Will Vedanta Be Victorious?
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It seems to be a season of acquisitions. At least that is what it appears to be considering the events taking place in the Indian industry. While recently Mahindra & Mahindra acquired the South Korean company sangyong Motor, Fortis Healthcare was also in the race for the acquisition of Singapore-based Parkway Holding, but later opted out of the same. And if these were on an international scale, there was a lot of buzz on the domestic front too such as ICICI Bank acquiring Bank of Rajasthan and Inox Leisure acquiring a majority stake in Sringar Cinemas. But while these acquisitions were of players operating in the same sector, there were some more interesting ones of compa-nies opting for opportunities outside their domain specialisation.
In the international market BHP Billiton announced a bid to acquire Potash Corp and in India Vedanta Resources PLC (the holding company for Hindustan Zinc, Sterlite Industries and Sesa Goa that is controlled by Anil Agarwal) has entered into an agree-ment with Cairn Energy PLC to buy 40-51 per cent stake in Cairn India. In both the cases, the offers are being made for new lines of businesses. Here, with more than two lakh individu-al investors in Cairn India, the deal between Vedanta Resources and Cairn India is surely important. The deal has raised many questions in the minds of investors about whether to hold the counter, exit in the open offer or exit in the open markets. Going ahead in the story we have presented the appropri-ate answers.
Understanding The Deal
Let’s first understand the deal struc-ture. Vedanta Group plans to acquire 51 to 60 per cent stake at USD 8.5 to 9.6 billion in Cairn India through the purchase of Cairn Energy PLC’s stake and through an open offer. In this all-cash deal, the price has been agreed at Rs 405 per share, which includes Rs 50 per share as non-compete fees. In simple words, while the shareholders will be paid Rs 355 per share, Cairn Energy PLC will be paid Rs 405 per share. Now, minimum 40 per cent of the planned 60 per cent will be acquired by THL Aluminium (a wholly-owned subsidiary of Vedanta Resources PLC) from Cairn UK Holding (a wholly-owned subsidiary of Cairn Energy PLC).
The balance 11-20 per cent stake will be acquired through a mandatory 20 per cent open offer to the share-holders of Cairn India by Sesa Goa. Now if the open offer fails to get mini-mum stake, Cairn Energy PLC will sell its stake to enable Vedanta to hold a minimum 51 per cent in Cairn India (see table). This transaction is expected to be completed by the first quarter of CY11. Again, the acceptance ratio for the open offer depends on Petronas which holds 14.90 per cent in Cairn India.
Impact Of The Deal
There is no reason to doubt the managerial and execution capability of Vedanta Group with respect to the closure of this deal. The group has shown great success with domestic acquisitions. It has a track record of integrating, managing, and success-fully growing through the inorganic route. And the strong performance and wealth creation by Hindustan Zinc, Sterlite Industries, BALCO, Madras Aluminium, and Sesa Goa vindicates the same. But here the deal is much larger, almost ten times its earlier largest deal (see table: Acquisitions By Vedanta Resources). Additionally, another risk associated with the deal is Vedanta’s lack of expertise and experience in managing the asset portfolio as it is a new player in the segment. However, at the current juncture it is premature to assume the deal to have an adverse impact as Cairn India’s current manage-ment would continue to run the busi-ness in a professional manner.[PAGE BREAK]
Impact On Sesa Goa
We feel that the deal is negative for the shareholders of Sesa Goa since they are forced to take an exposure into the unrelated business of oil & gas. This is injustice to the shareholders who have invested in Sesa Goa taking it as a fer-rous player. However, the promoters are taking this as a foray into natural resources. Further, Sesa Goa will have to shell out around Rs 13,500 to 15,400 crore (considering Rs 355 and Rs 405 per share, depending on the open offer price and from whom the stake is acquired). As on March 31, 2010, on a consolidated basis, the company had cash and cash equivalents of close to Rs 8,000 crore. But there will be an addi-tional debt burden on the company as the total outgo will be more. This will impact company’s bottomline.
Counter-bids
Another factor is that regulatory approval through the government is also important to close the deal. But the news articles suggest that the government is not comfortable with the deal. Further, with ONGC having 30 per cent interest in the Mangla, Aishwarya, Raageshwari and Saraswati develop-ment field areas, intervention is anyway expected. Rather, some of the news-papers published stories stating that ONGC, Oil India and Gail may team up to launch counter bids and have managed to lined up USD 10 billion. Past experience shows that if there are counter bids the investors tend to gain. But even if it happens, the counter bids will not be as lucrative as the valuations already seem to be high considering the quality of Cairn fields. Further ONGC will take a call on the same only in October 2010. Till then the stock will remain range bound. We feel that the counter-offer, excluding non-compete fees, will not be more than Rs 380 per share. So there is no much upside expected in the counter.
Valuations
After understanding the deal inves-tors would be more curious to know about the valuations that are being paid for the acquisitions. The open offer discounts its long-term crude price of USD 96 per bbl in perpetu-ity. This, we feel, is anyway higher. In addition to that, the acceptance ratio (which depends on whether Petronas tenders its shares in the open offer) will also impact the returns earned by the investors. With Petronas not making its stand clear, the uncertainty remains. Hence, with price depending upon factors such as speculations about the open offer acceptance ratio, stance of the regulator on the pricing for major-ity and minority groups, and the role of government we feel it will be better for the investors to exit in the open market. We are not suggesting an exit in the open offer as it will attract capi-tal gains tax of around 20 per cent and will lower the post tax returns.