Reliance Industries, the Rs 16 lakh crore conglomerate, has been the shareholders’ darling since its IPO in 1977. Over the past 10 years, the company has given 5.4x returns, while the broader Nifty 50 has provided 3x returns. If we exclude Reliance Industries, the returns of the Nifty 50 would be even lower. The company has created shareholder value by diversifying its businesses and demerging the entities to create growth opportunities. 

Now, Reliance Industries has announced the demerger of its financial services arm from the parent company. The demerger will happen in the second half of FY23, and the new entity will be named Jio Financial Services Limited (JFSL). However, the resolution is subject to approval from shareholders at the annual general meeting (AGM) on May 2.  Once the necessary approvals are in place, JFSL will be tentatively listed on the bourses in September 2023

How will the demerger work? 

Reliance Industries is demerging its financial services business and its wholly owned subsidiary, Reliance Strategic Investments Limited (RSIL), to form Jio Financial Services Limited. Post demerger, JFSL will hold investments in Reliance Industrial Investments and Holdings Limited (RIIHL), which indirectly owns a 6.1% stake in Reliance Industries. 

The demerger will take place through a share swap arrangement, with shareholders of Reliance Industries receiving one share of JFSL for each share held in Reliance Industries.

Why is Reliance demerging this business?

The demerger is driven by the belief that the sum of the parts is greater than the whole. By creating a separate entity, JFSL will have higher growth opportunities and be valued in line with its industry peers. The demerger is also part of Reliance Industries' broader plan to monetize its investments in the financial services business. 

Debt is also a key factor here. Reliance Industries would like to build its financial services arm without impacting its debt/equity ratio. For a financial services firm, raising debt is a crucial growth lever, and JFSL will be able to raise more debt using its asset base. JFSL’s holding in RIL will provide the much-needed collateral to raise debt, and the higher credit rating of its parent firm will help it get lower interest rates.

JFSL’s net worth is around Rs 1,24,000 crore, taking into account its stake in RIL which is worth approximately Rs 96,000 crore, and assets of Rs 28,000 crore. This capital base gives JFSL a significant head start in capturing market share as a new entrant. For instance, Bajaj Finance has a net worth of Rs 44,000 crore, and an AUM of Rs 2.3 lakh crore.

JFSL also plans to leverage its existing retail customer base and develop consumer and merchant lending businesses based on credit bureau-based underwriting. Additionally, JFSL will explore opportunities via joint ventures and acquisitions in insurance, broking and asset management.

JFSL's net worth was around Rs 28,000 crore in FY22

According to a report on the scheme of arrangement for the demerger released by RIL, JFSL 's net worth/book value at the end of FY22 is Rs 28,079 crore. JFSL’s book is not expected to have any significant liabilities. The table below provides a breakdown of the book's contents, excluding JFSL's 6.1% stake in RIL.

Note: All values in crores

The debt-free nature of the book gives significant scope to raise capital for growth. JFSL can also benefit from the AAA credit rating of the parent firm, which will help lower its cost of capital. The consolidated turnover of the financial services business as of March 31, 2022, was Rs 2,127 crore, which is 0.3% of RIL’s total turnover.

Valuation of JFSL to be in the range of Rs 1-1.5 lakh crore

Several brokerages have been vocal about RIL’s undervaluation. Trendlyne’s forecaster shows a 23% upside for RIL from the current price of Rs 2,327. As for JFSL, multiple reports suggest different price bands. A report by Jefferies indicates the market cap of JFSL in the range of Rs 90,000-1,50,000 crore. This puts the share price of JFSL around Rs 134 to Rs 224. The Jefferies report also states that JFSL should list at a base price of Rs 179/share.

JFSL's book value is at Rs 1,24,073 crore considering its 6.1% stake in RIL. It’s the highest among the listed NBFC players in India.

Note: All values in crore. Book value is JFSL’s net worth (Rs 28,073 crore) plus its stake in RIL (Rs 96,000 crore)

Another report by Macquarie suggests that JFSL’s valuation is around Rs 1,52,000 crore, which is significantly higher than Jefferies’ estimates. The difference in valuations can be attributed to different assumptions of holding company discounts and P/B ratios. Here is a simple methodology to determine JFSL’s valuations.

JFSL holds a 6.1% stake valued at around Rs 96,000 crore in RIL. If we consider a holding company discount of 40%, the valuation of the holding translates to Rs 57,600 crore.

 At the end of FY22, JFSL’s combined net worth (Financial Service Business and Reliance Strategic Investments Ltd) was Rs 28,079 crore. Assuming JFSL will trade at a P/B ratio of 1.5 to 2, its book would be valued in the range of Rs 42,118 crore to 56,158 crore. 

This would take the overall valuation to Rs 99,718-1,13,758 crore, implying a share price range of Rs 147 to Rs 168.  Every 0.5-point increase in the P/B valuation of the JFSL book will result in a share price increase of Rs 21-22.

Post demerger, JFSL is expected to be valued at over Rs 1,00,000 crore, making it a part of the Nifty 50. This means that ETFs holding roughly 2% stake in Reliance Industries need not sell their shares. 

Future course of action for JFSL

Reliance’s large customer base in the retail and telecom sectors positions JFSL company well in order to target consumer finance in electronics and digital services. With strong vendor partnerships and merchant banking, JFSL has the potential to capture a significant share of the market. 

However, competition in consumer finance for high-value electronics goods is currently dominated by banks with credit cards, with NBFCs playing a smaller role. 

JFSL plans to expand its offerings beyond consumer finance to include insurance, broking and asset management. The company has already submitted applications to the Insurance Regulatory and Development Authority of India (IRDAI) and RBI for approval. It might foray into the life insurance business, along with the broking business involving bankers, traders, investment managers, dealers and advisers. 

With RIL's backing and a debt-free balance sheet, JFSL is well-positioned to disrupt the consumer finance space. In addition to organic growth, JFSL may pursue acquisitions and mergers to consolidate its position in the market. 

Banking veteran K V Kamath to head JFSL

K V Kamath, the former CEO of ICICI Bank from 1999 to 2011, will be leading JFSL post-demerger. His track record in increasing the retail customer base and making strategic acquisitions in the NBFC space at ICICI Bank makes him a promising choice to steer JFSL towards growth and profitability. 

Investors will be closely watching the company's performance post-demerger and how it capitalizes on the opportunities in the rapidly growing financial services sector in India. Below is the list of JSFL’s board of directors.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.