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The Mystery of the Missing Reliance Retail
The Nutgraf is a 10-min newsletter sent at 10 AM IST every Saturday. It connects the dots and synthesizes one big event in business, technology and finance that happened over the week in India. In a way you’ll never forget.
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Just 10 mins longSynthesis not analysisSometimes memes
India's largest retailer is raising money. And that gives rise to a question that nobody seems to have the answer to.
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Good Morning Dear Reader,
Every Saturday, this newsletter usually looks at what happened in India the previous week and tells you what happened, how it got there, and what it means going forward. Some of you write back to me saying nice things, which I try to reply to, mostly unsuccessfully. Some of you send angry emails disagreeing with me, which I immediately forward to the Cyber Crime Cell. That’s how it’s been nearly every week, right from the beginning.
Not this week. This week, we don’t have a perspective, a hypothesis or a clear argument. Instead all we have is a mystery. A mystery to which we don’t have the answer. It’s like a whodunit, but with a missing last chapter.
Today’s edition is about Reliance Retail—India’s largest retailer. A lot of action is happening around Reliance Retail of late, but we’re unable to figure out something really important and fundamental about what’s going on, no matter how much we tried.
So we thought maybe we’ll throw it open to the smartest people we know—the subscribers of The Nutgraf.
We’ll tell you what we’ve learnt so far, and hopefully, one of you will be able to tell us the answer.
Let’s dive in.
Not who but how
Over the last few weeks, two major international publications have been furiously reporting about recent goings-on and rumours about Reliance Retail, which is owned by Mukesh Ambani, the richest man in India.
Undeterred, on September 10th, again fromBloomberg:
But there are some commonalities between all these stories. All of them have been sourced from unnamed sources with “direct knowledge of the matter”. Bloomberg and FT are hardly alone. Many other outlets—big and small—have jumped into the ring, all armed with sources who claim to know who is interested in getting a stake in Reliance Retail.
This is all too reminiscent of the series of reports, rumours, and leaks about potential buyers of TikTok over the last month, and we’re reminded of the masterful satire column by Tim Culpan from Bloombergtitled, ‘Why I am in Talks to Buy TikTok’:
Dear investors readers,
In response to recent rumors, started by me, that I’m in talks to purchase the U.S. operations of TikTok, I’d like to clarify. I am indeed interested in buying the hip viral short-video service. I’d also like to fly to Mars, cure cancer, or climb Mount Everest. Just as with my bid for TikTok, I have no intention of doing so.
However, I have “held talks” with TikTok. By which I mean I tweeted at them. They didn’t reply.
Why I'm in Talks to buy TikTok, Tim Culpan, Bloomberg
Culpan goes on to make a larger point about why entities are motivated to pretend to express interest in random companies during an M&A process. Similarly, during fund-raising, there are similar motivations from those who choose to leak “talks” to media outlets selectively. Create FOMO. Jack up the price. Get free press. Done.
Now, I’m not saying that FT, Bloomberg, and everyone else who’s breathlessly reporting developments in this process are wrong. In fact, the private equity group Silver Lake did announce an investment into Reliance Retail a few days later. Others will probably follow. Maybe Amazon. Maybe Walmart. Maybe even Tim Culpan.
What I’m saying is that it doesn’t matter. We’ll know soon enough anyway. Instead, I have a another question—one that everybody seems to be ignoring:
How is the investment into Reliance Retail going to be made?
It’s a much more interesting question.
The how matters more than the who.
And right now, the how is the mystery. I’ve tried my best to work it out, but I haven’t got an answer. So let me tell you what I’ve found so far.
Let’s start with how Foreign Direct Investment (FDI) works in India’s retail sector, and how Reliance Retail is structured as a business.
Both are related. That’s where our story begins.
"Of the foreigners, by the foreigners, and for the foreigners"
India has always been a little fickle, and often Janus-faced, as far as allowing money from foreign entities into Indian businesses is concerned. Depending on how the political winds blow, the audience being addressed, and the company in question, India’s lawmakers do both—they are simultaneously proud of foreign direct investment into India’s companies and shout about it from the rooftops...and they rattle their regulatory sabres and insist that foreign funding is a form of neo-colonialism to the detriment of India and its people.
This is also why laws around foreign funding in Indian companies depend on the following aspects:
The sector—retail, e-commerce, payments, finance, etc.
The customer—direct-to-consumer, business-to-business, etc.
The level of investment—the percentage stake that’s acquired by foreign companies.
The nature of approval—does it need a special approval from the government or is it ‘automatic’, requiring no special approvals
Depending on the sector and the customer, the Indian government sets limits on the investment level and the nature of approval.
