Podcast #30: The Big Hairy Audacious ReliancePodcast #30: The Big Hairy Audacious Reliance

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"Dhirubhai Ambani himself is responsible for a lot of the shareholder culture in India. Till the early 80s minority Shareholders were considered like second class citizens - there were institutions and promoters - that was all that people cared about. In Dalal street, the “Operators” would consider retail shareholders the pits, they would con people all the time. People would lose money, no one would care. Reliance was one of the few companies that would care about the shareholders. People from his village, from Gujarat would come in and buy shares of Reliance - those people are now probably multi multi millionaires. He built that culture."

In this episode Deepak takes on the Reliance Jio story. Is the stock in a bubble, is there any danger of it becoming a monopoly and why is there only one Reliance in India.

Transcript

Shray Chandra: Hi Everyone and welcome to Episode 30 of the Capitalmind Podcast. Thanks for all your support so far. We’re here to talk about what is very truly the [financial] topic of the month, of this lockdown and the topic of the stock markets for the last several months - you’ve guessed it - it’s Reliance and Jio in particular. To discuss this we have as always Deepak Shenoy, welcome Deepak. Deepak will help us unpack what’s happening with Reliance, what’s the deal with JIO - what is Reliance worth today?

So how did Reliance get here? You’ve been around for more than most of us. And you know more of the war stories of the past? How has Reliance got here and how does it continue to have such a grip on our attention or on the narrative.

It seems Reliance has moved from a commodity giant to a B2C powerhouse, there’s been so much written about them. Let’s assume our listeners are familiar with the Polyester Prince, the movie Guru, that Finshots infographic, the great blog posts by Vedika Kant and of course Ben Thompson's blog posts on stratechery.

If just a couple of years ago Reliance was about the same size as TCS or the combined HDFC twins, today that’s simply not the case - it’s worth as much as TCS and HDFC Bank combined!.

What’s going on, where did Reliance come from and how has it become so big?

Deepak Shenoy: Hi Shray, in fact Reliance has been the topic of all financial conversations this lockdown. While the lockdown was on, we’ve seen it raise Rs 150,000 crores which is more than the collective dis-investment target of the Indian government this year. I guess that obviously creates conversation but there’s more to this story than just that. Reliance has everything that an Indian consumer loves. There’s been stories of a person who grew from rags to riches (Dhirubhai Ambani) who built the company from very small origins as a yarn trader and built it into one of the largest petrochemical companies in India. Indeed his son [Mukesh Ambani] went on to build the refining and exploration and it became one of the largest in the world and then there was a family fight, you had two brothers fighting - they had to split the business almost vertically.

[In 2004-05] Mukesh Ambani lost a key part of the business that he had built up - the Telecom business that he had to give to his brother. There were fights, a patch up story, how they sued each in other in court, a long protracted legal battle - all of this alongside a bunch of other smaller fascinating pieces.

Let’s start from where Reliance was. Its origins were in the Direct to Consumer brands. They started off manufacturing polyester and they built a consumer brand called Vimal which is fairly famous for people my age, there were these “Only Vimal ads” they used to come on TV. Vimal had these suitings and shirtings cloth - from a showroom that was directly owned by the company. It was a wholesale approach and done a long time back.

They moved out of it - the Direct to Consumer brand and built a B2B brand where they were primarily in the petrochem area - there were doing petrochem manufacturing and part of the refining process. They owned the entire supply chain from exploring for oil, to refining it, taking parts of the process and selling it as petrol and diesel. And other parts being used to build petrochemicals. This was part of what Reliance built over a period of 20 years. It was one of the largest players in that space.

From there, in the last 10 years, they made another transformation back to Direct to Consumer - they now own the largest telecom player - Reliance JIO in the country. In a short time, Maybe 6-7 years from launch and now everyone knows who they are. They’ve got Reliance Retail stores all over the country - 10k or 11k of them. This transformation has happened fairly rapidly compared to the past.

Dhirubhai Ambani himself is responsible for a lot of the shareholder culture in India. Till the early 80s minority Shareholders were considered like second class citizens - there were institutions and promoters - that was all that people cared about. In Dalal street, the “Operators” would consider retail shareholders the pits, they would con people all the time. People would lose money, no one would care.

