Cairn stock falls 4.5% on Vedanta merger talks

Cairn lost 50% of market value since Vedanta takeover in 2010

The stock of oil & gas producer, Cairn India fell by 4.5 per cent on Tuesday as investors feared a possible merger with  Vedanta (earlier known as Sesa Sterlite) will be negative for the former's shareholders. For one, the  huge cash pile of Cairn India is likely to be used to pay up Vedanta’s Rs 72,000 crore of debt, said analysts , without much tangible benefits for Cairn’s shareholders.

As per investment  banking sources, Cairn and Vedanta are closing in on a merger which would give Vedanta access to Cairn India’s cash and investments worth Rs 16,000 crore. An announcement by both the companies on the merger is expected this week.

Both companies have not confirmed any merger but in a statement to the stock exchanges on Tuesday, Vedanta said its stated strategy is to simplify and consolidate its corporate structure. “The management reviews options to deliver on this strategy from time to time,” it said.

Chairman of Vedanta Group, Anil Agarwal had indicated in January this year the group plans to merge India listed Vedanta with Cairn India. The Cairn India stock has lost 28 per cent of its value since January and a massive 54 per cent of its market value in the past one year. The promoters own about  60 per cent stake in the company, but a large part of the decline in share price can also be attributed to the fall in global crude oil price.

Vedanta , on the other hand, was up 3.11 per cent to Rs 182.55 a share on the BSE. In a complex restructuring, London-listed Vedanta had transferred its stake and its massive debt for acquiring Cairn India Ltd to Sesa Sterlite. Ever since  Agarwal bought Cairn India in August 2010 for $10 billion, its stock has consistently  lost value of almost 51 per cent as against 46 per cent rise in the BSE Sensex — making its shareholders jittery.

There have been other events that have hurt sentiments. In July last year, Cairn India gave a $1.25 billion loan to Sesa Sterlite, at lower-than-market rates which resulted in further erosion in shareholders wealth and  angering investors. Though one of its large investors LIC — which holds 9.06% stake in Cairn — had raised objections initially, it did not go ahead with any action against the company in spite of losing wealth in its portfolio since then.  

Giving a warning, analysts at Ambit Capital in their July 24, 2014, report had said the capital misallocation risk looms large on Cairn India given the stress on the Vedanta Group’s balance sheet.

The downward journey for the stock got fuelled by declining crude oil prices. From the high of $115 a barrel in June last year, brent oil fell to lows of sub-$50 levels in January. Though it has recovered to $65 levels now, the  impact of the same was evident in Cairn India’s financial year 2015  results as its revenues fell 22 per cent to Rs 14,646 crore and profits eroded by 64 per cent at Rs 4,480 crore on a year-on-year basis.

What’s more, the company also has a pending tax demand of Rs 20,495 crore raised by the income tax department on gains made by its former parent Cairn Energy. This is another overhang on the stock prices though the company is contesting the demand in  courts.

On  June 4, 2015, when the stock was trading at Rs 185 levels, analysts at HSBC set a target price of Rs 190 and said that if they have to account for the loan given by Cairn India to its parent,  the company's fair value would be Rs 211. However, if the merger happens, Cairn's cash will be utilised by Vedanta to pare debt and hence the value of cash being accounted for in stock's fair value will be cut leading to a much lower fair value.

Analysts say weakness in Cairn's stock price is likely to continue and any upside from these levels may not be significant until Vedanta gives a very attractive offer to investors in case of a merger.

Piyush Jain at Morning Star says that if as per media reports the merger is taking place then it is to get access to subsidiary’s cash (about Rs 18,000 crore) which was not possible without a merger. Also the cyclical downturn provides Vedanta to get Cairn India at attractively low prices. A merger will also take away the option from investors of investing in a pure crude oil play like Cairn India, and instead they will have to hold on to a highly diversified entity or exit.   

In another shocker for the investors, in April this year, Cairn took corporate India’s biggest impairment of over Rs 19,000 crore after a crash in crude oil prices. The impairment reflects the high price that Vedanta paid for Cairn India at the peak of the oil and gas cycle, when Brent crude prices exceeded US$ 100 per barrel. Moody’s said Vedanta's investments in Cairn India will take longer to recoup.