Chapter: 5

Effect of RPL-RIL Merger on Shareholder’s Wealth and Corporate Performance

This study analyses the Reliance Industries Limited merger with Reliance Petroleum
Limited -the largest ever merger in India. The study examines the effect of the merger on
the wealth of the shareholders of Reliance Industries Limited and also on post merger
corporate performance.
The results fail to support the capitalization hypothesis that merger gains are
captured at the beginning of the merger programs. The study finds that the stockholders
suffer loss for different time window period around the announcement period. The
announcement day return was found to be 4.78%. But the average abnormal return from
20 days before until 40 days after the announcement period was found to be -0.17%.
Merged firm did not show improved operating performance in terms of per share ratio.

Introduction
For a firm characterized by an objective of stockholder wealth maximization the
appropriate test of a Merger's success is the Merger's effect on stock prices. In an
efficient capital market, investor’s expectations of the merger's future benefit should be
fully reflected in stock prices by the merger date. Formally if the capital markets are semi
strong efficient, then the value of future benefits should be fully reflected by the first
public announcement of the merger and should certainly be fully reflected by somewhat
later merger date. The increase in the equity value of the acquiring firm in the wake of a
successful merger is a compelling evidence for the synergy theory of mergers.
Given that value is based on profits, and profits are the difference between revenue and
cost, the magical arithmetic happens in at least two ways in a merger: shared cost (e.g. by
sharing overhead) and enhanced revenue ( eg by increasing sales without adding to costs)
Two types of synergy need to be distinguished –cost based and revenue based. Cost
based synergy focuses on reducing incurred costs by combining similar assets in the
merged businesses. Revenue based synergy focus on enhancing capabilities and revenues,
combining complementary competencies. Revenue based synergy can be exploited if
merging businesses develop new competencies that allow them to command a price
premium through higher innovation capabilities (product innovation, time to market etc)
or to boost sales volume through increased market coverage (geographic and product line
extension). Vertical mergers take place between firms in different stages of production
operation. There are many reasons why firms might want to be vertically integrated
between different stages. There are technological economies such as avoidance of
reheating and transportation in the case of an integrated iron and steel industry.
Transaction within firms may eliminate the costs of searching for prices, contracting,
payment collecting and advertising and may also reduce the cost of communicating and
of coordinating production. Some economic activities really do create value that did not
formerly exist. Planning for inventory and production may be improved due to more
efficient information flow within a single firm. The efficiency and affirmative rationale
of vertical integration rests primarily on the costliness of market exchange and
contracting. Anticompetitive effects have also been cited as both the motivation of
vertical mergers and the result. Most conceived anticompetitive effects assume a
monopoly power of the integrated firm at one stage of operation. Operating synergy or

1
operating economies may be involved in horizontal and vertical mergers. Combining
firms at different stages of an industry may achieve more efficient coordination of the
different levels. The argument here is that costs of communication, and various forms of
bargaining, and opportunistic behavior can be avoided by vertical integration
(Williamson, 1971;Klein et al 1978).

Objective of the study:

In the theoretical context, where mergers has to lead to synergistic benefits such
as complementary resources, greater market share and increased capacities, this study
analyses whether the RPL-RIL merger- the largest ever merger in India has borne fruitful
results with respect to economic value addition and enhancement of shareholder wealth.
The analysis was done with respect to both share price and operating performance.
The study has been divided into five sections. Section 1 deal with the scenario
surrounding the merger, business review, advantages, opportunities and challenges for
Reliance Industries Limited. Section 2 deals with Review of literature. Section 3
discusses Methodology; Section 4 and 5 deals with Share price and operating
performance analysis. Section 6 deals with Conclusion and Implication of the study.

Section 1
1.1 Highlights of Merger

In the year 2002, RPL merged with RIL, the largest ever merger in Indian
corporate industry.
The merger of Reliance Petrochemicals with Reliance Industries limited was
formalized in a record time of about 7 months. The merger was aimed to enhance
shareholder’s value by realizing significant synergies of both companies. Liberalization
of Government policy and the accompanying economic reforms created this opportunity
for the company’s shareholders. During the year 2002, the Board of Directors of Reliance
Industries Ltd. (RIL) and Reliance Petroleum Ltd. (RPL) unanimously approved the
merger of RPL with RIL, with retrospective effect from April 1, 2001 subject to
necessary approvals. The media announcement of the merger was held on March 1,2002.
The Boards of both companies recommended an exchange ratio of 1 share of RIL for
every 11 shares of RPL. Shareholders of both companies approved the merger with an
overwhelming majority of over 99.9%. Pursuant to the receipt of approvals from the high
court of Gujarat and Bombay, and filing of requisite documents with the Registrar of
companies, the effective date for the merger was fixed as September 19 2002. Reliance
Petroleum Limited was delisted from the stock exchange by 10th Oct 2002.
The Merger has created India’s only world scale, fully integrated energy company
with operations in oil and gas exploration and production (E & P), refining and marketing
(R&M), petrochemicals, power and textiles. The merged entity RIL enjoys global
rankings in all its major businesses and leading domestic market shares. In fact RIL will
probably be the only company in the world that will start with crude oil and end up with
saris, shirts and dress materials. Merger is in line with global industry trends for
enhancing scale, size, integration, global competitiveness and financial strength and
flexibility to pursue future growth opportunities, in an increasingly competitive global