Reliance was one of the few companies that would care about the shareholders. People from his village, from Gujarat would come in and buy shares of Reliance - those people are now probably multi multi millionaires. He built that culture. He was known to have an IPO nearly every year. Every year in the AGM he would announce another company and then merge it back.

A lot of this was financially strange - because of the way India wanted to give export subsidies and export related help, Dhirubhai ensured that his accounting was such that legally he never paid any tax in any year. So no matter what happened the tax department would change some law and Ambani would not pay tax because of some other loophole that existed. Till this date Reliance is known to have the best tax planning and perhaps have hired most of the people who retired from the tax department after ages of experience so that their tax planning is absolutely brilliant.

Over a period of 10-15 years, after which the Indian government literally gave up and said we will create a minimum alternate tax - if under all the other laws you still pay no tax - you will have to pay 20%. This law was created for Reliance. Imagine its mindspace in government circles, how can a company this big not pay any tax. They had to change the tax laws to ensure that anyone who could pay tax would.

We did a separate podcast about this - there were bear operators hitting Reliance stock and Reliance shareholders would have lost money. So what Dhirubhai Ambani ended up doing was that he attacked them and he ensured that there were enough buyers for his shares and the people who were shorting them went bankrupt. This was in 1984 or so. It was so big that they shut down the Bombay Stock Exchange for 3 days because of the peculiar structure of the dealings. Dhirubhai refused to back down just to prove you should not attack Reliance or minority shareholders. He could have let it go and the price would have come back in 6 months but he wanted to make that point. Since then cartels do not touch Reliance shares.

Mukesh Ambani proved similar, it’s known in industry circles that in Reliance IPOs you won’t lose money. Prices will never go down below the IPO offer price. When the prices of Reliance Petroleum which is one of the companies they registered in 2006, when its prices started to come down after the global financial crisis, instead of having people make a loss, he merged it with Reliance Industries at the same price as the IPO.

That was another reason I think these tales are folklore perhaps, but we’ve had all of these different stories and all of them come together to make them greater in our mindspace. Reliance has made money - it has gone from Rs 55 in 2000 (effectively, not considering the demerger in 2004) but from Rs 55 to Rs 2000 (40x times). vs HDFC Bank Rs 19 to Rs 1000 today (50x) - it has been a stock which has made money for people as well and that really matters.

S: What do you think explains the grip though? Is it personalities involved? Is the rags to riches as you said. Is that - what’s with the mindspace?

D: If you think about it. The movie Guru had this right - where it was obviously about Reliance but the idea here was that this person was big enough to have broken the license raj when it existed and then thrived even after it. He controls sort of the system in the movie and the folklore is that he does that even now.

People say - listen if this party is in power, it's Ambani friendly. But the other party comes to power that's somehow also Ambani friendly. The feeling is that this is this guy who literally controls the strings of government no matter who the government is.

I don't know how true that is but it is folklore. And that is essentially the love hate relationship India has now with them. They have this massive house. They have these parties where they call everybody who matters. These fancy videos that somehow seem to come on social media, where someone's opening up the invitation, which they have sent for someone's wedding in their family. It's like, you know, India's opera playing out in real life,

S: Now let’s get back to the numbers. If I’m a shareholder of Reliance which Capitalmind Premium and PMS are - as a shareholder of Reliance, currently we’re counting our lucky stars - the stock has gone 4x in the last 5 years. It’s been brilliant right? But this creates nagging worries like is this like owning Microsoft or Wipro way back in 1999? There’s a story of success and future riches but is this story now over-done and are we braced for a big correction [like the dotcom collapse] or 10 years of stagnation?

D: Let’s take the examples that you've given. Okay, so we're looking at, say, Microsoft which had a monopoly in 2000 or 1999 that monopoly was Windows. Unfortunately for it, the Internet was coming. Microsoft disregarded it [bit controversial point but let’s run with it]. It couldn't use the monopoly it had to dominate the Internet. Otherwise we would not have heard of Google or Facebook or whatever.

So to that extent, Microsoft could not use the substantial power it had to be able to dominate the next big thing that was, coming ahead which was the Internet. They kind of missed the opportunity. It’s not like they couldn't - they didn’t and so they lost the opportunity.

If you look at Wipro on the other hand, it had lots of cash, and it was a very interesting stage in 1999-2000. But it didn’t use that cash to either acquire companies that could have given it more technology. Look at TCS. It acquired a bunch of companies and grew into the next big league.

