06 July 2018 05:17:05 IST

Timing good for Vedanta as Cairn price was right

Cairn may face possible bankruptcy scenario if pressure on cash-flows continues

The Cairn India and Vedanta merger is a related-party merger deal and hence we will analyse the deal from that angle.

Let us start the analysis by putting forth the benefits and issues of the deal from the acquirer’s point of view.

Vedanta Ltd

The deal will help Vedanta consolidate its subsidiaries after a major realignment last year. It would certainly create a diversified natural resource company, like BHP Billiton and Rio Tinto.

Vedanta can cut debt using the cash pile of Cairn India. This no-cost debt will come as a relief to Vedanta, which is struggling under a huge debt burden.

Vedanta will add oil and natural gas to its already diversified portfolio

An inter-corporate loan of $1.2 billion to Vedanta from Cairn will be waived

The deal will help strengthen the balance sheet to maintain, if not improve, Vedanata’s ratings

From the viewpoint of acquired entity

Positives for Cairn India

Cairn India will diversify from a oil and natural gas company into a portfolio of natural resources company

It will gain from the Vedanta asset base and output increase forecasts compared to what is interestingly Cairn India’s moderate output growth plan (the moderate output growth plan could be a result of the conflict of interest by the promoters who want to acquire Cairn India)

It will gain from the $1.3-billion cost-saving plan resulting from the marketing efforts of Vedanta

The deal will help tide over cyclical downturns in the oil industry and generate more stable cash-flows

Cairn India will gain access to Vedanta’s low-cost larger life-cycle assets.

It will benefit from better economies of scale and improved free-float and trading liquidity

On the other hand, Cairn India will also

Inherit Vedanta’s problems of a standoff against environmental activists in Odisha

Move to debt from a debt-free situation

Face a possible bankruptcy scenario if pressure on cash-flows continues

Role of large minority shareholders

Even after SEBI amended the listing agreement norms to allow companies to approve any material related-party transaction by passing an ordinary resolution instead of a special resolution, and reduced the required vote of minority shareholders from two-thirds of minority shareholders to 50 per cent on the lines of the Companies Act, the vote of LIC and Cairn Energy becomes crucial to go ahead with the merger.

Having put together the points just mentioned from the facts of the case, let us analyse the case based on the concepts and theories of mergers.

According to merger theories, a deal will be successful if it helps to remove inefficient management or to bring in differential efficiency. But as the promoters are the same for both the parties, this reason for the merger will not stand.

Analysing the case from the theory of synergies, we see some scope for operational synergies as both the entities are involved in exploration. However, it remains to be seen how the existing assets of Vedanta will be used by Cairn, how issues like new technology will be handled and what kind of role legacy assets will play.

We can also see the scope for financial synergy as Vedanta will be using the cash pile of Cairn and there is no issue of cannibalisation in the product line. The addition of a new product line will only add to new revenues.

On the issue of strategic realignment , it is definitely important from Vedanta’s point of view. It will help the parent company consolidate and try to simplify a complex web of crossholdings that will, most importantly, address corporate governance issues and put to rest the speculation and motives behind inert corporate lending.

Not convincing

Though there is scope for synergies and realignment, one is not likely to be convinced about the merger as a shareholder of Cairn India, especially for the following reasons.

Why would a shareholder of Cairn who knows well what the company was involved in and wants to have an exposure to oil and gas, like to diversify into mining and metals? There a large number of standalone oil and gas companies among the top 10 of the Fortune 500 list. If the motive was to invest in a diversified company, then one would not have invested in Cairn India.

It is also not convincing whether the merger would have taken place if there was an arm’s length distance between Cairn and Vedanta.

We may presume that Cairn would have used the cash pile better for acquiring strategic assets and oil fields which are available at a lower valuation or have the acquirer take it over for its own use. The cash pile at Cairn could be used to acquire strategic assets in the oil and natural gas industry as the valuations are low. At these times, cash is king. All great natural resource and mineral companies buy strategic assets cheap when the industry is in a downturn, provided they have cash or access to debt. In this case. I strongly believe that Cairn could have put the cash pile to better use by buying oil assets cheap. The company would have reaped phenomenal results and achieved great valuation when the situation turns around.

While reasons for merger are one issue, the price to be paid for it is also equally important.

Even if the merger is beneficial to all the parties, the right price has to be paid to the acquired party. Going back to the theoretical backing and empirical results from past research, it can be seen that the price of the acquiring companies rises by an average of 15 per cent on announcement of the merger. But in this case, there was no spurt in the share price of Cairn. What was interesting was that after a few hours of the announcement, Cairn India’s share price fell more than that of Vedanta, reflecting the mood in the market on the deal (data given in the case).

Also, the timing of the merger was not convincing. The share price of Cairn India fell drastically by more than 25 per cent in the couple of months preceding the merger. Though this could be attributed to a fall in global oil prices, the percentage of the fall was comparatively higher than that of its industry counterparts. This might be due to the speculation that the Cairn management did not have any strategic plans or directions for the company in the wake of the deal.

This absence of direction could have been due to a conflict of interest on the part of the management. I am convinced that at this price, had Cairn India been at an arm’s-length distance, it would have been more difficult to convince it to merge, especially when it did not have urgent need to merge, like stress on cash-flows or a large credit burden. However, the timing is good from Vedanta’s point of view, as Cairn India was available cheap.

Share price

The price offered was way below the six-month average share price of Cairn India and paying a higher premium could satisfy the Cairn minority shareholders, especially when issues such as the timing of the merger and the criticism that the primary motive of the merger was to save Vedanta from the debt crises it was facing were doing the rounds among some analysts. However, even with a huge tax litigation , which will now be treated as a contingent liability for Vedanta, I feel there has to be an incentive for the minority shareholders of Cairn India to give up the share price at this point of time.

After the analysis of the case using a mix of multiples based on the March 2015 financial results, it certainly looks as if Cairn India shareholders deserved a better premium. Going by the market prices of Cairn India and Vedanta Limited as on September 15, 2015, when the share price of Cairn India was quoting at around ₹145 and the share price of Vedanta was quoting at around ₹96, it looks as if the share swap ratio with a preference share of face value of ₹10 would make it very difficult for the Cairn India shareholders to accept the merger. I would, therefore, reject the merger and vote against it, given the deal details and prevailing developments.