2
environment. The merger was said to been implemented in the context of the ongoing
economic reforms in the country and takes into consideration various factors such as:
• Continued progress in hydrocarbon sector reforms and regulation
• Dismantling of the administered pricing mechanism (APM) in the refining
industry
• The Government’s decision to grant marketing rights for the transportation fuels
to the private sector
• The proposed disinvestments of domestic public sector oil companies.
The merger gives RIL the distinction of becoming India’s first private sector company, in
the internationally tracked Fortune Global 500 list of the world’s largest corporations.
Based on available data in 2002, RIL Ranks:
• Amongst the top 200 companies in terms of net profits
• Amongst the top 300 companies in terms of net worth
• Amongst the top 425 companies in terms of assets
• Amongst the top 500 companies in terms of sales.
The merger also ranks RIL amongst the top Asian oil and gas and chemical companies as
well. RIL ranks:
4th in terms of profit
7th in terms of sales.
The merger has resulted in accretion of over Rs 2450 crores (US $ 500 million) to RIL’s
cash flows and acquisition of facilities which has been valued at over Rs 21000 Crores
(US $ 4.3 billion) by leading international industry consultants, Chemsystems . The
merger was aimed to contribute the following substantial benefits for RIL, thereby
substantially enhancing shareholder value.
• Scale • Integration •Global Competitiveness •Operational Synergies
• Logistics Advantages •Cost Efficiencies •Productivity Gains
• Rationalization of business Processes •Optimization of fiscal incentives.
• Reduction of volatility in the earning stream.
Reliance‘s leadership position in India is reflected in its all round contribution to the
national economy. Reliance contributes:
• 3% of India’s GDP
• 5% of India’s Exports
• 9% of Indian government’s indirect tax revenues.
• The group has also accounted for 2.3% of the gross capital formation in the
country in the last five years.
Reliance also accounts for:
• Nearly 25% of the total profits of the private sector in India
• Nearly 10% of the profits of the entire corporate sector in India
• 7% of the total Market capitalization
• Weightage of 16% in the Sensex.
• Weight age of around 13% in the Nifty index
• 1 out of every 4 investor in India is a Reliance shareholder.
The merger has led to a 32% increase in RIL’s equity from Rs 1054 Crores to Rs 1396
Crores. Reliance in another strategic move, acquired Indian Petrochemicals Corporation
Ltd. (IPCL). IPCL is India’s second largest petrochemical company and is amongst

3
India’s top 25 companies in terms of sales. Reliance acquired 26% equity stake in IPCL
held by Government of India. The acquisition of BSES for Rs.743 crore made it one of
the largest power companies in the country.
The Indian Economy is generally forecast to grow by 5 to 6% per annum over the
next few years. Per Capita consumption in India for most products and services remains
amongst the lowest in the world. Domestic demand growth in most of the Reliance’s
products has been at double-digit levels for the past several decades. There are also
increasing opportunities for Reliance’s products in the export market. In the year 2002
RIL sold 20% of its production for exports market .RIL continues to be ranked amongst
the top 10 producers globally in all its major petrochemicals products. Reliance is the
second largest producer of POY and PSF, the third largest producer of paraxylene (PX),
the fourth largest producer of PTA and the 7th largest producer of polypropylene (PP) in
the world. Reliance‘s integrated refining, petrochemicals, power and port complex at
Jamnagar, Gujarat, set up at a capital outlay of Rs 25000 crores (US$6 billion) represent
the single largest investment ever made by the private sector in India at a single location.
RIL is India’s largest private sector player in E& P with over 177,000 sq kms of awarded
exploration acreage, in 26 offshore and onshore deep and shallow water blocks including
one at Yemen. Reliance faces the challenges of competing with low cost producers from
the Middle East and parts of Asia Pacific. Reliance’s continued domestic market
leadership, even after the opening up of the Indian market to imports and steep decline in
import duties reflects the global competitiveness of its operation.

1.2 Business Review:

Oil and gas: India ‘s consumption of crude oil is 2.2 million barrels per day. The
country produces just about 32% of this requirement and imports balance 1.5 million
barrels per day. Consumption of natural gas in India is about 68.5 million standard cubic
meter per day or 883 billion cubic feet per year. Public sector companies presently
dominate the oil and gas industry in the country. RIL’s oil and gas strategy is aimed at
further enhancing the level of vertical integration in its energy business, and capturing
value across the entire energy chain. RIL holds a 30% interest in an unincorporated Joint
venture with British gas and ONGC, to develop the proven Panna Mukta. On the product
distribution front, Reliance has a 10% stake in Petronet India limited, the holding
company set up for creation of pipeline infrastructure for evacuation of petroleum
products all over India. India is expected to become the world’s third largest polymer
market after the US and China by the end of this decade. Current polymer consumption
of 3.4 million tonnes in the country is expected to treble during this decade owing to the
huge latent demand potential. Reliance is the world’s second largest polyester
manufacturer (fibre and yarn). Demand for polyester in the country crossed 1.3 million
tonnes during the year 2002, reflecting growth of 5% despite the impact of the global
slowdown. Reliance is the country’s largest manufacturer of these products, having a
market share of 54%. Reliance entered into a strategic alliance with Dupont for exclusive
distribution of Lycra- the most widely used stretch fibre and a registered trademark of
DuPont. RIL‘s refinery at Jamnagar with the capacity of 27 million tonnes per annum is
the world’s largest grassroots refinery and 5th largest refinery in the world at any single
location. RIL’s refinery is the first and only refinery to be set up in the private sector in
India, pursuant to oil sector reforms. RIL’s refinery accounts for almost 25% of total

4
production of petroleum products in the country. Public sector oil companies dominate
the Indian refining and marketing industry, Reliance being the only private sector
company. Within the country RIL continues to be the largest manufacturer of polyester
Intermediates with the market share of about 80%. RIL operates one of the largest
grassroots multi feed cracker at Hazira with capacity of 750,000 tpa. RIL is the country’s
largest producer and exporter of linear alkyl benzene (LAB), a leading surfactant
ingredient in the manufacture of detergents. Reliance accounts for 40% of the domestic
Normal Paraffin production. RIL produces commercial grade of butane from its cracker
at Hazira . Packed LPG is marketed as “ Reliance Gas” in cylinders to domestic and
commercial customers. Bulk product is being sold directly to industrial users for use as
fuel and to private bottlers. Reliance’s textiles complex at Naroda, Gujarat is one of the
India’s largest and most modern textile complexes. Reliance’s flagship brand is one of
the India’s largest selling brands of premium textiles.

