The rating agency has said that the $561-million structured product investment is a clear indication of Vedanta’s willingness to deploy its cash to support Volcan’s interests. “This willingness to deploy funds and Volcan’s probable cash-flow shortfall by March 2020 support our expectation that Volcan will likely tap into Vedanta’s liquidity. Volcan has a $900-million loan repayable over the next three years. If this repayment responsibility falls to Vedanta, we expect its liquidity to weaken,” it said on Tuesday. Vedanta’s high-yield lite covenant package does not restrict similar related-party investment in the future. “Vedanta has successfully negotiated a high-yield lite covenant package for its outstanding $4.2 billion bonds. The absence of a restricted payments covenant exposes Vedanta’s creditors to a cash leakage risk, including by way of distributions to its shareholders,” said the report.
Moody’s Investors Service also sees ownership and control as the key to the assessment of governance risk. The upstreaming of cash to Volcan through the structured product is an important precedent because it was not aligned with creditor interests. “The transaction was not what we would typically expect of high-profile Ba-rated issuers such as Vedanta. Further similar transactions could cause us to review Vedanta's governance and put pressure on the Ba3 rating…With concentrated ownership and control, there is increased potential for conflicts of interest and/or related-party transactions that are not aligned with creditor interests.”
Vedanta's 50.1 per cent-owned operating subsidiary Vedanta Limited will need to pay more dividends if asked to support Volcan's obligations. Vedanta, at the holding company level, currently has annual interest obligations of $400 million and is required under Volcan's privatisation loan to pay out a minimum dividend of $175 million. “To service these cash needs of $575 million, we estimate Vedanta’s 50.1%-owned cash-generating subsidiary Vedanta Limited will need to pay around $1.15 billion in total dividends each year. Vedanta Limited will likely need to pay additional dividends of $1.39 billion if Volcan’s debt obligations -- the principal and interest payments on the $900 million bank debt and interest on the MXB -- are borne by Vedanta.”
The report expressed apprehension that Volcan is likely running out of cash even as public details on its finances are limited. It said Volcan's cash flow, derived primarily from dividend income and its $561-million structured product, would be insufficient by the quarter ending March 2020 in meeting its debt-servicing obligations. In line with historical dividend payouts and keeping with the minimum dividend that Vedanta is required to pay to Volcan as part of the $1.1-billion term loan, it’s estimated Volcan will receive an annual dividend of $175 million. And with deferred payments from the $561-million investment likely to deplete by March 2020, Volcan may be required to dip into Vedanta’s large consolidated cash holdings.
In December 2018, Vedanta's wholly owned subsidiary Cairn India Holdings Limited (CIHL) invested $561 million in a structured product issued by Volcan. According to Moody’s Investors Service, the investment in Volcan’s structured product blurs the financial separation of the two. As a result, Vedanta's rating outlook was changed to negative to highlight the increased risk that Vedanta might be called upon to service Volcan’s debt.