CAIRN VEDANTA MERGER - FOR WHOSE BENEFIT ?

• Most companies today undertake an acquisition for increasing market share and increasing there revenue potential in a more faster way rather then doing it in the organic way to cut time and costs.
• Firstly Acquisitions have to be viewed from the angle of what the acquiring company is paying, that is what premium or discount to buy out the other company
• Secondly how is the acquisition funded whether it is a full cash buyout or a equity share funded deal. More importantly in an acquisition what is also important from shareholders point of view is whether the management team has strong bandwidth to deliver results after the take over.
• Also investors should also focus that when a Acquisition is announced, is the acquired company have any strong synergy with its existing products and whether there is a sound economic logic in the proposed buyout.
• Usually acquisition of loss making companies which are typically commodity based businesses or companies acquired at a huge premium to the current price and paid via cash only are not something the markets will like and this will obviously result in long term destruction of shareholder value
• Historically a cash buyout deal has also not worked out favorably with the Acquiring company as this impacts the cash position on the balance sheet and the ROCE also gets depressed in the initial years when the merger gets started and pays off in the long term only.
• Example where an Acquisition went wrong
• Daiichi Sankyo has faced a rocky road in India since 2008 when it entered the market with a bang taking control of Ranbaxy from the billionaire brothers Malvinder and Shivinder Singh, paying $4.6 billion or Rs 737 per share
• Since then, Ranbaxy has had a host of problems with the US Food and Drug Administration which culminated in a ban of certain drugs and a $500 million fine for alleged manufacturing deficiencies at its Indian factories. The dispute had caused bad blood between Daiichi and the Singh brothers with the Japanese company accusing the Singhs of misrepresentation
• When the deal was announced in June 2008 the Ranbaxy stock stood at Rs 532 and which was at a premium of 38% and never saw this high again in the next 7 years till March 2015 clearly reflecting that the markets were not happy with this deal

Examples of Acquisitions which Mkts viewed positively

• In Nov 2014 KMBL announced the acquisition of  Ing Vysya Bank in an all-stock deal. ING shareholders were offerred 725 Kotak Bank shares for every 1,000 shares they held in ING Bank .
• The deal will make Kotak the fourth-largest private bank in the country in terms of total business.
• The combined banking entity would have a widespread network of 1,214 branches across the country. The deal implied a price of Rs 790 for each ING Vysya share, valuing the deal at around Rs 15,000 crs
• Right from the time the merger deal was announced the KMBL stock rose from Rs 900Level to Rs 1473cum bonus (1:1) in June 2015 clearly giving the merger a big thums up by the markets
• Cairn Indian is the largest crude oil producer in India. It accounts for almost 25% of Indian’s total production with 1.3 billion barrels of gross proved and probable reserves and resources as of 31 March 2015
• Till date Cairn India has opened 3 frontier basins with over 40 discoveries, with 26 in Rajasthan alone.Cairn India has a portfolio of 9 blocks - one block in Rajasthan, four on the east coast and two on the west coast of India and one each in Sri Lanka and South Africa. Rajasthan, Ravva and Cambay are the area from where the oil and gas is being currently produced.
• Vedanta Resources is a globally diversified FTSE 100 and London Stock exchange listed company. Headquarted is in London, UK. It is the largest mining and non-ferrous metal company in India. It is diversified in natural resources basically in Zinc, Lead, Silver, Copper, Iron Ore, Aluminium, and Power. Vedanta Operated across India, Liberia, Australia, Zambia, Ireland, South Africa, Namibia and Sri Lanka.

• The Vedanta Group has announced the merger between its flagship Indian mining firm  Vedanta Limited  (formerly Sesa Sterlite) and its oil subsidiary  Cairn India  .
• The deal offers minority shareholders of Cairn India one equity share in Vedanta for each share held, along with one 7.5 percent remeemable preference share with Rs 10 face value for a 18 month time horizon
• In move to cut debt at Anil Agarwal group, India’s largest private miner Vedanta Ltd will absorb oil firm Cairn India in a USD 2.3 billion all-share deal to create India’s largest diversified natural resources company.

Logic for this Merger from the Managements point of view

• The merged entity will have a Diversified Tier-I portfolio which will de-risk earnings volatility and drive stable cash flows through the cycle.
• It will also improve its ability to allocate capital to the highest return projects across the portfolio.
• It will have a greater financial flexibility to sustain strong dividend distribution.
• Cost savings and potential re-rating to benefit all shareholders
• A stronger balance sheet will allow for the overall cost of capital to be reduced
• Earnings will be de-risked through increased diversification, offering exposure to a larger, more resilient and more diversified commodity mix.
• Stable cash flow supporting investment and dividends through the cycle, driving long term value.
• This merger will offer Cairn India shareholders exposure to Vedanta Limited’s well invested Tier-I, structurally low cost, longer-life assets, including a best-in-class zinc platform, which have significant latent capacity ramping up.
• Being part of a larger entity will allow Cairn India to benefit from increased economies of scale and improved free float and trading liquidity
• Is this merger value accretive for shareholders ?