1.3 Advantages of Merger

The merger was aimed to help RIL create great deal of synergies. RIL is a
petrochemical company producing plastic raw materials (HDPE, PVC, LLDP,
polypropylene etc) intermediates for polyester (MEG, polyester chips, paraxylene etc)
and chemicals like LAB. The feedstock for its cracker is gas and Naphtha, which is
produced by RPL (along with other petroleum products like petrol, kerosene, diesel
etc). In addition RPL’s Jamnagar refinery also supplies aromatic naphtha and propylene
to RIL’s Hazira cracker (both in Gujarat). In all nearly 25% of RPL’s output will be
used for captive consumption, bringing in large saving in terms of sales tax because
these transactions will be treated as inter divisional transfers. Besides both RPL and RIL
operate continuous process chemical plants, there will also be great deal of engineering
synergy in terms of operation, maintenance and expansions. The merger was aimed to
create India’s only world scale fully integrated energy company with operations ranging
from oil and gas exploration, production, refining and marketing of petrochemicals,
power and textiles. A merger has to lead to strong financials. Under the merger shares
of RPL held by RIL representing 28% of RPL ‘s equity shares capital will be cancelled.
RIL’s subsidiaries and associate companies will hold 12.2 % of company shares in
exchange of present holding in RPL. These shares are transferred to a trust and can be
monetised up to Rs 5400 crore at an appropriate time in the future. This aggregate
shareholding may also be leveraged to pursue significant acquisition and growth
opportunities. The other big advantage is the huge depreciation cover from the RPL.
RIL’s plants are relatively older and have used up its depreciation cover to a large
extent. While RPL whose refinery was set up in the last 6 years enjoys a huge
depreciation cover on its assets worth Rs 25000 crores. This will come handy in saving
taxes. Besides RPL’s products like petrol, diesel, kerosene sells most on cash basis as
against RIL’s products, which are sold on credit. The merger results in a balance in cash
management by churning out cash faster. As the debt equity and interest coverage ratio
will improve post merger, RIL will be in a position to leverage its strong balance sheet
to raise fresh funds at ease. It has paid off entire expensive loans from financial
institutions. Reliance group needs outlets for selling its refinery products. In the petro
sector where RIL has been a major player for years, it has major retail plans under
which over 5,800 retail outlets will be set up across the country. But the disinvestments

5
 derailment of the oil PSUs may prove to be a dampener as acquiring an oil PSU which
has a huge retail network in urban areas is critical as the state owned firms own most of
the prime retail space in this areas. Stronger balance sheet will make the job easier in
terms of fund availability.

1.4: Challenges

With the deregulation of oil sector and dismantling of Administered Price

Mechanism (APM) the regime of assured return on investment is coming to an end.
There is a strong possibility that in future competition among oil companies at the market
place will be intense and margins will be under pressure. RIL being one of the largest
producers will naturally be faced with stiff challenges. Reliance faces the challenge of
competing with low cost producers from the Middle East and parts of Asia Pacific.
Refining of petroleum products and the manufacture of petrochemicals products presently
account for the core of Reliance’s business portfolio. Both these businesses being global
in nature, the outlook for margins and profitability depends in large measure upon the
overall global economic outlook, the global demand supply scenario and trends in
feedstock and product prices. Any economic slowdown can adversely impact demand
supply dynamics and profitability of all industry players. But it is stated that the
company’s operations have historically shown significant resilience to the fluctuations of
economic and industry cycles. Reliance’s operation has significant exposure to the
domestic market, which accounts for nearly 80% of the revenues.

Table 1 & 2 gives a comparative picture of RIL’s financial performance with

respect to the largest Indian companies and the peer group in the oil sector in the year of
merger. Table 3 compares RIL’s performance with Global peers in the year of merger.

Table: 1 Comparison with Largest Indian Cos /Groups in the year of merger (2002)
Crores
Company RIL TATA AVBIRLA INFOSYS WIPRO HLL
SALES 57120.16 40000 17000 2603.59 3486.54 11056.04
NET PROFIT 3242.70 1100 1300 807.96 866.11 1825.86
MARKET CAP 49000 15000 10471 23879 38013 57,782
Source: Prowess database

Table: 2 Indian Peer Group in the oil sector: Rs in Crores (2002)

RIL IOC ONGC
SALES 57120.16 117106.93 23754.70
CASH PROFIT 5633.23 4487.70 9682.06
NET PROFIT 3242.70 2884.66 6197.87
NET WORTH 25073.90 15166.30 29511.84
ASSETS 56776.27 56434.87 57548.76
CASHFLOW from 7987.16 14443.18 11631.81
OPERATIONS
MARKET CAP 49000 13500 34500
Source: Prowess database

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Table 3: Comparison with Global Peer in the year of merger (US $ billion)
RIL BP Exxon SHELL DOW DUPONT
SALES 11.8 174.2 212.8 149.1 27.8 28.2
NETPROFIT 0.8 8 15.3 12.7 (0.4) 2.3
NET WORTH 5.8 75 73.3 57.1 11.4 13.3
ASSETS 11.2 134 111.5 121 30.4 34.6
Source: Economy & Business, Deccan Herald, Monday March11 2002

Section 2
Review of literature:
Studies related to the post merger performance generally follow either of the two
approaches: share price analysis or analyzing the operating performance.