In fact, if you go to InvestIndia.org, the Government of India website, it lists out these FDI limits in an interactive way, with filters and everything. It’s actually quite helpful.
Some sectors are straightforward. Some aren’t. One of the ones that’s been quite controversial, and generally arouses a lot of passion is the question of FDI investment into the retail sector.
For a long time, nobody was quite sure how to do FDI investment into retail. This is because retail is a massive sector, with many different flavours from groceries, electronics, apparel, electronics, and so much more. The sale of nearly every consumer product is a form of retail. Consequently, due to the sheer size of the sector, it also employs a significant number of Indians. An even larger number are connected to retail supply chains in direct and indirect ways.
So India broke the offline retail sector into three categories :
Cash and Carry Wholesale Trading
Single Brand Retail—products sold under one brand by one company.
Multi Brand Retail—products sold under multiple brands.
For the first two categories, India permitted foreign companies to invest and own 100% of Indian companies. Over time, it even let these investments in through the automatic route—no special approvals were needed. This made sense. That’s how global companies like, say, Ikea, Nike, Adidas, and Starbucks are able to have a 100%-owned subsidiary in India and sell their branded products here.
The problem was what to do about the third category—Multi-brand retail.
Again, the argument was this. Single brand retail would be good for India and for Indians. But if multi-brand retail was permitted, companies like Walmart would set up shop across India and the millions of Indians who are dependent on the vastly fragmented retail store network all over the country would suffer. In fact, for a long time, the idea of foreign investments into multi-brand retail stores in India was politically charged. In many ways, it still remains that way today.
Finally, in December 2012, the Indian Parliament passed a law permitting FDI into multi-brand retail—up to a limit of 51%, subject to government approval, and a range of fairly rigorous conditions. Things like 50% of the investment had to be made for ‘back-end infrastructure’. Or 30% of the materials had to be sourced locally. The list went on and on.
How was it received?
Well, here’s what an up-and-coming Chief Minister of a major state in India said when the law was passed.
Taking a dig at Manmohan Singh for allowing FDI in multi-brand retail, Gujarat Chief Minister Narendra Modi today said the Prime Minister has altered the definition of Indian democracy to "of the foreigners, by the foreigners and for the foreigners."
"Now onwards pen, pencils, notebooks would not be sold by your neighbourhood shopkeeper but some 'Gora'(foreigner). So, local traders and retailers will lose employment," Modi said here while addressing a large gathering at at Vivekananda Youth Convention here in Kutch district.
"Former US President Abraham Lincoln gave world famous definition of democracy --'of the people, by the people and for the people'--, but our Manmohan Singhji has given us a new definition --'of the foreigners, by the foreigners, for the foreigners'," he said.
FDI in retail: PM has given Indian democracy 'new' definition, says Narendra Modi, The Economic Times
There were several other overarching restrictions. Like how the Government would have the first right to procure agricultural products. Or how e-commerce will not be permitted.
But there was one more thing. Here it was, the eighth point in the notification:
The above policy is an enabling policy only and the State Governments/Union Territories would be free to take their own decisions in regard to implementation of the policy. Therefore, retail sales outlets may be set up in those States/Union Territories which have agreed, or agree in future, to allow FDI in MBRT under this policy. The list of States/Union Territories which have conveyed their agreement is annexed.
Here are the states that have agreed to allow FDI, as shown in a report about India’s retail industry by the law firm Nishith Desai Associates:
There are 13 states in all. Note the ones that are missing. Gujarat. Tamil Nadu. Uttar Pradesh. All huge states.
Now this is unusual. As Nishith Desai associates note in their report,
With this restriction, each investor will have to comply with policy on FDI at both Centre and State levels. Depending on State policy on MBRT, the investors may or may not be permitted to invest in those States.
Interestingly this seems to be the first time that discretion on whether to permit FDI in a sector or not has been left to the States.
Remember, this doesn’t mean that multi brand FDI isn’t permitted in these states, but that every state government will have the freedom to approve or reject it, depending on how they feel about it.
Got it? Cool.
Okay, now let’s talk about Reliance Retail.
The best way to illustrate the scale and size of Reliance Retail is to look at how it is spread across India.
The rest of the report of India’s mightiest company is just as impressive.
Take Reliance Retail’s Fashion Pyramid for instance. Look at the number of brands they have across the entire value chain.
Also, here’s the distribution of Reliance Retail’s 11,000-plus stores across the country.
The one that needs some attention is the last column. The one where the number of towns and cities where Reliance Retail has a presence. That’s over 7000+ towns and cities in India.
I didn’t even know we had 7000+ towns and cities in India.
