Home / Companies / The curious case of Cairn India’s loan offer

When it comes to cash management within a group, this deal was seen as a lesson on what companies should not do. On 23 July, Cairn India Ltd, the cash-rich oil and gas unit of Vedanta Resources Plc, said it had extended a $1.25 billion loan to a subsidiary of its affiliate Sesa Sterlite Ltd. The announcement was made on a conference call after its annual general meeting the same day. The move that did not go down well with Cairn investors, who gave its stock the thumbs-down. Experts debate the issue.

Capex plan is well supported

Spokesperson, Cairn India

Quashing concerns that the loan will hurt the company’s capital expenditure programme over the next three years, Cairn Indiasaid its “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. As such, considering the exploration-oriented focus and its advancement plan over the next two years, the company is adequately funded".

A Cairn India spokesperson said the loan was extended for two years at a floating rate of 3% plus the London interbank offered rate after requisite approvals, which is significantly higher than comparable rates being received on fixed deposits of the same tenor.

The spokesperson also said the extension of the facility is not material in nature. “A material transaction is a transaction that exceeds 5% of the annual turnover or 20% of the net worth of the company, and needs shareholder approval," the spokesperson said. In Cairn’s case, the loan extended amounts to almost Rs7,750 crore, just Rs6 crore shy of the limit of a material transaction, according to Shriram Subramanian, founder of InGovern Services, a proxy advisory firm.

In a conference call with investors on 23 July, Cairn India’s management called the loan a smart treasury investment, earning more than the 2% interest it was getting earlier.

Also, in a post-earnings conference call of Sesa Sterliteon 29 July, the company management tried to allay investor concerns, saying the inter-corporate loan was extended at arm’s length, with the first tranche of $800 million being used for paying all of the accrued interest of the overseas subsidiary as well as a part of the principal amount.

Move merits investigation by Sebi

J.N. Gupta, former executive director, Sebi; founder and managing director, Shareholders Empowerment Services

“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 out 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 added.

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

InGovern Services, a proxy advisory firm, in a report one day after the loan was announced, said, “That the company chooses to disclose the related-party transaction at an earnings call shows the scant regard for good corporate governance standards. The company has not even made a formal disclosure of this related-party transaction to stock exchanges. This shows disregard for fair disclosure on the part of the company, and merits a full-fledged investigation by Sebi (Securities and Exchange Board of India)."

The report said the board of directors seemed to have been mute spectators to the related-party transaction. In the interest of good governance, the board should have insisted that the company take shareholders’ approval. “Rather than giving the loan to one shareholder belonging to the promoter group, the company should have returned the surplus cash to shareholders in the form of a special dividend or a buy-back. The business of Cairn India is not to act as a financial institution and provide loans to a promoter," it added.

Sign of weak corporate governance

Shashwat Alok, assistant professor of finance, ISB

Taken at face value, it seems like a case of ‘tunnelling’ and it is rampant in emerging markets group firms," said Alok.

“Lot of cash on a company’s balance sheet is a concern, as it is a sign that the management is not doing something right," he added.

When a company has excess cash, it should ideally be distributed to shareholders (say through dividends). Besides that, the only reason for a company to be holding on to such a large amount of cash is an ongoing financial crisis where companies may hoard cash as insurance against the fear of a liquidity crisis or if the company needs it for investment opportunities, explained Alok.

Cairn India had promised investment possibilities in 2013, but nothing has materialized.

“Even though transferring money across group companies is legally permitted, it is typically a sign of weak corporate governance," said Alok.

Evidence from Indian business groups shows that it may be optimal (from the perspective of shareholders) to transfer capital to financially weaker group firms in order to prevent negative spillovers across groups. However, this argument does not apply in the case of Cairn India, which is a cash-rich, profitable firm and it is safe to assume that any trouble at Sesa Sterlite would not have an adverse effect on Cairn India, he pointed out.

Cairn India’s market cap fell by approximately $1.15 billion between 23 July and 25 July, suggesting that shareholders perceive most of the $1.25 billion loan to Sesa Sterlite as a loss, added Alok.

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