Now, if you look at IBM, for instance, and say IBM vs Wipro in 1999 IBM was way bigger and you would not compare the two and neither would you compare IBM vs. TCS. But you can now compare TCS and IBM because TCS has bumped itself up the scale. Wipro hasn't.

In both these cases these companies didn’t use an opportunity. JIO on the other hand, has no lacking for such an ambition. If you look at what it says it seeing the future. It's telling us what the future is. It has serious ambitions. It's saying it's going to use and own the infrastructure, the data that you will have in order to access this next big thing. So it’s not only ambitious enough to and hungry enough to go for it - it actually is dictating the path that a lot us will take which both of these companies could have done.

On the other hand, if you look at the cash cows that Microsoft had, Windows and Office and WIpro had traditional business and the Y2K business, these cash cows were never really used to build into new businesses at that time. Microsoft has started to do it now, But Wipro still hasn't and but Reliance did this right, so they actually got rid of the dependence on Oil and Petrochem as the only driver of their future into now the drivers being both retail and JIO both of which are very different businesses from Petrochemicals and from oil refining businesses. So he acted using his cash in getting into a completely new business.

See what Microsoft has done since Satya Nadella. Satya Nadella has come in and he said, - okay, let's now get less dependent on Windows and Excel [Office] going forward. Suddenly you're seeing Microsoft acquired Skype, got a bunch of Internet businesses. They are now with Azure one of the largest players in the shared cloud space. They got GitHub, they have embraced open source. There's a bunch of things that have been done and Microsoft is back up again. As soon as the businesses changed contours and ambition came back in.

This is precisely what I think the reason is that Reliance today is also at a P/E ratio of 33 times, even considering everything not accounting for the Corona quarter. With this, with no net debt, with the cash it is valued at about 33 times. Apple today's is 30 times. [This seems fair]

Microsoft and Wipro in 99 - 2000 were probably 100 times earnings at that time. So you don't have the same layer of over-valuation. You don't have the same layer of under ambition, and you don't have the ability or the fear of moving out of your own business and creating new ones that both these companies Wipro and Microsoft had in 199.

That’s why I think it's different. And while you may still see Reliance being overvalued, I don't think the comparison with a Wipro or Microsoft in 1999 is quite the same.

S: Since you’re saying that how would you value Reliance today? Could you talk us through the numbers - what is it today? 14.5 lakh crores - not quite 200 Billion dollars yet but at numbers at this, can you make the individual businesses add up to something that explains this?

D: You can value Reliance the traditional way by saying listen let’s look at the earnings as a whole and give it some multiples and a P/E of 33 X is just an overall aggregate number. Now they have three main businesses.

The oil to consumer business. Let's call it that that is the petchem, the oil refining the exploration businesses. These businesses are valuable, of course, but at what level? They make a lot of money - you will give them commodity level valuations - we’re talking off roughly $75 billion USD which is about six lakh crores.

There is a retail which in private valuations is higher. But we're talking Amazon might come in with 10% - there’s rumour that will happen soon. But if you look at the numbers, they're talking about roughly three lakh crores. This is also about 30 times EBITDA which I think it was 10,000 crores a year [in retail]. We're talking about roughly that much, which is, you know, which is less than what a DMART is getting, but okay, assume that that's the kind of valuation you will get 3 lakh crores.

So six lakh crores for the oil consumer. Three lakh crores for retail.

JIO platforms - currently its valued at five lakh crore number. Now, if there is, I say currently, because that's what Facebook and Google and all of those companies have invested at. But given the future, the fact that you can value this company in many multiple ways but let give you just one comparison - Zoom the media company. It's valued at $70 billion today. That's a company that makes one [admitelly brilliant] piece of software that is, of course, in use in lots of parts of the world, it does not have anywhere close to either the subscriber based JIO has about 400 million subscribers.

I don't think Zoom has anywhere close to that many paying subscribers. A lot of them are going to be able to use Reliance's technologies on top of their Reliance connection that can use technology that is going to be owned by Reliance. So if you give it just a marginally higher valuation if it were to list today in the US as Zoom - ok, 70 billion for zoom so $100- $110 billion for JIO.

