Offer for Cairn still in Vedanta's favour, say analysts

Despite the sweetened offer to Cairn's minority shareholders, Vedanta stands to benefit more from the merger

Vedanta’s sweetened offer to Cairn India’s minority investors is a step ahead from last year’s move, but the offer still remains in favour of the mining major, say market experts.

Vedanta, with exposure to aluminium, copper, silver, iron ore, zinc and owning a majority stake in Cairn India, on Friday announced a revised offer to merge Cairn India into the mining major. Apart from allotment of a share each in Vedanta for every share held in Cairn India, shareholders of Cairn India will also get four redeemable preference shares (bearing annual interest rate of 7.5 per cent) of face value of Rs 10 each. The preference shares are redeemable after 18 months, while shareholders will also have an option to encash with 30 days of the merger getting cleared. The earlier merger terms offered only one redeemable preference share to Cairn India shareholders. The sweetened deal is positive, but more for Vedanta than for Cairn India, say most experts.

Cairn India shareholders, after seeing crude oil prices fall from the highs of $115 in June 2014 to $27 levels in January 2016, might get some respite through exposure to a diversified portfolio of excellent assets. Vedanta has world-class metals and mining assets that are cost-efficient (low cost of production), which, coupled with the strengthening of aluminium and zinc prices, bodes well for the company.

However, G Chokkalingam at Equinomics, says, “The cash on Cairn’s books and profitability will be equal to 70 per cent of its market cap (of about Rs 36,000 crore). So, Cairn’s assets are being undervalued.” The acquisition, thereby, still remains in favour of Vedanta, feels Chokkalingam.

Not much has changed for investors compared to the earlier offer, says Goutam Chakraborty at Emkay Research, and the offer is still in favour of Vedanta, he adds. The share swap ratio remains the same except for the three additional preference shares.

In comparison, Vedanta stands to gain more with debt on its books reducing significantly. It will also enjoy better credit ratings after the merger besides a reduction in cost of debt.

The cost of debt for Vedanta is currently 7.5 per cent, and should fall to 6.5 per cent, as indicated by the management. Also, there will be no more need for Vedanta to service interest payments through dividend from subsidiaries. All this will improve Vedanta’s cash flows.

Edelweiss Securities’ analysts led by Jal Irani said in a July 22 report that the merger was attractive for Vedanta. “Despite a better deal, the merger is negative for Cairn as Vedanta gets: 1) free access to Cairn’s $3.5-billion cash pile; and 2) write-off of $1.25-billion loan earlier extended by Cairn.”

There could be another impact for Cairn’s shareholders. “An imminent conglomerate discount will further impact Cairn’s value given the merger. If the merger gets shareholders’ nod, Cairn’s stock will be pegged to Vedanta’s intrinsic value (Edelweiss estimate: Rs 175 per share) plus Rs 40, providing only 12 per cent upside,” say Edelweiss’ analysts. The analysts, however, believe that if the merger falls apart (which they think is less likely), then they see an upside of 22 per cent for Cairn’s stock.

“We, therefore, downgrade Cairn to ‘hold’ with revised target price of Rs 215 (Rs 175 earlier),” they added.

Analysts/market experts, however, are also not sure whether the deal will be completed in the timeline of first quarter of 2017 (January-March), as indicated by the management. Apart from the approval of minority shareholders including Life Insurance Corporation (holds 9.1 per cent in Cairn), there are concerns over tax liabilities, too. Cairn India has a pending income-tax demand of Rs 20,495 crore on gains made by its former parent, Cairn Energy Plc, on account of a share transfer transaction eight years ago.

The stake of Cairn Plc (9.8 per cent) remains frozen (by the government) pending the tax demand. Although Vedanta said the tax liabilities would be accounted for as contingent liabilities in merged entity and that it is reasonably confident of the government approving the merger, Kamlesh Bagmar at Prabhudas Lilladher as well as Emkay’s Chakraborty are not sure of the merger getting cleared in the stated timeline.

The stock price of Vedanta (Rs 168.95) and Cairn (Rs 192) are currently factoring in the merger now, say Bagmar and Chakraborty.

The good news for Vedanta is that most analysts, including those of Edelweiss, believe the merger is more likely to go through, given the sweetened deal.