Also, this was before Reliance Retail acquired Future Group’s retail business, another massive retail chain last month, which, according to a Jeffries report, would lead to this:
The combined entity would house prominent retail brands, some of which have been around for longer than Reliance Retail’s own formats. In grocery, Reliance Retail would add around 1,300 stores (15m sqft) to own stores at 800 currently; and 440 stores in Fashion to own 2,400 store network.
Future (Group) Is in Reliance Retail, Jeffries
So yeah, it’s just getting bigger.
This is also a good time to tell you one additional restriction I didn’t mention earlier about FDI in multi-brand retail.
Here it is, from the FDI notification passed by the Government of India.
Retail sales outlets may be set up only in cities with a population of more than 10 lakh as per 2011 Census and may also cover an area of 10 kms around the municipal/urban agglomeration limits of such cities;
I checked the number of cities with a population of more than 10 lakh as per the 2011 Census in India.
As per Wikipedia, there are a grand total of 46 cities.
To be fair, the report from Nishith Desai Associates also says this.
While, the previous restriction to Tier 1 and Tier 2 cities seemed reasonable given the sensitivity around the sector and prevalent undeveloped / unorganised retail segment in small towns / villages which would be unable to compete with large players, the recent change to allow State Governments to determine the cities in which retail outlets can be set up will also ensure that every State Government has the discretion to choose the cities in which multi-brand retail outlets are set up and provide a sense of uniformity amongst the States.
So what is Reliance Retail’s plan to continue operations the way it’s doing today after it becomes a FDI multi-brand retailer? Does it really plan to get approvals to operate from every single state government in India?
What does Reliance know that we don’t?
That’s the question.
The how is more important than the who.
Three ways to make this work
Obviously, this is an important question and Reliance Retail must have figured this out.
As I see it, there are three possibilities.
a. Reliance Retail is going to create a new subsidiary
Back in 2012, when Tesco, the international retailer, made the first major foreign investment for retail in India when it invested in Trent, a Tata retail subsidiary. For many reasons, while the results haven’t panned out the way it’s expected, here’s what Trent did, as per its own annual report from back in 2012:
Following the discussions and subsequent to receipt of approval from the Foreign Investment Promotion Board (FIPB), Trent and Tesco entered into definitive agreements to form a 50:50 Joint Venture (JV) with respect to THL in March 2014.
Out of the 16 Star banner stores operated by THL, four were in States that do not invite FDI in multi-brand retail trade. These four stores in Gujarat and Tamil Nadu were divested by THL in April 2014 into a separate wholly owned subsidiary of Trent (Fiora Hypermarkets Ltd - FHL).
62nd Annual Report 2013-14, Trent Limited
Basically, Tesco and Trent created a separate subsidiary to operate in states that don’t permit multi-brand retail.
Is that Reliance Retail’s plan?
Maybe.
Doesn’t seem like Reliance’s style. In fact, earlier this year, Reliance Retail acquired Shri Kannan Departmental Stores, a retail chain in Tamil Nadu for Rs 150 crores. Tamil Nadu isn’t on the list of FDI approved states. So, if Reliance is planning to setup a subsidiary, why acquire a local retail chain?
b. Reliance Retail is going to raise money through private equity investors
Perhaps Reliance Retail intends to take FDI through private equity players, which is somehow different from taking money from, say, foreign retailers.
I haven’t found any rule, notification or document that says that the nature of the investor matters. But there’s some precedence here. This is exactly what happened in aviation recently.
India eased rules for foreign investment in the country’s aviation sector on Monday in a bid to boost air travel and develop new airports in Asia’s third-largest economy.
The new measures allow 100 percent foreign ownership of India-based airlines, raising the limit from 49 percent, but only with prior approval from the government, according to a statement issued by Prime Minister Narendra Modi’s office.
[...]
India has limited the equity holding of foreign airlines to 49 percent, but these airlines can bring in investors such as private equity firms or sovereign wealth funds to establish a 100 percent owned airline in India.
India eases foreign investment rules for airlines, Reuters
Maybe there’s something similar for retail?
I’m not sure.
That still doesn’t explain how it plans to continue to operate in multiple states in India.
Or maybe...
c. Reliance is going to convince every state government to let it operate
Perhaps Reliance Retail believes that it can persuade every state government in India to agree to let it operate in that state as an FDI-fuelled multi-brand retailer.
It’s possible. If any company can do it, it’s probably Reliance.
But seems like a hell of a bet.
Or maybe I’m missing something really obvious.
How is Reliance Retail going to make this work?
Think about it. Do your research. Ask your friends. Then write to us with your answer.
I'll feature the most creative solution in a subsequent edition of this newsletter
That's about it from me.
Write back. Let me know what you thought.
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Synthesis not analysis 
