Vedanta Resources Plc is betting on its ability to lower costs, sweat assets and execute projects to make its acquisition of Anglo American Plc’s zinc business work.
It will pay $1.3billion (Rs5,850 crore) to acquire this business, which is proposed to be routed via Hindustan Zinc Ltd (HZL). The Indian government, a minority investor in HZL, will have to approve the deal.
HZL’s cash and fixed deposits of around Rs11,900 crore as of March will fund the acquisition. Anglo American’s zinc business revenue and Ebidta (earnings before interest, depreciation, taxes and amortization) were $670 million and $213 million, respectively, in calendar 2009. The valuation thus works out to approximately two times enterprise value to sales and around six times Ebidta. HZL itself trades at around six times sales and nine times Ebidta. But that is explained by Anglo’s zinc business Ebidta margin being less than half that of HZL.
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Anglo has mines in Ireland, Namibia and South Africa, which produced 343,000 tonnes of zinc and 55,000 tonnes of lead in 2009. It will add around 37% to HZL’s zinc and lead production capacity and around 23% increase in its reserves. Anglo’s output has been stagnant in the past three years, except in Ireland, which contributes 45% to sales. But its cost of production is quite high, at $1,287 per tonne, thereby reducing its profitability. Namibia’s cost is lowest at $902 per tonne while South Africa’s cost is higher at $1,237. HZL’s cost of production is just $850 per tonne.
The key is HZL’s ability to lower that cost of production. Higher production and better recoveries are the two main areas that can contribute to better margins. While margin improvement will be the near- to medium-term objective, the buy will be worthwhile if HZL completes two new projects. The South African project is in a more advanced stage and could produce around 400,000 tonnes of zinc. The second project in Namibia is in a preliminary stage. The real returns from this buy will be realized if either of these projects come on stream. For now, the acquisition adds approximately 40% to HZL’s sales and around 20% to net profit, and also makes better use of its cash surplus.
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