2.1 Share Price Studies:

The acquiring firm generally earns positive returns prior to announcements, but
less than the market portfolio in the post merger period ((Servais 1994), (Bhagat, Shleifer
and Vishny 1990, Asquith 1983). Empirical research has consistently documented that
bidding firms largely pay large premiums for target firms. Most of the broad based risk
adjusted studies on mergers, Mandelker (1974), Langeteig (1978), Dodd (1980) has
shown that the stockholders of acquiring firms either gain a small statistically
insignificant amount or as in the study by Dodd (1980), lose a small significant amount
from the announcement of a merger bid. Mandelker and Langeteig‘s methodology uses
the merger date as their event date and effectively hides the stock market response before
the merger bid, i.e. the period from the bid’s beginning to its outcome None of theses
studies however examine possible changes in value for the entire merger process. The
study by Paul Asquith et al (1982) examines the effect of mergers on the wealth of
bidding firm’s shareholders. The study by Asquith investigates the entire merger process
from 480 days before a merger bid until 240 days after a merger bid. Two merger events
are used, the announcement date and the outcome date. The results reflect that the
bidding firms gain significantly during the twenty-one days leading to the announcement
of each of their first four merger bids.
Bidders abnormal returns are positively related to the relative size of the merger
partners. Study by Asquith (1982) examines whether firms are worth more combined
than separate. Mandelker (1974) and others suggest that there are resources, which earn
positive rents when combined across firms. If the resources are unique to only target
firms, a competitive acquiring market results in most of the gains being captured by the
target firm’s shareholders. If the resources are unique to only bidding firms, then their
shareholders should capture the rent from the resource. If the resources are unique across
a particular pair of firms or limited to a set of firms (e.g. monopoly power or horizontal
economies of scale) the gains from the merger will have to be split, between the bidding
and target firms. The study by Asquith concludes that resources are unique to the target
firms and that their shareholders receive large abnormal gains in successful mergers. In
an efficient capital market, if there is certainty about scope, timing and success of a
firm’s merger program, then the entire net present value of a merger program should be
capitalized in stock prices when the program is first announced. If there is uncertainty
about the program, the market’s reaction should be an ongoing process as new
information is released. The study by Langeteig (1978) reexamined the magnitude of

7
stockholder gains from merger. In the study stockholder gains were computed by
employing four alternative two-factor market industry models in combination with a
matched non-merging control group. Post merger stock prices could experience a merger
related increase (or decrease) as actual merger benefits are realized to be greater than (or
less than) expectations. Market efficiency requires that realization of merger benefits
represent a “fair game” in the sense that at the time of merger, it is just as likely that
merger benefits will be greater than expected as less than expected (Langteig, 1978). A
second implication of market efficiency is that merger related stockholder gains, if any
should be reflected in pre merger stock price performance. Theoretically the merger
should produce a non-negative operating or financial benefit. Assuming that the
managers act to maximize stockholder wealth, it is expected that both the merging firms
exhibits normal or superior pre merger price performance.
Reid (1968) and Hogarty (1970) report inferior post merger price performance
with respect to a non-merging control group. Shick and Jen (1974) and Halpern (1973)
report somewhat superior price experience immediately before the merger. Lev and
Mandelker (1972), Mandelker (1973,1974) and Franks, Broyles and Hecht (1977) report
positive, but insignificant price increase in the year before the merger. Advocates of the
benefits of takeovers cite evidence of substantial wealth gains at the time takeovers are
announced. Critics claim, however that the positive announcement returns reflect
optimistic expectations that fail to be realized. Evidence consistent with the latter position
is found in seven studies [summarized by Jensen and Ruback (1983) which report an
average abnormal return of –5.5% during the twelve months after takeover. Jensen and
Ruback interpret such negative returns as “unsettling” because they are inconsistent with
market efficiency and suggest that changes in stock prices during takeovers overestimate
the future gains from the merger. Negative post merger abnormal returns are also found
by Franks, Harris and Mayer (1988) using a comprehensive sample of US and UK
bidders straddling a period of thirty years from 1955-1985.A study on post merger share
performance of acquiring firms by J Franks et al indicates that prior findings of negative
post merger share price for bidders are more likely due to benchmark errors than to
mispricing at the time of announcement. The study concludes that while acquiring firms
may have poor post merger returns measured against an equally weighted index, their
returns are not reliably different from the returns of other firms with similar attributes as
captured by multiportfolio benchmarks. The study by Anup et al using a nearly
exhaustive sample of mergers over 1955 to 1987 measures post acquisition performance
finds that stock holders of the acquiring firms suffer a statistically significant wealth loss
of about 10% over the five years following merger completion. The Journal of Financial
Economics published a compendium of studies of mergers and tender offers in 1983. In
their comprehensive summary article, Jensen and Ruback (1983) reviewed 13 studies of
which six were on mergers. The study finds 20% return to targets in successful mergers.

2.2 Operating Performance Studies:

The study by Paul Healy et al (1992) examines the post merger cash flow
performance of acquiring and target firms. Further the study integrates accounting and
stock return data in a consistent fashion to permit richer tests of corporate control
theories. Tehranian and Cornett (1991) and Linder and Crane (1991) analyzed
performance in bank mergers, and Jarrell (1991) investigated post merger performance

8
using analysts’ forecasts of sales margins. Ravenscraft and Scherer (1987) examined the
target line of business performance using operating earnings and found no strong
evidence of improvement in performance for these target lines of business after mergers.
Cosh et al (1998) attempt to identify successful mergers based on the pre merger
characteristics, the impact of financial institutions as shareowners on the merger outcome
and finally the effect of mergers in the framework of the regression to norm.