If that's the case you're talking of about 6 to 7 lakh crores or about eight lakh crores for JIO by itself. This added up about 15 lakh crore. So if you add all of this up, it will probably be 200 + billion USD in valuation. And you want to give it a little bit of a discount because JIO Reliance owns most these businesses but not all of it. So if you take $110 billion dollars of JIO, Reliance owns only 70% so you could give it a bit lesser valuation.

Overall, I think currently Reliance is reasonably valued. It’s not phenomenally overvalued. but then you have levers. So you’ve got a bunch of other things. But before we come to that we might as well say if you want to take the individual pieces of the business and not count any of the synergies within - the individual businesses probably add up to 14 lakh crore valuation that we have today.

We actually have a business which has these three or four moving parts, all of which now they can actually combine with each other in order to add value, right? You’ve got retail - they have stores - They have 11,000 stores all over the country. They don't really have an ecommerce arm yet - not much at least. They're talking about it so they’ve built something called JIO Mart. This is Jio, the telecom company with Reliance JIO Platforms, the software in tech company married with Reliance Retail, the retail company. So if you take all these three things you can say, listen, I could use all of the infrastructure we’ve got and build something that could compete with Amazon.

Amazon is a company that has been losing money every year for the last 6-7 years [actually net income is positive, point is around investments amazon is making] and probably will lose a few billion dollars every year of the next five or 10 years and you are competing with that - and the only guy who can do that is somebody like Reliance, who's got all of the other pieces so firmly built in that he can generate value out of that - so that that additional value creation come from combining these arms in different ways to compete with the likes of Amazon.

S: That’s a good argument but look at the size point, Reliance is currently equal to combined the market cap of numbers 2 and 3 on the Indian stock market - TCS and HDFC Bank. So if it’s as big as them combined and the fact that they seem to be able to lose money, no debt anymore, are you or is anyone seriously worried about Reliance becoming a monopoly? Is this something that’s happened in the past? Is this a concern we should look out for? As you just pointed out, when people do get concerned about Microsoft becoming a monopoly - forces conspire to then make sure the future prospects aren’t as bright. Could that be a potential downside for Reliance looking ahead?

D: So I mean, you're a Reliance shareholder obviously like we are, we would like it to become a monopoly at some point. But the problem is and everybody fears this. Reliance will own your world, your data - own everything that you have.

But to be honest, they have never been on a monopoly on anything they’ve done. I am looking all the way back. They built polyester - they were not the only guys doing it. There was a licence as a number of people could do, and that number was more than one.

They have Vimal suiting but there was also a Gwalior suiting and Raymond and all sorts of things.

There is the refining business. Are they the only people who can refine petrol?. No they have always competed worldwide with Refiners worldwide and trades done in Singapore and in Dubai and so on. There is no reason why they could be called a monopoly in refining.

In Petrochemicals are they the only folks who make polystyrene, a lot of the plastic stuff that Reliance currently produces - No, the answer is again there is a tonne of others. There was the exploration business where they did KG D-6 - They were not monopolies in this, K G D 6 was a block that they bid for. But there were other companies bid for other blocks and got those as well. So there was no monopoly then and there is no monopoly now.

Reliance retail is not the only shop to go to and it will not be the only shop you go to even if they were to buy out all of say Kishore Biyani’s Future retail. The rumours are in that they will. But even if they did, that's not the only set of shops in town.

They bought Hamleys. So they bought a toy store which again is not the only toy store. There are hundreds of toy stores, and they will continue to be. It's not even a monopolistic toy store. It's just not going to be.

The same thing applies in Telecom. They may be the biggest but Bharti Airtel and to whatever extent it can - Idea, still are giving it serious competition. Even if it were to go to another extreme in terms of being able to “kill” Idea by making losses - I believe like the airline industry eventually we will see another player in the telecom space because the space can take three large players. Bharti isn't going anywhere, so I don't think we should be worried that Reliance will become a monopoly.

In fact, the only thing that I feel that we should be worried about is is the fear that the government itself saying that listen politically, we cannot be seen as being aligned with this person because everybody feels or whatever we do, this person takes the maximum impact or benefit out of it, and so therefore, they may try to actively take steps like the V P. Singh government did in the 1980s, to distance themselves from Reliance or make it inconvenient for Reliance. But other than that, I don't see that as a monopoly threat.

