Analysts slam deal valuation, say investors short-changed

Analysts slam deal valuation, say investors short-changed

Mumbai: A day after London-based natural resources company Vedanta Resources Plc announced that it would acquire a majority stake in oil and natural gas producer Cairn India Ltd, analysts across brokerages have expressed concern about the deal, with some saying that retail investors have been offered a bad deal and others questioning the valuation.

In a related development, credit rating agencies have either downgraded Vedanta or placed the company under rating watch because the firm plans to borrow $6.5 billion (30,355 crore) to finance the acquisition.

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While Fitch Ratings downgraded Vedanta’s rating from ‘BBB-’ to ‘BB+’, Moody’s Investors Service placed Vedanta’s rating under review for a possible downgrade.

Standard and Poor’s (S&P) has placed Vedanta’s ‘BB’ long-term corporate credit rating and “the rating of all the company’s issues on CreditWatch with negative implications".

“The CreditWatch placement reflects our view that the proposed acquisition could significantly increase Vedanta’s debt and weaken its financial risk profile to levels below our expectation for the current rating," S&P said.

While Vedanta would pay 405 per share—including non-compete fees of 50 per share—to Cairn Energy Plc to buy up to 40% of Cairn’s Indian arm, the open offer price for an additional 20% has been fixed at 355. Under the existing takeover norms, any acquirer buying at least 15% stake in a firm needs to make an open offer for another 20% stake.

On completion of the open offer, Vedanta could end up controlling up to 60% of Cairn India at an investment of $9.6 billion.

“We see limited rationale in paying a non-compete fee for a commoditized business and hence believe that the deal is unfavourable from a minority shareholders’ point of view," said a 17 August report by analyst Saeed Jaffery of Ambit Capital Pvt. Ltd.

Analysts stated that the public shareholders of Cairn India, whose holding represents 37.64% of the company’s paid-up equity, could have got around 3,570 crore, had the non-compete premium been extended to them as well.

Ambit downgraded Cairn India to “hold", stating that the new promoters’ lack of experience in handling exploration and production operations could “impact valuations in the medium-term", though it noted that the Vedanta management had delivered superior operational performance in assets acquired historically, such as Sesa Goa Ltd and Hindustan Zinc Ltd.

Echoing similar sentiment, a report by Anand Rathi Financial Services Ltd stated that the differential pricing for the open offer led the shares price of Cairn India to tank 6% in Monday’s trade on the Bombay Stock Exchange (BSE).

On Tuesday, Cairn India’s share prices rose 1.74% to close at 338.65 on BSE, while the exchange’s benchmark equity index, the Sensex, lost 0.01% to 18,048.85 points.

Shares of Sesa Goa, in which Vedanta holds a controlling stake, shares lost 0.88% to close at 319.70 apiece. Sesa Goa will make the open offer to Cairn India shareholders.

Vedanta’s shares gained 3.11% at 2,220 pence (1,623) on the London Stock Exchange at the time of writing the report, while Cairn Energy Plc lost 1.52% and traded at 485.70 pence.

Minority interest

A Cairn India investor said the interests of minority investors needs to be protected. “The deal provides for a non-compete fee of 50 to the promoters. This amounts to roughly 15-16% of the price offered to others. We will represent the matter with Sebi (Securities and Exchange Board of India) since a draft code banning such discrimination is under consideration by Sebi." The retail investor declined to be identified.

In July, a Sebi-appointed panel had suggested sweeping reforms in the takeover regulations.

One of the key changes proposed in the draft is on the non-compete fee. The draft proposed to bar acquirers from paying the promoters of the target company a premium over the price offered to minority investors. It has also proposed that the acquirer company needs to make an open offer for the entire 100%.

According to a senior corporate lawyer, who did not want to be named: “Ideally, these rules should take effect only prospectively. But Sebi can take a view that there should be no non-compete fee since the broad policy stand is towards equal treatment for all investors."

An investment banker involved in the deal, however, said, “The offer document will be considered on the basis of existing rules. The draft code will not have any impact."

Highlighting key risks for Sesa Goa, a Kotak Securities Ltd note said the company might have to acquire shares in Cairn India through an open offer price of 405 if Sebi decides that “the significant non-competing premium being paid to Cairn Energy was unjustified and it is just part of valuation of Cairn India whose benefits should be enjoyed by all shareholders".

To be sure, the Kotak report also pointed out Vedanta’s excellent track record of inorganic growth for assets acquired in India. While stating that Sesa Goa’s massive cash resources were being deployed “in a reasonable sound asset" with excellent production growth profile, the report maintained an “accumulate" on Sesa Goa’s shares.

Calling the development a “negative surprise" with respect to Sesa Goa, a report by Prasad Baji and Manan Tola of Edelweiss Securities Ltd downgraded its rating on the stock to “reduce".

“We see no synergies between Cairn India’s crude oil business and Sesa Goa’s existing iron ore business," the Edelweiss report stated.

The stake to be acquired by Sesa Goa would be financed by the Indian company’s own cash flows, Vedanta had said on Monday. Tarun Jain, Vedanta’s director of finance, added that Sesa Goa had around $2.5 billion in cash with itself.

A senior Vedanta official present during a conference call with analysts on Monday said that the acquisition would be beneficial for the shareholders of Sesa Goa, as the company had no immediate capex (capital expenditure) requirements and the cash was sitting in banks earning a return of merely 4-5%.

“Through the acquisition, it is possible to earn a return of 15%," he said.

The Vedanta management had said on Monday that the new debt would not have any negative impact on the company. It also said the new acquisition would not have any impact on its other expansion plans.

Meanwhile, Cairn Energy’s top management met oil minister Murli Deora and other key officials on Tuesday to clear any regulatory roadblocks to the deal with Vedanta Resources, adds PTI.

Cairn Energy chief executive Bill Gammell flew into the Capital this morning and straight got down to business, meeting government officials and Cairn India staff to clear doubts, if any, about the proposed transaction.

Sources close to the development said Gammell, along with Cairn India chief executive Rahul Dhir, met Deora and oil secretary S. Sundareshan to explain the rationale behind the deal.

“It will be business as usual at Cairn India," a source quoted Gammell as telling Deora.