Section 3

Methodology

The studies of abnormal returns provide a basis for examining the issue of
whether or not value is enhanced by mergers. The study analyses the share price
performance using the Market Model and Market adjusted method.
The market‘s reaction to a merger bid is measured using daily stock return data to
compute excess stockholder returns. These excess returns are a measure of the
stockholder’s return from the new information, which becomes available to market. The
daily excess return for the security is estimated by
XRt = Rt –E( Rt )
Where t = day relative to an event.
XRt = Excess return on the security for day t.
Rt = Actual Return on the security for day t.
E ( Rt) = Expected rate of return on the security for day t.
The choice of the benchmark is probably the most important factor in making
accurate measurement of a merger’s impact.
The expected rate of return on the security is found out using the Market Model and
Market Return Adjusted Method.

Market Model Method:

Residual analysis basically tests whether the return to the common stock of
individual firm or groups of firms is greater or less than that predicted by general market
relationships between return and risk. One problem involved is the choice of reference
period for obtaining the parameters to be used in calculating excess returns caused by the
events such as mergers. If the reference period chosen is too long or far removed from the
event, then the risk characteristics of the sample firm may have changed in the interval. If
the reference period is too short, it may not represent a valid benchmark.
To use the market model a clean period was chosen –50 to –200 days (0 day being
the merger announcement day) to estimate the model parameters. The model parameters
were estimated by regressing daily stock return on the market index over the estimation
period. The market model is given by Rt = α + β Rmt +∈t. Where Rmt is the return on
Sensex for day t, β measures the sensitivity of the firm to market –this is a measure of
risk and ε t is a statistical error term where Σ ε t =0. Thus the predicted return for the
firm in the event period is the return given by the market model on that day using these

9
estimates. Market model method is the most widely used method since it takes explicit
account of both the risk associated with the market and mean returns.

The Market Adjusted Return Method:

The predicted return for a firm for a day in the event period is just the return on
the market index. BSE Sensex- 30 for that day
Rt = Rmt .
Where Rt is the expected return. , Rmt is the market index return.
Two merger events are used, the announcement date (press date) and the outcome date,
which was the day RPL was delisted from stock exchange.

Operating Performance:
The financial statement figures for 2002 (the year of merger) include figures of
erstwhile RPL, which is amalgamated with the company with effect from April 2001, and
are therefore to that extent not comparable with those of previous year. Hence for the
comparative study of operating performance between the premerger and post merger
period, two base period year 2000 for premerger and 2002 for post merger period were
selected and percentage changes in operating performance were found out.
The model used for analyzing operating performance is by the ratio :
(Operating Cash Flow) / (Market Value of Assets)

Operating cash flows are sales less cost of goods sold, less selling and
administrative expenses plus depreciation and goodwill expenses. This measure is
deflated by the market value of assets (market value of equity plus book value of debt) to
provide a return metric, which excludes the effect of depreciation, goodwill, interest
expense and taxes. Hence it is unaffected by the method of financing and accounting.
Conceptually the focus is on cash flows because they represent the actual economic
benefit generated by assets. Scaling the cash flows by the market value of assets can
overcome the historic cost problem associated with return on assets. The market-based
measure has a potential limitation because unexpected cash flow realizations can change
expectations about future cash flows and hence market values. Data used was collected
from Company report, Prowess database of CMIE and IndiaInfoline website.

Section 4
Share Price Analysis & Interpretation
The share price analysis reveals that the announcement day return for RIL was
found to be 4.78%( Table 4). Cumulative return for the time –5 to + 5 days shows that
cumulative return has decreased by 1.44%. The excess return on announcement day was
1.5% and 0.58% based on market adjusted return method and market model method. The
abnormal returns for RIL based on both market model and market adjusted method shows
negative gains in different time windows except a marginal gain for two-day window in
the case of market model method. The abnormal return for 20 days prior to 20 days after
the announcement period gives similar negative gains by using both the methods. The
cumulative abnormal return declines from –0.57% to -3.9% under Market Return
Adjusted Method for 41 day period surrounding the announcement period.(-20 to + 20
day). The CAR declines from –0.74% to –4.99% for the same period under Market