S: Fair enough, as you talked about the scale and ambition - one question I’d like to ask is why is there only one Reliance, we’ve had success stories in India in the past, IT was a success story, Pharma was one, Finance has been quite a success, but it seems we’ve circled back to Reliance as we’re coming to grips with what they’ve accomplished - no one has come close. Certainly the stock prices reflect that. Can you talk about this. Why is it that the numbers are so favorable? 1.2 - 1.3 billion people, fast growing GDP - why is there only one reliance in this country?

D: So here's my thought process - is that of a big hairy audacious goal? I don;’t know where I read this, Dilbert? No Jim Collins! It abbreviates to BHAG which sounds like an Indian word - you see very few people in India actually have that kind of level of ambition.

Imagine a guy with the yarn trader stating I’ll build the largest polyester company and then the largest petrochemical complex. And then the largest …. He built the world's biggest petrochemical, most complex refinery. That could, because you need complex refineries to break down stuff that you get from Saudi Arabia, which is what is called heavy sour crudes. Heavy, sour crudes with an extreme amount of sulphur content and are very dense.

So you need a more complex refinery to do this, people said okay India is not going to be able to do this - mostly it is public sector refiners. What they did is build one of the most complex redinfers in the world with capital from India, which comes at a very high cost compared to everybody else.

And they built it even when there was an earthquake - they built it in the corner of Gujarat with close to a desert in an earthquake prone area and when there was an earthquake and there was a destruction of that factory apparently it was Mukesh Ambani's first big assignment after he was told to join the family business was to get this refinery back online as soon as possible and he did it in a few weeks. So this was almost unheard of that an Indian company company could do this.

Think of what he’s gone on - Not just once but twice - he has brought down the cost of Indian telecom to a fraction of what it was - in 2004 Reliance Communications, which introduced prices of a handset at ₹500 which is great even today if you think about it.

But he did this in 2004 and did it again in 2015 where he brought the cost of a connection down to a point, where today I pay less per year than I used to pay per month in 2005. It's that kind of big goals that you know Reliance has consistently achieved.

Very few other companies and look at the top Nifty companies today? Can we call any of them innovative with BHAG? The answer is perhaps No.

We thought we will be big players in Steel. We produce less than 10% of the capacity of China today and we think of ourselves as big. We have been nowhere close. Look at the commodities steel, copper, aluminium - There are attempts but we're nowhere close to being the world's biggest.

Take any of the others. We were called an IT Power House - but we don't today figure in the top revenue making tech companies worldwide. Tech companies now include the Google's and the Facebook's, which own product consumer space. But I don't think any of our IT companies has reached that level.

There were a lot of people with meaningful ambition and that ambition took them to a fairly large size by any standard, it's great. But we did not have anybody of the size thinking of - look at Google who thought a search will take over the world!

Often, the fact is that people give up somewhere in the middle. And now let's look at a huge disadvantage that India has when compared with the rest of the world, that's a cost of capital.

We have an extremely high cost of capital we have had for the longest time. Reliance, on the other hand, has been able to manage that substantially well in the last few years, though earlier Reliance was only able to raise at slightly higher rates than today. So you know you have people today with much lower cost of capital - I’m talking 3 to 4% per year is the cost of capital for a lot of companies today, and yet we're not seeing anything innovative come out of them or even BHAG come out of them in any way.

If you look at even the competitive companies have done really well. Let's take a look. We have Sanjeev Bajaj of Bajaj Finance. Very nice. It's now larger than SBI in tems or market cap, one of largest companies, non banking finance companies in India. These are companies that have used technology to a very large extent to scale from a little tiny non banking financial to now where they are one of largest consumer lenders, Home Lenders, one of the largest capital market based lenders and so on in India. And they have built this over a relatively short period - 10 years. This is innovation, I think, in terms of capturing a market where the other players were very inefficient, they consistently built small layers of efficiency and they’ve gotten better.

Take TCS - N Chandra came in early 2000s and then built this up to a point where now it's a powerhouse massive in took TCS to the highest league - again great execution, phenomenal execution but not equally phenomenal innovation.

Look at HDFC Bank and HDFC. It has kept away from all the negative things, lending to the government, lending to crony capitalists - they just focused on the areas they were good at and they became one of the largest companies. Not necessarily the best. We've talked about how the process themselves can lead to a lot of weakness and a lot of the headless chickens moments where you can call up the bank and it will take you 10 days to figure out that nobody inside the bank knows what to do.