• On the face of it the Vedanta management claims that the merger is the best thing to happen with Cairn and for its shareholders
• But is this really such a sweet deal to Cairn Shareholders ?
• Firstly Cairn India is a debt-free company. As a result of this merger, public shareholders of a debt-free Cairn will become shareholders of a heavily leveraged Vedanta Ltd.
• In other words, the merger will socialize the debt of Vedanta Ltd across the minority shareholders of both Vedanta and Cairn India. 
• Vedanta, which is struggling to reduce its debt of Rs 77,000 crs, and will get access to Cairn's cash pile of Rs 17,000 crs once the deal is approved. 
• Also a tax demand made by the income tax department on Cairn India is another hurdle that Mr Anil Agarwal will have to clear during the merger. The department has slapped a tax demand of Rs 20,495 crs
• Hence the clear winner in this Merger – is obviously Vedanta as without this merger the bigger loser will be Vedanta as reduction in debt is a primary reason to push this deal.

Key variables required for this merger to be successful

• The Merger of Cairn with Vedanta depends upon how large Institutional Holders look at this merger and what they decide to do.
• Cairn's minority shareholders, including UK-based erstwhile promoter Cairn Energy holds a 9.82% equity stake and LIC holds a 9.06% equity stake are already crying foul claiming low valuations for the company's shares.
• In the last one year, the market valuation of Cairn has halved because of the softening crude prices. Consolidated revenues and profit fell by 22% to Rs 14,646 crore and 64% to Rs 4,479.6 crs, respectively in 2014/15. That's why it clearly looks to be an opportunistic merger.
• Also problems of Vedanta Aluminum would cascade onto the minority shareholders of Cairn India. Vedanta Aluminum has been battling the activists for the refinery expansion in Orissa The minority shareholders of Cairn India will inherit these problems,
• Also this merger with Cairn has been proposed when shares of Cairn are trading at the lowest price over the last 5 years. Although the loss in market capitalisation is attributable to fall in oil prices, the timing of the merger indicates that public shareholders of Cairn India will have to undertake a massive write-off on their investment due to this merger

Will this merger be beneficial to cairn shareholders  

• We believe that both from a short term and long term point of view this proposed merger will benefit only Vedanta leaving Cairn India shareholders helpless
• This is because in the short term with crude prices already under pressure and with US Iran Nuclear deal recently finalised, its quite obvious that crude prices are likely to remain further weak putting further pressure on Cairn
• On the other hand a meltdown seen in Chinese markets recently with equity markets collapsing by around 30% from the peak have also impacted commodity prices severely across the board and this may spell further trouble for Vedanta for its core metals business.
• It is with this very intention that the Vedanta Group has chosen this time as a ideal time to get on with the merger of Cairn as it would help it restructure its consolidated debt and get recourse to Cairns cash which can give it some relief.

Also one must not forget that Cairn is in such a business which requires huge capex to be spent for future oil discoveries. In the absence of healthy cash flows it would be unfortunate that a cash rich corporate would soon become a debt heavy corporate in future.

Market Perception about the Vedanta Management

Ever since Vedanta acquired Cairn India from Cairn Energy in 2011 for $8.67

billion in 2011 the markets were always apprehensive about this takeover for two main reasons

1.Firstly the Vedanta Group has never been investor friendly towards shareholders

2.Also creating size and scale has been the foremost ambition of the Vedanta Group which is not wrong for a commodity player but this also means that ROE and Dividends payouts take a backseat for stakeholders and which are the primary drivers to re rate a stock.

3.The market feedback from the Fund community for the Vedanta Group is also cautious as most of them believe that even if this merger finally gets approved, it will take a long time for both Cairn & Vedanta shareholders to benefit 

• Hence we believe that from a short term point of view the Cairn Vedanta Deal is unlikely to offer any
• 1. Significant value upside benefits to Cairn shareholders
• 2. Vedanta Shareholders would obviously benefit from this deal as it helps it to reduce its debt and get a profitable asset at a very cheap cost
• 3. In the short term earnings for both Cairn and Vedanta are likely to remain under severe pressure as both oil and metal prices are down and no relief can be expected for both Cairn and Vedanta shareholders
• More importantly if the chinese economy de grows and is unable to recover soon, this could pose a very big risk to Vedanta for its core metal business.
• Also it would endanger Cairn India Shareholders as it would now be a part of Vedanta
• In conclusion whenever such big M & A deals are announced investors should keep away from such stocks as history has proven that consolidation and normalcy post  such mergers takes a time horizon of at least 2-3 years

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