10
Model Method. The announcement day return for RPL was found to be –0.867%. All
time windows show negative abnormal returns for RPL.
The mean and median return for RIL for the period 0 to 8 months where 0 is
the month of announcement was found to be –0.092% and –0.135%. The mean and
median abnormal return based on market adjusted return method for the above stated
period was found to be 0.034% and 0.0289%. Stock price changes in the period between
the press date and the outcome date demonstrate how the stock market responds to a
merger bid in progress. It also provides an insight into the stock market’s ability to react
efficiently to changes in probability. If the outcome of a merger bid is known at the time
announcement, then in an efficient capital market stock prices incorporate this
information at the press date. If however the outcome is uncertain, the abnormal stock
price change at the press date only contains an evaluation of merger probability.
Subsequent abnormal price changes in the period between the press date and the outcome
date will occur as new information become available. The size and direction of these
price changes reflect how much uncertainty is present at the time of press date and if the
announcement of a merger bid is evaluated correctly. The outcome day was defined as
the day the target was delisted from stock exchange. Announcement day is designated as
0. The analysis for time period 0 to 224 days (the period of announcement day to the
outcome day) shows that the mean and median returns were found to be –0.816% and –
0.315%. The mean and median abnormal return was –0.051% and 0.02% for the above
period. But this merger was not subjected to many regulatory and legal hurdles. In this
case, the outcome was certain, as it was a merger between group companies. The excess
returns in table 5& 6 from t = -20 to t = +20 merits some discussion. The results directly
contradict the hypothesis that gains to acquiring firm are capitalized early in a merger
program. Considering the excess return in announcement period, it is observed that the
excess return on the announcement day is not the largest. All support for capitalization
effect disappears when we examine the excess returns for time window greater than two
days. Dodd (1980) and Asquith (1983) identify the possible leakage of information
during the period from t = -20 until announcement day. These results were based on the
examination of target firm abnormal return prior to merger announcement. It can be
interpreted that large positive excess returns before the announcement day indicate that
the market is anticipating the merger. But the study finds that there was no large excess
return during the period t=-20 to t= -1 except for the day –16. Hence it can be interpreted
that there was no possible leakage of information. The excess returns to RIL on the
announcement day are further reduced till t =+ 8 days as measured by the cumulative
abnormal returns. Steady decline in the cumulative abnormal returns are also observed
for RPL from t= -10 days to t= + 10 days. Fig 3& Fig 5 graph the cumulative abnormal
return over the 121-day period t = -60 to t = + 60 days based on market return and market
model method. Both figures show that there is negative abnormal performance
surrounding announcement period. Both figures show that there is positive abnormal
performance before t = -19 days. Fig 3 show a declining trend after t= +24 days which
falls in the negative zone. Fig 5 shows that there is an increasing trend beyond t = +20
days with positive performance beyond t = + 47 days. It has to be noted that for the
Market model the value of parameters α and β were found to be –0.00043 and 1.30
respectively. This positive performance of stock under market model method relative to

11
the benchmark of estimation period may be due to the low returns during the estimation
period.

Fig: 1 RIL DAILY RETURNS

10.00%

8.00%

6.00%

4.00%
RETURNS

2.00%

0.00%

0
6
-6

12

24
18

30
36
42
48
54
60
-60
-54
-48
-42
-36
-30
-24
-18
-12

-2.00%

-4.00%

-6.00%
DAY

12
 Fig: 2

Excess Returns for RIL based on Market Adjusted Method

8.00%

6.00%

4.00%

2.00%
Return

0.00%

-15
-60

-55

-50

-45

-40

-35

-30

-25

-20

-10

50
-5

10

15

20

25

30

35

40

45

55

60
-2.00%

-4.00%

-6.00%
Day

Fig: 3
Cumulative Abnormal Return for RIL based on Market
Adjusted Method

10.00%

8.00%

6.00%

4.00%

2.00%
CAR

0.00%
4

12
0

18

24

30

36

42

48

54

60
0

6
-6
-4

-3

-1
-6

-5

-4

-3

-2

-1

-2.00%

-4.00%

-6.00%

-8.00%

-10.00%

Day

13
 Fig: 4
Excess Returns for RIL based on Market Model Method

6.00%

4.00%

2.00%
Returns

0.00%

8
12

16

20

24

28

32

36

40

44

48

52

56

60
0

2
-8

-4
-5

-4

-3

-3

-1
-6

-5

-4

-4

-2

-2

-2

-1

-2.00%

-4.00%

-6.00%

Day

Fig: 5
Cumulative Abnormal Return Based on Market Model Method

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%
CAR

0.00%
8

0
0

2
-8

-4

12

16

20

24

28

32

36

40

44

48

52

56

60
0

8
-4
-6

-5

-5

-4

-4

-3

-3

-2

-2

-2

-1

-1

-2.00%

-4.00%

-6.00%

-8.00%

-10.00%

Day

14
Table: 4 RIL- Share Price daily returns during Announcement Period.
Day t Returns % Cumulative Return
-5 0.33 0.33
-4 -0.016 0.31
-3 2.22 2.53
-2 0.93 3.46
-1 -5.32 -1.85
0 4.78 2.92
1 -2.85 0.07
2 0.19 0.26
3 -1.91 -1.65
4 1.56 -0.09
5 -1.68 -1.77

Table: 5 Abnormal Return from 20 days before the announcement day until day 20 for RIL based on
Market Adjusted Return Method:
Day t Abnormal Return % CAR Day t Abnormal Return % CAR
-20 -0.57 -0.57 7 -0.18 -8.66
-19 1.37 0.8 8 -0.46 -9.12
-18 -2.7 -1.9 9 1.08 -8.04
-17 -4.3 -6.2 10 2.56 -5.48
-16 4.68 -1.52 11 -0.43 -5.91
-15 0.28 -1.24 12 -0.78 -6.69
-14 -1.7 -2.94 13 0.81 -5.88
-13 0.81 -2.13 14 1.15 -4.73
-12 -0.45 -2.58 15 0.73 -4
-11 -0.54 -3.12 16 0.15 -3.85
-10 0.052 -3.06 17 0.25 -3.6
-9 0.16 -2.91 18 -0.18 -3.78
-8 1.6 -1.31 19 -0.80 -4.58
-7 0.019 -1.29 20 0.68 -3.9
-6 -1.47 -2.76
-5 -0.61 -3.37
-4 -0.27 -3.64
-3 -0.52 -4.16
-2 1.12 -3.04
-1 -1.45 -4.49
0 1.51 -2.98
1 -1.8 -4.78
2 0.23 -4.55
3 -1.26 -5.81
4 -0.53 -6.34
5 -0.77 -7.11
6 -1.37 -8.48
Table 6:Abnormal Return from 20 days before the announcement day until day 20 for RIL based on
Market Model Method:
Day Abnormal Return % Cumulative Abnormal Return
-20 -0.74 -0.74
-19 1.57 0.83
-18 -2.63 -1.80
-17 -5.35 -7.14
-16 4.64 -2.50
-15 -0.17 -2.67
-14 -1.86 -4.54
-13 1.01 -3.53
-12 -0.6 -4.13
-11 -0.81 -4.94
-10 -0.28 -5.23
-9 -0.06 -5.29
-8 1.97 -3.32
-7 0.39 -2.93

