Cairn Energy announced a stake sale of 51% (maximum) to Vedanta Resources (VED) at a price of Rs 405/share (including Rs 50/share non-compete fee). VED will have to make an open-offer for another 20% of outstanding shares. We see potential regulatory issues ahead, particularly with respect to differential pricing for majority and minority shareholders. We are suspending our rating and target price as the stock will now reflect the open-offer price as well as speculation on the likely roles of various entities involved.
We see limited upside for a minority shareholder of Cairn India (CAIR) unless VED raises the open-offer price to Rs 405/share for regulatory reasons. CAIR?s stock offers 6% potential upside to Rs 355/share, the maximum price possible to a shareholder assuming all his shares get accepted in the open offer.
The average price to a shareholder will depend on the acceptance ratio in the open-offer and the post open-offer price. Assuming all minority shares (including the 14.94% shares held by Petronas) are offered in the open offer, we compute the average price at Rs 315, 20 shares tendered at Rs 355/share and the remaining 17.36 shares held at Rs 270/share (post-open offer price based on our 12-month fair valuation; the transaction will likely take six months to complete).
We note there is a difference between the price for the majority shareholder (Rs 405/share) and the minority shareholders (Rs 355/share). We view this as detrimental to the interest of minority shareholders and do not rule out opposition from the Indian stock market regulator and the government to this two-tier structure.
We note that scrapping the concept of control premium or control fee was one of the recommendations of a Sebi committee, the other important one being the increase in open offer size to all shareholders and not just 20% as per the current regulations. Finally, the government of India may have a say in the transfer of natural assets from one entity to another.
The government of India is the owner of all natural resources in India and is the licensor of the blocks. Also, it is possible that the government may seek a resolution to the vexatious royalty and cess issues for the Rajasthan block while granting regulatory approval for the stake sale in CAIR.
We have suspended the rating and target price of CAIR, noting the stock price will now depend on speculation about open offer acceptance ratio, role of Petronas, stance of the regulator on the differential pricing for majority and minority shareholders and role of the government. Our reverse valuation exercise shows that CAIR stock is discounting $92/bbl in perpetuity.