and also the principal in advance for a specified date and time in the future. It helps them in planning their cash flow and budgets better. 2. The convertibles are secure investment as the company is legally bound to pay the interest and principal. 3. In the worst case scenario, debenture holders hold the highest priority in settlement in case company liquidation 4. The convertibles also offer the option of converting into equity shares through a predetermined price and on a specific date. So in case the company performance is better the returns will be higher when the convertible is transferred into share and sold.

b. Evaluate three options (Given in table II) provided to RPL TOCD holder on the basis of Yield to Maturity (YTM). Assume that the RPL shares and each warrant (in case of option I) issued in September 1993 at Rs.22 and TOCD holders sold Rs.5 in September 1997. Calculate the YTM on the basis of number of years completed? Year to Maturity is the rate of interest that will be earned by a bond/debenture if it is held till the maturity date. YTM is the long term yield of owning the bond expressed in annual rate. YTM considers the current market price, coupon rate (for fixed yearly interests), par value and time to maturity. YTM is complex to calculate by normal

calculations, a standard bond table or calculator is used. For the purpose of the current problem, Excel XIRR function is used. To calculate YTM based on the available information following summary is given: Payment Schedule 01/09/1993 (September 1st is assumed) 01/03/1995 (After 18 Months) 01/03/1996 (After 30 Months) 01/09/1996 (After 36Months) Amount Rs.20 Rs.10 Rs.15 Rs.15

The Investors were given three options to exercise between 47th -49th month (4th year after issue). They are given below:

Option I Retain the non convertibles and get it in 6th,7th and 8th year and sell the warrants in the market

Option II Surrender the warrants and non convertibles and get 2 equity shares @ Rs.40

Option III Mix of Option I and II with additional payment of. Rs.40 1. Exercise the warrant 2. Pay Rs.40 to get 2 equity shares 3. Get the non convertibles in 6th, 7th and 8th year

In September1997, the share price was Rs.22 and the warrants were sold at Rs.5, Based on the above, the cash Inflow, together with Cash outflow by year can be shown one by one and the corresponding YTM is also calculated. Option I Option I Column1 Remarks Date Value Remarks 01/09/93 -20 Zero date payment 01/03/95 -10 Payment in 18 months 01/03/96 -15 Payment in 30th month 01/09/96 -15 Payment in 36th Month 01/09/97 44 Share Price @Rs.22 for 2 shares 01/09/97 10 Excercising 2 warrants @ Rs.5 each 01/09/99 20 First portion of Non convertible in 6th year 01/09/00 30 Second Portion of Non convertible in 7th year Third and final Portion of Non convertible in 8th 01/09/01 30 year There are many ways to calculate the YTM, for the current problem Excel formula XIRR(Values,Dates) are used. This formula is alternate to calculating IRR in in excel when the cash flows are uneven (which is the current case) The YTM is 21.45%

Option II Option II 01/01/93 30/06/94 30/06/95 31/12/96 01/01/97 01/01/97 Column1 -20 -10 -15 -15 44 44 Remarks Remarks Zero date payment Payment in 18 months Payment in 30th month Payment in 36th Month Share Price @Rs.22 for 2 shares Share Price @ 22 for 2 shares aquired by surrendering convertibles

Based on the above data, YTM for Option II using excel is 17.89% Option III Option III Column1 Remarks Date Value Remarks 01/09/93 -20 Zero date payment 01/03/95 -10 Payment in 18 months 01/03/96 -15 Payment in 30th month 01/09/96 -15 Payment in 36th Month 01/09/97 -40 Additional Payment of Rs.40 to aquire 2 new shares 01/09/97 44 Share Price @Rs.22 for 2 shares Share Price @ 22 for 2 shares aquired by paying 01/09/97 44 Rs.40 for 2 new shares 01/09/99 20 First portion of Non convertible in 6th year 01/09/00 30 Second Portion of Non convertible in 7th year Third and final Portion of Non convertible in 8th 01/09/01 30 year YTM for the option III using excel is 19.6%