Business

Problems of Plenty : The Challenges Before Reliance

Sanjeev

Sanjeev

Saudi Arabia has set up a Desalination project producing 800 cu km of water per day. This came for $3.4 bn, and its 28 Desalination plants use the oil energy equivalent of 1.5 mn bpd. 50% of the cost of the water is the cost of energy, another 35% would be the cost of capital.

Disclaimer: This article was written originally in August 2010, so some data points may be outdated.

Desalination Market

By 2030, India has a looming water deficit of 6900 cu. km per day at current levels of growth in usage. At current prices, water would find a market at about Rs.1-3 per liter in domestic and industrial markets, while the rest can be left for agriculture.

Going by the Saudi numbers, it would take about $30 bn to convert India’s domestic and industrial water markets to Desalination. Add piping and transportation, and we are looking at about $60-100 bn max. The cost of energy and the cost of capital could be brought down by a co that decides to charge off this huge investment to revenue.

Such a co would sit at the heart of India’s economic growth. If the co decides to invest in Solar plants at Rs.13 cr per MW, it would need another $30 bn to reduce the cost of water by half. Put it all together, and we are looking at a game plan for nearly $100 bn, with an impact on the Indian economy of about 2-3 times what telecom has done.

More than the investment capability, such a co would need to move Govt and get the Regulator’s support. The business would be domestic and would need high-quality project management skills and the ability to manage complex logistics and financing. Only Reliance can do it, I can’t think of anybody else in India who would even think of doing something so transformational. I wish Dhirubhai had lived longer; he had just the ability to pull off something so audacious.

Yet look at what it is doing. A late (re)-entrant into Telecom, down $5 bn and trying to catch up with a pack of global Telecom players already spread out over many countries, with far superior brands. If Reliance uses the regulator to try and bend the rules, the resultant PR backlash could prove suicidal for both the co and the Govt that it manipulates.

In Retail, it was a good idea to buy the Real Estate (while the competition was leasing it) and use its enormous cash pile to muscle its way into what looked like a big industry. At the moment, the jury is out on whether Retailing is a need in a country with high infrastructure costs and low spending power per person. If somebody is just sitting there with free Real Estate, waiting for retail spending to rise,  he would have garnered an unassailable position in the business, should it ever take off. On the other hand, we are not yet sure that Organised Retail will ever take off in the manner that it has in the US and Europe.

The Major Laws of Human Behavior

Have Money, Will Use/ (Lose) It:

This is a simple encapsulation of one of the major laws of human behavior. The clause in brackets is the automatic, ‘normal’ way to go after the first state of existence has been achieved. You make money, because you do something right; and then you do something with the (resultant) money that has NOTHING to do with what you were doing right in the first place.

Reliance made its money from oil and petrochemical assets: its main forté being project management, financial engineering and managing the cost of capital, and of course, handling the Govt interface. Its weaknesses have been its HR and the ability to attract (and retain) talent, build brands, and generally, deal with intangible assets. Quite simply, Reliance (like most big cos) fails at decentralized businesses which are light on assets and heavy on ‘spend’.

A business like Water or Solar would need one-time Project Management skills, good financial engineering, and the ability to manage the cost of capital. In other words, these businesses would operate from Reliance’s strengths, rather than its weaknesses.  If all these are in place, the resultant assets would sit at the heart of the economy, competing with other more expensive options (like coal-based Thermal assets). If Reliance throws its weight behind these two ‘big trends’ it would be saved from the following problems:

  • The Sumo Wrestler’s Problem: if you are too big, people don’t like you anyway. For the same reason that Blue Line/ DTC buses are disliked on Delhi roads, Reliance’s attempts to muscle into anybody else’s domain will see a PR backlash. We have already seen this in Retail, and (I think) we will see it in Telecom.
  • The Governance of Reliance: Water and Solar are vacant areas, where Reliance’s muscle power will be welcomed. Their ability to ‘harness’ Govt policy, will be seen as good for the country and they will be seen as a ‘gentle giant’ (like the Tatas). MDA has once said that the problems of India are the problems of Reliance; in fact, Reliance would be spearheading India’s movement toward Clean Tech, achieving parity with China’s ambitious move into green energy. As the biggest user of green energy, the water sector would see the development of a water market, dominated and ‘managed’ by Reliance.
  • From a Doing Co to a Platform Co: with such a huge size, it cannot retain flexibility, like the Sumo Wrestler above. Therefore, it should harness markets and create infrastructure to do things, rather than try and make things or sell services to people. Telecom qualifies as a platform business, but the management of brands is a decentralized activity, at which Reliance is unlikely to be the best.
  • Underperformance: some of the best money managers in the world are distinguished by a unique ability: to write cheques back to their investors when they can’t find proper avenues for investing their vast hordes of cash. At Reliance, that does not mean Dividend payouts, but certainly, Buybacks should be considered. That would be a very good way to consolidate control and even take the co private if need be. At least, the stock price will not underperform. There is no precedent in history for a co that accounts for >4% of GDP in a major economy, actually outperforming that economy.
  • The Alligator in the water: for any foray to make a difference to the giant’s P & L and cashflows, Reliance would have to scale up to a significant size. The probability that it will do this too soon and too much, is very high. That will destroy the fundamentals of any business that it gets into, but most of the damage will be to itself. The exception would be a concept business like Solar, where the only risk is technological…and that can be passed off to the Govt.
The size is the problem

It is most likely that Reliance will now underperform its past track record of creating wealth. Certainly, even if Reliance the Co remains the largest private organization for a long time to come, Reliance the Stock will underperform the markets, especially if it tries to reinvest its cash in new businesses, in trying to compound its earnings growth.

Perversely, the younger Ambani’s now discredited strategy of spreading himself too thinly on the ground, with partial stakes in concept businesses & immature industries, could be the way to go, if RIL must hold onto its cash. Maybe then RIL should look at turning into a PE Fund, where it buys management teams and backs small cos in immature businesses. There is nothing about RIL that points to them being able to beat the markets, but this could be a last resort.

History has no precedent, where a co the size of Reliance has CHOSEN to shrink in size, only so that it can manage itself better. Warren Buffet runs Berkshire Hathaway at $180 bn, but that is in the US economy. Besides, Berkshire has decentralized management, which will stand independently, even if Warren (and the earlier holding structure of Berkshire) is no more. This cannot be said of Reliance.

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