The Ambani brothers may have settled the issue of ownership amicably, but RIL [Get Quote] shareholders don't seem to have got a fair deal.

Soon after the Ambani brothers arrived at a final settlement, Anil Ambani has been making news about his group's mega plans in energy and the financial services business.

While that is great news for the respective group companies, issues of corporate governance still remain.

The Reliance Ownership Issue

Reliance Industries shareholders don't seem to have got their due share in the group's telecom company, Reliance Infocomm.

While the price of Rs 32 per share decided for the conversion of preference shares held by RIL in Infocomm may look attractive given the potential gains when the company goes for listing, it is not commensurate with the level of risk undertaken by the group's flagship in pursuing the venture right since inception.

And, in Anil Ambani's own words, RIL has committed not just its financial resources but other group infrastructure in building the telecom business.

Last week, Reliance Industries converted the Rs 9,208 crore (Rs 92.08 billion) worth preference shares it held in Reliance Infocomm in exchange for a 40.9 per cent equity stake in Infocomm's diluted equity.

Including its existing stake in the company, mainly through subsidiary Reliance Communications [Get Quote] Infrastructure, Reliance Industries now owns a 65.9 per cent stake in Infocomm.

The first thing that strikes from the preference shares conversion is that Infocomm's equity has been valued at Rs 22,500 crore (Rs 225 billion). Infocomm had debt worth Rs 2440 crore (Rs 24.4 billion) as on March 2004, which would give it an enterprise value of close to Rs 25,000 crore (Rs 250 billion).

In comparison, Bharti Televentures has an enterprise value of Rs 49,000 crore (Rs 490 billion), which means that Infocomm was valued 49 per cent lower than Bharti.

But analysts point out that Infocomm's debt currently would be much higher than the FY04 figure of Rs 2440 crore (Rs 24.4 billion). This is because free cash flow would have been negative, what with Infocomm's EBITDA being as low as Rs 912 crore (Rs 9.12 billion), far from sufficient to meet capex, and interest and tax payments.

Based on the various estimates of what Infocomm's debt could be, the valuation differential compared to Bharti would, at best, come down to 36 per cent.

This is more in line with the street's estimate of the valuation differential, considering that Infocomm's FY05 revenues were 33 per cent lower than that of Bharti and also the fact that its EBITDA (earnings before interest, tax, depreciation and amortisation) was about 70 per cent lower than Bharti's.

Yet, from a Reliance Industries shareholder point of view, it doesn't really matter whether Infocomm's valuation for the purpose of the preference shares conversion was in line with market valuations.

What matters is whether the 65.9 per cent stake Reliance Industries has ended up with in Infocomm is in line with the proportion of capital invested and the amount of risk taken. How does one ascertain that?

Including the Rs 8,100 crore (Rs 81 billion) Reliance invested in Infocomm's preference capital, the company has invested close to Rs 10,500 crore (Rs 105 billion) in the telecom company (this includes the Rs 2,331 crore (Rs 23.31 billion) the company invested in Reliance Communications Infrastructure).

Considering that Infocomm had a net profit of barely Rs 51 crore (Rs 510 million) in FY05 and since no significant equity infusion has been reported since the end of FY04, the accumulated dividend of Rs 1,108 crore (Rs 11.08 billion) on the preference shares would be the only meaningful addition to the company's equity capital.

As of March 2004, Reliance Infocomm's equity capital (including reserves and preference capital) stood at Rs 11,700 crore (Rs 117 billion), which would mean that the current equity capital would be about Rs 12,800 crore (Rs 128 billion).

Since Reliance Industries had put in Rs 10,500 crore (Rs 11,600 crore, if one were to give it the credit of the accumulated preference dividend), it accounts for 82 per cent of the equity capital infusion into Reliance Infocomm. In exchange, it has got only a 65.9 per cent stake.

Another way to look at it is to compare the recent acquisition price of Rs 32 per share with that of other investors. While we don't have the exact break-up of which investors paid what amount for acquiring shares in Infocomm, what we do know is that the 416.35 crore (Rs 4.16 billion) shares issued by the company (prior to the conversion) had fetched it Rs 3,035 crore (Rs 30.35 billion).

This means that the average acquisition price for investors was Rs 7.29 per share, which makes the current acquisition price 339 per cent higher. But some of these shares were issued at par or Re 1 per share, which could distort the picture.

However, the company had issued 69 crore (690 million) shares in FY04 (this is the same period during which the preference shares were issued) at an average price of Rs 14.43 per share. This makes the current acquisition price about 122 per cent higher than the price at which equity shares were acquired in FY04.

Analysts point out that since Infocomm was in its early stages, the risk profile of both equity and preference share holders was similar, especially since preference capital accounted for over 60 per cent of the company's total capital employed as on March 2004.

If the preference shares had been converted at say, Rs 13.44 per share, Reliance Industries would have ended up with a stake of over 78 per cent in Infocomm.

The fact that they now have a 12 per cent lower stake and considering that the equity portion of Infocomm is valued at Rs 23,000-25,000 crore (Rs 230-250 billion) by analysts, the company stands to lose Rs 2,800-Rs 3,000 crore (Rs 28-30 billion).

However, minority investors would have lost even more if earlier proposals to convert the preference shares at Rs 50 and Rs 96.2 were approved.