Home >Companies >News >Cairn India’s $1.25 billion loan to Sesa Sterlite unit spooks investors

Mumbai: Investors dumped Cairn India Ltd shares on Thursday, spooked by an announcement that the cash-rich oil and gas unit of Vedanta Resources Plc. was lending $1.25 billion to a subsidiary of its affiliate Sesa Sterlite Ltd.

The related-party transaction disclosed by Cairn India in a conference call with analysts on Wednesday revived investor suspicions of so-called promoter risk the company had been perceived to be carrying since Vedanta, controlled by billionaire Anil Aggarwal, took control of it in 2011.

The company said it had already disbursed $800 million of the $1.25 billion loan to a unit of Sesa Sterlite for a period of two years and would advance $450 million more soon.

“The loan has been extended for two years at a floating rate of 3% plus Libor after requisite approvals, which is significantly higher than comparable rates being received on fixed deposits of same tenor," a Cairn India spokesperson said in an email response to queries from Mint on Thursday. Libor, or the London interbank offer rate, is an global benchmark.

Investors hammered Cairn India shares, which fell 6.67% to 322.65 on BSE; Sesa Sterlite shares closed 0.93% up at 298.15, after falling 1.16% in early trade. The benchmark BSE Sensex closed at 26,271.85 points, up 0.48%, while the BSE oil and gas index closed 0.19% down to 11,017.63.

“Cairn points out that the Libor+300 bps rate (basis points) is accretive relative to existing alternatives but we suspect that investors will be less kind. This may weigh on Cairn’s shares," analysts Somshankar Sinha and Pooja Gupta of Barclays Plc. wrote in a research note on Thursday morning.

They said the real focus could be firmly on corporate action within the Vedanta Group, which is always a shadow on Cairn’s strong operating performance.

An analyst who did not want to be named because his firm does not track Cairn India said he had always advised his clients to keep off companies that have embedded promoter risk because there is always an element of unexpectedness looming over their stocks.

Apart from the related-party nature of the transaction, the loan facility drew flak also because Cairn India is in the midst of a three-year, $3-billion capital expenditure programme to develop up to 10 billion barrels of oil equivalent (boe) of reserves and maintain production from its tapering Mangala field in Rajasthan’s Barmer basin.

The prolific Barmer basin, in which India’s biggest oil explorer Oil and Natural Gas Corp. Ltd (ONGC) holds a 30% stake, has five main producing assets—Mangala, Bhagyam, Aishwariya, Raageshwari and Saraswati.

Together, they produced up to 183,000 boe per day in the first quarter—planned to be raised to 300,000 boe per day in the next two to three years.

Cairn India also wants to ramp up its currently minimal gas output from the basin substantially, which could be its ticket to a 10-year extension of contract to produce from the basin, expiring in May 2020.

Cairn India insisted the expansion plans would not be affected.

“The company’s three-year capex plan of $3 billion, which includes both development and exploration, is well-supported with its current cash reserves of $3 billion and is further bolstered with its annualized operational inflows of over $1.5 billion," the company spokesperson said.

“As such, considering the exploration-oriented focus and its advancement plan over the next two years, the company is adequately funded," the spokesperson said.

Cairn India’s move is a compromise of its liquidity position, according to J.N. Gupta, a former executive director of the Securities and Exchange Board of India (Sebi) and founder and managing director of Shareholders Empowerment Services (SES), a proxy advisory services and corporate governance research enterprise.

“When there are related-party transactions, the main concern is the nature of the transaction and its fairness. In this case, the thing to look for is whether Cairn had a bigger need to lend money or Sesa Sterlite had a bigger need to borrow money. To me, Sesa Sterlite’s need was the driving force," he said.

Gupta said a more pertinent question is whether Sesa Sterlite could have borrowed a similar amount from an unrelated party at the same rate.

“We note that such related-party transactions typically raise market concerns about conflict of interest on the most shareholder-friendly way of deploying surplus cash," Nilesh Banerjee, managing director and head-Asia Pacific energy at Goldman Sachs Investment Research, said in a Thursday morning note to clients.

“While management justified it as just a treasury operation, given a relatively higher yield (Libor + 300bps), we believe returning surplus cash to investors through a dividend payout or buy-back would have been a better utilization," Arya Sen, an analyst at securities house Jefferies India Pvt. Ltd, wrote in a post-conference call note.

According to Dhaval Joshi, an analyst at Emkay Global Financial Services Ltd, a higher dividend payout or strategic use of the cash would have been a better option than an inter-corporate transfer.

As of June, Cairn India had cash and cash equivalents of 13,561 crore in rupee funds and $922 million in dollar funds, the company said on Wednesday.

In April 2013, Cairn India, which was then sitting on a cash pile of $3 billion, said that considering the exploration activity lined up for the coming years, the company would retain the cash. “We will retain the cash in the company. This will give us flexibility for accelerated discovery and production from the Barmer basin," P. Elango, its then chief executive officer, had said.

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