15
-6 -1.54 -4.47
-5 -0.85 -5.32
-4 -0.31 -5.63
-3 -1.30 -6.93
-2 1.22 -5.71
-1 -0.26 -5.96
0 0.58 -5.39
1 -1.53 -6.92
2 0.29 -6.64
3 -1.00 -7.63
4 -1.12 -8.76
5 -0.46 -9.22
6 -0.90 -10.11
7 0.42 -9.69
8 -0.70 -10.40
9 1.03 -9.36
10 2.30 -7.06
11 -0.35 -7.41
12 -0.30 -7.72
13 0.68 -7.04
14 1.58 -5.46
15 0.95 -4.51
16 0.62 -3.89
17 0.36 -3.53
18 -0.23 -3.75
19 -1.03 -4.78
20 -0.21 -4.99

16
Table 7: Mean and Median Return % for different time window period.: RIL
-20 to + 40 days -20 to + 20 days -10 to + 10 days -5 to + 5 days -2 to + 2 days
Mean 0.102 0.05 -0.20 -0.16 -0.45
Median 0.11 0.16 0.33 0.19 0.19

Table 8: Mean and Median Abnormal Return % based on Market Adjusted Return Method for
different time window period: RIL
-20 to + 40 days -20 to + 20 days -10 to + 10 days -5 to + 5 days -2 to + 2 days
Mean -0.17 -0.09 -0.11 -0.49 -0.093
Median -0.19 -0.18 -0.27 -0.53 0.23

Table 9:Mean and Median Abnormal Return % based on Market Model Method for different
time window period.: RIL

-20 to +40 days -20 to +20 days -10 to +10 days -5 to+5 days -2 to +2 days
Mean -0.03 -0.12 -0.10 -0.43 0.06
Median -0.10 -0.26 -0.28 -0.46 0.29

Table 10:Abnormal Returns from 10 days before announcement day until 10 days for RPL based on
Market Adjusted Return Method.
Day t Abnormal Return% CAR
-10 -1.74 -1.74
-9 -1.5 -3.24
-8 -2.08 -5.32
-7 -0.4 -5.72
-6 1.5 -4.22
-5 -0.77 -4.99
-4 -0.59 -5.58
-3 -1.07 -6.65
-2 -0.79 -7.44
-1 -0.28 -7.72
0 -4.13 -11.85
1 2.20 -9.65
2 -2.37 -12.02
3 -1.21 -13.23
4 -0.65 -13.88
5 -1.2 -15.08
6 -0.55 -15.63
7 -0.14 -15.77
8 -0.0095 -15.78
9 0.0612 -15.71
10 1.96 -13.75
Table: 11 Mean and Median Return% for different time window: RPL
Day -40 to + 40 days -20 to +20 days -10 to +10 days -5 to + 5 days -2 to + 2 days
Mean -0.91 -0.071 -0.567 -0.758 -1.44
Median -0.337 -0.482 -0.645 -0.867 -0.987

17
Table 12: Mean and Medium Abnormal Return % based on Market Adjusted Return Method for
RPL
Day -40 to +40 days -20 to + 20 days -10 to + 10 days -5 to + 5 days -2 to +2 days
Mean -0.232 -0.188 -0.66 -0.99 -1.07
Median -0.311 -0.284 -0.65 -0.79 -0.796

SECTION 5

Financial Performance:
The data for analyzing the financial performance is given the appendix (E)

Analysis:
The figures for the year 2002 (the year of merger) include figures of erstwhile
RPL, which is amalgamated with the company with effect from April 2001, and are
therefore to that extent not comparable with those of the previous year. Hence for the
comparative study between pre merger and post merger period, two base period –2000
for pre merger period and 2002 for post merger period were selected and percentage
changes were found out for both the pre merger and post merger period.

Table13: Operating Performance

Percentage changes Pre Merger Period Post Merger Period
Sales 37.96 13.93
Operating Profit 18.34 7.74
Net Profit 10.08 26.57
Cash Profit 14.37 14.56
Cash Flow from operations 189.25 -15.25
Reserves & Surplus 8.5 9.44
Net worth 6.98 10.04

18
Table14: Per Share Ratio
% Changes –Per share Ratio Pre Merger Period Post Merger Period
EPS 5.69 -0.14
Cash EPS 22.32 7.61
DPS 6.25 5.26
Operating profit per share 21.04 -22.84
BV (Excl Rev Reserves) per share 9.85 -15.81
BV( Incl Rev Reserves) per share 7.85 -16.68
Net Operating Income per share 42.46 -18.11
Free Reserve per share 3.79 -18.16

Table 15 : Profitability Ratios

% Changes Pre Merger period Post Merger period

P/E Ratio 35.80 -5.03
P/B Ratio 31.6 -37.8
Yield -0.36 0.17
Gross Profit Margin -2.21 -0.63
Net Profit Margin -2.75 1.23
RONW 0.06 0.42
ROCE 2.23 -2.48
Return on Sales -2.19 1.89
Return on Asset 5.1 16

Table 16: Liquidity and Solvency Ratios

% Changes Pre merger period Post merger Period
Current Ratio -28.48 -41.25
DER -17.47 -4
Solvency 3.46 -1.97
Quick Ratio -72.2 -61.36

Table17 :Coverage Ratios:

% Changes Pre Merger Period Post Merger Period
Fin Charges Coverage Ratio -5.88 24.62
Fin Charges Cov Ratio ( post Tax) -3.09 28.13

Table: 18 Payout Ratios:

% Changes Pre Merger Period Post Merger Period
Dividend Payout Ratio 2.80 -5.87
Dividend Payout ratio (Cash Profit) -0.59 4.02

19
Table: 19 Component Ratios:
% Changes Pre merger period Post merger period
Material Cost Component 2.08 7.91
Selling Cost Component 0.89 0.63
Export as % of sales 1.20 -0.4

Table: 20 Operating Performance Model Analyses

Year 2000 2001 2002 2003
Operating Cash Flow (CFO) (Rs in Crores) 4788.44 5597.48 9123.85 9388.26
Market Value of Assets*( Rs in Crores)(MVA) 36894.72 46020.04 48418.80 47296.06
CFO/MVA 0.129 0.122 0.188 0.198
*Market Value of Assets: Market Value of Equity Capital + Book value of Net debt.

The percentage increase in sales and operating profit had been lesser in the post
merger period compared to pre merger period. But the net profit showed significant
increase in the post merger period. The reserves and surplus grew by 9.4% in the post
merger period compared to 8.5% in the pre merger period. There has been a sharp
negative growth rate in the cash flow from operations during the post merger period.
(Table 13). All the per share ratios have shown decreasing trend in the post merger
period. In fact negative changes have been observed for EPS, operating profit per share,
book value per share and net operating income per share. P/E ratio decreased by 5.03% in
the post merger period. (Table 14). Negative percentage changes are also observed for
Return on capital employed in the post merger period. Return on sales has increased by
1.89% in the post merger period (Table 15). Financial synergy has not resulted in the
short run for the merger as reflected by the percentage changes in EPS, P/E ratio and DPS
The operating cash flow return on market value of asset shows a negative –5.4%
during the premerger period and a growth of 5.3% during the post merger period. This
can be accounted by the fact that the debt has been reduced by 25% compared to the
increase in operating cash flow by 2.89% and market value of equity by 9.77% in the post
merger period. (Table 20).

Section 6
Conclusion and Implication
Mergers, Acquisition and corporate control represent a major force in the modern
financial and economic environment. For a firm characterized by an objective of
shareholder wealth maximization, the appropriate test of a merger’s success is the
merger’s effect on stock prices. In an efficient capital market, investor’s expectations of
the merger’s future benefit should be fully reflected in the stock prices by the merger
date. Formally if the capital markets are semi strong efficient, then the value of the future
benefit should be fully reflected by the first public announcement of the merger and
should certainly be fully reflected by somewhat later merger date. The increase in the
equity value of the acquiring firm is a compelling evidence for synergy theory of
mergers.
This study analyses the RPL merger with RIL- the largest ever merger in India.
The study examines the effect of the merger on the wealth of the shareholders of RIL and
also on post merger corporate performance.

20
 The result fail to support the capitalization hypothesis that bidder’s gains are
captured at the beginning of merger program. Focusing on the period between
announcement period and outcome period it is observed that negative excess returns do
not represent a ‘fair game’ as required if markets are efficient. The analysis for time
period 0 to 224 days (the period of announcement day to the outcome day) shows that the
mean and median abnormal return was –0.051% and 0.02%. The results exhibit negative
abnormal returns in almost every time interval surrounding the announcement period.
The announcement day abnormal return was found to be 1.5% under the market return
method and 0.58% under the market model method. RIL’s shareholders receive a 5-day
average excess return of 0.06% under market model method. But there is negative
abnormal performance during the 20 trading days before the press day to 20 days after
the press day.
The study identifies that there was no possible leakage of information about the
announcement of the merger before it appeared in the press based on the pattern of
abnormal returns surrounding the announcement period. The results indicate that this
merger is not positive net present value activities for acquiring firms and merger program
was not consistent with the value maximizing behavior by Management. For the target
firm RPL, the announcement day return was found to be –0.867%. The Cumulative
abnormal return decreases from –1.74% to –13.75% during the period t = -10 days to t =
+ 10 days. The results do not support the argument that all benefits from merger are
capitalized in the acquiring firm’s stock price at or before the announcement of a merger
program. Another implication of market efficiency is that merger related stockholder
gains should be reflected in premerger stock price performance. In the context of wealth
maximization by the managers, it is expected that both merging firms exhibit normal or
superior pre merger price performance. The Cumulative abnormal return graph observes
some positive abnormal performance for RIL in the premerger period.
The merger, which could be explained in terms of operational synergy, has not led
to financial synergy in the short run. The operating performance analysis reveals that
percentage changes in the post merger period has declined compared to premerger period
with respect to EPS and P/E ratio showing negative changes. Net profit increased by
26.51% in the post merger period. Sales increased by only 13.93% in the post merger
period compared to 37.96% in the pre merger period. The merged firm has not shown
significant improvement in asset productivity based on percentage changes of comparison
between the pre merger and post merger period.
The question remains if this merger could be justified from stockholder point of view and
is the enhancement of stockholder wealth the sole motive for the merger. Or was this only
a reflection of the general erosion in stock market values the world over, in the aftermath
of terrorist attacks in the United States in September 2001 and the consequent global
slowdown in economic growth.
The study cannot be generalized, as it could not be justified on the basis of a
single case study. The long-term effects of merger in terms of financial performance
could be analyzed only in the due course of time. Given the complexity and heterogeneity
of reasons for mergers, a more promising approach that provides new insights into factors
that influence the outcome of mergers would be to pursue clinical studies involving a
number of mergers in greater detail. These clinical studies can become the fruitful
avenues for future research.

21
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