HDFC for instance wants you to walk into a bank in, this is three years after Demonetisation and during a lock down also, they want to to walk into a branch in order to just repay a loan.

Take Kotak Bank. Phenomenal execution. He did it at the same time when HDFC and HDFC bank were dominating but he was a turnaround specialist. Turned businesses around, took a hold of ING Vysya bank and they grew that business from there to a much higher level.

Take Maruti - fantastic execution, A little bit of help from the government at the time but built it to the scale that it is. But again, none of these are greatly innovative - we don't look at a Maruti car and think my God, this is so innovative - in any meaningful way.

And the same applies to whether it's Asian Paints which is phenomenal on distribution, we’ve heard a lot of stories about it but it’s a Paint company. An unlike Reliance that changed its entire model from Petchem to Oil refining to entirely into telecom and retail direct to consumer retail your don’t see an Asian Paints or a Maruti any of these things ever getting into businesses that will be completely different from what they are, even though they have a lot of cash on access to lot of capital, that innovation change of a Big Hairy Audaciousness has been seen only in the private space.

More early stage, private space. You see Flipkart - they built a fantastic business but in the end, of course had to sell out to Walmart, but they did get it to a reasonable amount of size. We’re seeing Zomato which has ambitions worldwide, not just in India.

There’s Swiggy and Ola - perhaps even more innovative than Uber. You enter an Ola cab and you start to watch a movie and then you reach your destination somewhere in the middle of the movie. The next time you take an Ola cab later, a different cab, the movie will start at the same point you left it in the previous Ola.

This is actually an interesting innovation when they worked on some of these nicer, interesting aspects and they brought to us but they’re not all not listed, right? So even Paytm - the new innovative companies don't seem to want to list. Or maybe they can't list in India because of Indian rules, they can’t gain access to the cheaper capital. They're the only ones who can compete with Reliance because they seem to have the BHAG. And they've taken capital from VCs and PEs, who have a limited shelf [fund] life and they want you to exit after a certain period of time,

Which is why WalMart had to take over Flipkart - otherwise Flipkart could have listed on our bourses and maybe the Bansals would still be around the compete. I mean, I'm just saying, but maybe it's just the lack of big goals and ambition that has kept away other competition from growing too big.

S: Fair enough, that’s a sensible argument. Your point is that the Indian stock markets are rewarding and therefore attracting people who are phenomenal at execution but not so much at innovation. Private companies do innovate and you’ve named some compelling examples but since they’re backed by people who need exits - they end prematurely. Reliance seems to have managed to capture the best of both worlds.

That’s a comprehensive and interesting look at Reliance. I don’t hear you saying 10x from here or anything along those lines. It won’t be India’s trillion dollar company [imminently]? But it seems fairly valued at the moment as you pointed out.

D: Yeah, In fact, you have to take this with a little bit of salt as well. Because everybody tries to out execute everybody else. But it doesn't mean that we will always see Reliance on the top of everything. I just think that it's a great firm and it has very interesting opportunities. It's not the only one.

It’s also something that we have to put a caveat to saying. Listen, we sound so enthusiastic. It's almost like you should sell your neighbors house and buy Reliance. We're impressed.Very seriously I am impressed by their execution. The ability to raise 150,000 crores in a lockdown and also of course the JIO,scale and size. But at the same time, I think, you know, challenges lie ahead

Even now they're not up to the best standards. Jio Mart - you can still order stuff on JIO market and get something completely different and it will take you 30 days to find out who to contact before they fix things. So it's not like everything is roses out there. But, I mean, you're seeing pretty much a very different Reliance than the Reliance of the past.

S: With that let’s bring an end to today’s episode. Just for everyone out there Deepak is on @deepakshenoy on twitter, Capitalmind is at capitalmind_in, you can read our research content and other stuff like this at capitalmind.in and if you’re interested in investing with us (and we own quite a bit of Reliance and have done very well from it) you can visit us at capitalmindwealth.com. Deepak any last words?

D: No, I think you've said it all - keep talking, asking us questions. I'd love to hear what you have to say. Thanks a tonne for for listening in and be safe in this lock down. Use as much data as you can, I suppose!