Analysts suggest cash from oil producer could help deleverage miner
The boards of Vedanta, a debt-laden miner and Cairn India, a cash-rich oil producer, both promoted by industrialist Anil Agarwal, on Sunday approved a merger of the two companies, through a 1.04:1 share swap in a $2.3-billion transaction, suggesting cash from Cairn would be used to deleverage Vedanta. The merger will help Agarwal own a diversified natural resources company, that resembles a BHP Billiton, an ambition he has long harboured.
Minority shareholders of Cairn India, which has a cluster of oilfields in Rajasthan, will get one share of Vedanta for every share held; the swap ratio implies a premium of 7.3% to Cairn’s Friday closing price of Rs 180.75 per share. Cairn shareholders will also receive one 18-month redeemable preference share of Rs 10 each, carrying a coupon of 7.5%, and listed on the NSE.
Critical to the related-party transaction going through will be votes of Life Insurance Corporation(LIC) which holds a stake of 9.1% and Cairn Energy Plc, which owns 9.8%, together accounting for close to 50% of the minority vote.
The merger will require the approval of a majority—greater than 50% — of minority shareholders, for both listed entities, according to Sebi rules. It will also need approval from more than 75% of all sharholders, including the promoter group, for a statutory clearance by the Tribunal, as per Section 230 of the Companies Act. Government approval may be needed for a transfer of petroleum mining rights.
Vedanta could now potentially dip into the Rs 17,000 crore ($2.7 billion) cash lying with Cairn to pay off part of its Rs 77,752 crore debt and to beef up its balance sheet. The merger will take away the rights of minority shareholders on usage of cash on Cairn’s balance sheet.
Cairn’s cash could have been funnelled to its parent through dividends, but that would have attracted taxes. Indeed, the merger is being seen as a ‘necessity’ for Vedanta, whose interest coverage on its borrowings is just 1.1 times, in an environment where commodity prices are weak. “This becomes a priority especially given the delay in buying out the government stake in cash-rich Hindustan Zinc,” Rakesh Arora of Macquarie Research observed late last week. The merger with Cairn should help improve the interest cover to 3 times.
Analysts say Cairn could use the cash on its books to boost capex at a time when production has been stagnating; capex has been lowered by 60% to $500 million for current year. In a related-party loan, in July, 2014, Cairn had loaned Vedanta $1.2 billion at a return of just Libor plus 300 basis points. DD Jalan, CFO Cairn India, observed that this had been duly factored into the valuation and was adequately reflected in the swap ratio.
Indeed, given how Cairn India’s market capitalisation has more than halved to around Rs 33,000 crore currently from close to Rs 77,000 crore a year back, in the wake of a collapse in crude oil prices, the swap raio might have been much more favourable to the oil producer’s shareholders had the merger taken place earlier.
However, the Rs 21,000 crore($3.3 billion) tax litigation, that Cairn is embroiled in, will now become a contingent liability for Vedanta shareholders and would have weighed on the swap ratio. The IT authorities have asked Cairn to pay Rs 10,500 crore for failing to withhold capital gains tax arising in 2006-08, in the hands of Cairn UK Holdings, and levied interest charges of Rs 10,500 crore on the pending tax liability.
Tom Albanese, MD and CEO, Vedanta Limited, described the merger as being positive for Cairn shareholders saying earnings would be de-risked through a diversified resources outfit. “They would have exposure to well invested Tier metals and mining assets that were structurally low-cost and will longer lives, “he said, adding that diversified producers have enjoyed better shareholder returns than pure plays.
Experts, however, were not quite sure how the oil and gas business would fit in with a ferrrous and non-ferrous portfolio. Amit Tandon, MD, IiAS, a proxy advisory firm, said the logic behind merging a hydrocarbons company with a metals player ‘wasn’t entirely convincing as they were entirely different business”.
Analysts suggest, the merger is also expected to facilitate a repayment of debt to the $13 billion Vedanta Resources Plc, Vedanta Limited’s parent entity which had a net debt of $7.7 billion as on March, 2015; the firm is relying on cash flows from Indian subsidiaries to service the debt since the Zambian copper operations were struggling with low profitability. In May, this year, Moody’s Investors Service noted that “Vedanta Resources will have to strengthen its balance sheet in FY2016 to avoid further pressure on its ratings. In January this year, Moody’s changed Vedanta Resources plc’s outlook to negative from stable to reflect the sharp drop in crude oil prices and the resulting impact sustained lower prices will have on Vedanta’s credit profile.
Following the merger, the parent company Vedanta Resources Plc’s holding in Vedanta Ltd will drop to 50.1% from 62.9%. Cairn India minority shareholders will hold 20.2% and Vedanta Ltd minority shareholders will own 29.7% stake in the elarged entity. Vedanta Ltd, India’s top producer of aluminum and copper, is the nation’s second-most indebted metals company and its annual interest costs are nearly three times that of the London parent.
The merger between Cairn and Vedanta is scheduled to be closed by March 31, 2016. Vedanta had started simplifying its complex structure in 2012. In 2013, Agarwal had consolidated iron ore mining business by merging Sesa Goa Ltd with Sterlite Industries (India) Ltd, which ran copper and aluminum businesses. Vedanta Resources also transferred its 38.8% per cent holding in oil producer Cairn India, including a debt of $5.9 billion, to the new company.
Albanese maintained that the merger is the second step in the series that started in 2013 towards simplifying the corporate structure. “We are creating value for both sets of shareholders. We have a strong refinance plan in the pipeline to reduce debt at Vedanta,” the CEO observed.
Also, Cairn India shareholders will get a larger, more resilient and diversified commodity mix,” he added. Vedanta has been able to refinance repayments to the tune of $400 million due this year and is in talks to refinance a further $ 2 billion due in Jun-Jul 2016. The blended cost of capital for the company remains at 7.5%.
The exchange ratio for the share swap was determined by a joint independent valuation done by Price Waterhouse &Co LLP and Walker Chandiok & Co LLP, the company said in its presentation.