Market’s View On Future Group-Reliance Retail Deal

In a three-step deal, Future Group will sell its retail, wholesale, logistics and warehousing business to Reliance Retail for an overall transaction value of Rs 27, 513 crore.

• All listed Future Group companies to be merged into Future Enterprises Ltd.

• Future Enterprises to transfer assets of retail and wholesale undertaking and logistics and warehousing business to Reliance Retail entities.

• Reliance Retail will also invest Rs 2,800 crore for an up to 13% stake in Future Enterprises.

The deal will lead to substantial consolidation in the organised retail market giving Mukesh Ambani-led Reliance Industries’ retail venture pole position in the close to over $700 billion retail sector in India. The deal will add over 1,700 retail stores to Reliance’s footprint of 10,900 stores across groceries, electronics and other formats.

With over Rs 15,000 crore in debt and a substantial decrease in sales and cash flow on account of the pandemic, the Kishore-Biyani founded Future Group has been seeking funding support for several months. It won a minuscule investment from Amazon Retail several months ago but India’s foreign direct investment rules restrict foreign ownership of multi-brand retail.

Despite this consolidation, India’s retail market is highly fragmented and dominated by corner stores or kirana wallas. There is large headroom for the top 5 retailers to increase their market share from the current less-than 5% to 10-12% in the next decade, said a recent BCG report.

The deal will avert any further financial crisis at the Future Group, which last week averted a debt default at the minute.

BloombergQuint spoke to market experts for their views on the transaction.

Amit Rustagi, Sunita Sachdev, Navin Killa, analysts at UBS

“We would expect Reliance Retail to re-rate further and trade on a par with Avenue Supermarts (resultant increase of $4 billion in our target EV). This does not include potential synergies from increased geographic presence; improving sourcing efficiencies; and cost rationalisation.”

The brokerage maintains its 'neutral' rating on Reliance Industries (with significant challenges from pandemic-driven macro slowdown), and hiked its price target from Rs 2,300 to Rs 2,340 with the increased valuation of Reliance Retail.

Anubhav Aggarwal, Sayantan Maji, Krati Sankhlecha, analysts at Credit Suisse

“Significant synergies exist which can more than double acquired Ebitda. Ebitda per sq ft of acquired portfolio is less than one-third of that of Reliance Retail and Avenue Supermarts. This is due to lower revenue per sq ft and higher cost structure (both rent and employee cost)."

Further synergies, it said, should come from higher scale with benefits from saving in procurement, logistics and supply chain costs; and lower delivery cost and reduced delivery timelines for JioMart (deeper presence through Future Retail’s neighbourhood store network of Heritage Fresh in South India and EasyDay Club in North India.) “Both should help to improve competitive positioning of its online and offline retail segments.”

Anil Sharma, Aditya Bansal analysts at Nomura

“After Reliance Retail, Future Group’s retail business is the largest offline organised retail business in India. It is particularly strong in the grocery and fashion/lifestyle segments, has a pan-India presence, and has outlets at strategic locations."

Due to high leverage and the impact of Covid-19, Future Group has faced challenges. A financially strong Reliance could significantly turn around operations and grow sales volumes and improve profitability, the brokerage said. "Also, we expect the combination with Reliance’s existing retail advantage to bring synergy and scale advantages. The recently launched new commerce venture, JioMart, will also benefit from an increased number of physical outlets. A combined entity with larger market share will increase potential strategic investor interest.”

Puneet Gulati, Saurabh Jain, and Amit Sachdeva, analysts at HSBC Global Research

“We believe this deal will allow Reliance Retail to almost double its retail area under operation and increase the store count by 15% (assuming it doesn’t close any stores). It could also add another about 60% to brand licenses and JVs. From a revenue perspective, the deal could potentially add 16% and 29% to total and core retail revenue, respectively. It could also add 26% to Ebitda."

Interestingly, it would take away the offline support that Amazon was trying to build by integrating with Big Bazaar, the research firm said. From a valuation perspective, RIL has paid just slightly more than replacement value of the business. A successful conclusion of the deal would create significant incremental valuation of Rs 37,000- 64,500 crore ($4.9-8.6 billion), or 16-23% to its existing retail business as RIL could potentially integrate it with its own best practices and create synergies of procurement and economies of scale, it said. "However, we believe this is not material enough to re-rate the stock. The incremental value creation could add 2.7-4.8% to RIL’s valuation, and, in our view, is already partly discounted in the stock price.”

Nikhil Bhandari, Aditya Soman, Vinit Joshi, Aditya Gupta, Ethan Liu, and Shawn Shin, analysts at Goldman Sachs

“The proposed transaction is yet to close pending several regulatory approvals. However, if the transaction does close, it would likely bolster Reliance Retail’s position across retail categories, especially grocery retail, apparel retail and mixed retail. While integration of these assets into RIL’s existing portfolio would be key, and we note the margins of Future Group retail business are lower than Reliance Retail, we believe the addition of Future Group’s warehousing and logistics business could allow for a faster ramp for Reliance’s own Retail business, as well as for its newly launched online platform JioMart."

Furthermore, if completed, the potential transaction would also reduce the number of potential avenues that competitors (especially Amazon and Walmart) would have to bolster their physical presence in retailing in India, to strengthen their online business, the research firm said.

"We note RIL had a FY20/CY19 market share of 1.2% in the overall India grocery retail market, and Future Group had 0.7%. For fashion and lifestyle, RIL has a market share of 2.9% in vs 1.3% for Future Lifestyle & Fashion.”

Latika Chopra, Sushruta Mishra and Pinakin Parekh, analysts at JPMorgan

“Consolidation is underway in the Indian organised retail space with Reliance Retail (subsidiary of Reliance industries) announcing the acquisition of the retail business of Future Group through a slump sale for a total consideration of Rs 24,713 crore. This further strengthens Reliance Retail’s leadership position in the grocery and fashion segments, adding about 30% to the existing revenue base for the core retail operations (ex-connectivity/petro)."

The research firm sees multiple strategic positives for Reliance—scale and synergy benefits to add to top line/earnings growth trajectory; leveraging the supply chain and retail infrastructure for a faster scale up of the online JioMart platform/new commerce; and access to good retail locations particularly in tier-I/metro cities where Future had strong presence.

"In the grocery retail space we now have two large players — Reliance and D-Mart, implying a structural shift of bargaining power towards these two players. Their growing dominance will make it tougher for new players to enter the fray particularly on back and mortar front. However e-commerce remains a competitive space with JioMart scaling up fast to challenge Amazon, e-grocers (Big Basket, Grofers) and potentially Walmart-Flipkart," it said. "With RIL looking to sell its stake in Reliance Retail over the next one-two years, this acquisition is a positive from a valuation perspective."

Parekh estimates this acquisition adds Rs 45-55 a share value to RIL.

Deven Choksey, Managing Director, KR Choksey Investment Managers

“The deal is cash flow positive as they (Reliance) are getting a Rs 30,000 crore business for an initial investment of Rs 24,000 crore and further investment. Reliance Retail in the grocery business is around Rs 35,000 crore, whereas the grocery business of Future Group is around Rs 30,000 crore. With this acquisition, Reliance Retail will become the largest grocery player in the country with close to Rs 65,000 crore of business. The important part with this deal coming in is that they are not only acquiring the front-end stores but also the backend for retail, which is extraordinarily important because today when you’re going into the grocery business if you have a proper backend then you have the ability to earn margin out of it.”

Chakri Lokapriya, Managing Director, TCG Asset Management

“It's a brilliant deal for Reliance Retail. In one swoop it has three vital ingredients for retail - store front, warehousing and logistics. Future Group's loss was its excessive leverage. Future’s Group’s loss is Reliance’s gain as it gets a ready made reach and supply chain built over the years and ready for further execution by Reliance. The Rs 24,000 is peanuts for the execution juggernaut in retail that will roll out in months to come and the promise of growth from an established platform.”

Abhimanyu Sofat, Head of Research, IIFL Securities

“The Future Group deal is a big relief to banks like Bank of India, SBI, Axis Bank, Canara Bank and RBL Bank. Since Reliance Retail is also taking stake in the company (Future Enterprises Ltd.) post slump sale we see this comforting for the banks. Asa large part of the deal is in a form of slump sale, open offer to minority shareholders is not happening which may disappoint some investors.”

Mayuresh Joshi, Head of Research – Equity, William O'Neil India

“Access to Tier 2 and Tier 3 towns where the Future group has inherent presence shall drive further inroads for the overall franchise footprint in grocery, retail, lifestyle and other business. Also, over a period the warehousing and supply chain dynamics should aid in cost synergies and overall digitisation of the Jiomart platform.

Additionally, the opportunities to make a 360 degree presence through digital mediums, brick and mortar stores, supply chain backward operations should ensure that they (Reliance Retail) are able to take over the competition from global players. The need for lower capital spends on store capex and better credit terms for the overall business should result in an improvement in EBITDA/sq ft as the synergies progress.”