06 July 2018 05:12:45 IST

Why the Vedanta-Cairn India merger is a bad idea

Dealing with heavy debt and negative market sentiment, Vedanta can't make the merger succeed

Vedanta Ltd currently faces several problems, the chief of which is its high debt situation. With a standalone debt of ₹376.36 billion (₹37,636 crore) Vedanta Ltd is the second-most indebted metals firm in the country.

Market sentiment regarding the merger is negative as the minority shareholders are opposing the merger, concerned that Vedanta wants to access Cairn’s cash pile only to clear its debts.

Loans repayment : Vedanta Ltd is in the process of refinancing an additional $2 billion by replacing loans from foreign banks with credit from Indian banks so as to maintain a blended cost of interest. The balance sheet might improve but its EPS would remain the same.

Acquisition cost : The impairment charge taken on by Vedanta on its investment in Cairn India is credit-negative for Vedanta because, with oil prices expected to remain weak, it will take Vedanta longer to recoup its investment of $8.7 billion. It also increases the challenge of repaying $4.4 billion of acquisition debt financing from its operating cash-flow.

The above points highlight that Vedanta itself is in a crisis situation. Dealing with all the loan repayments and negative market sentiments would not make the deal a successful merger.

The graphic on ‘Map of Synergies’ outlines the areas common to both companies and explains if and why the companies will gain in these areas or not.

The synergy value parameters have been calculated on the basis of cost savings, revenue enhancements, process improvements, financial engineering and tax benefits.

As the merging companies belong to different industries, there are fewer synergies. The probability of success is quite low for development of long-term synergies through sharing of resources and combined projects.

As indicated in the Table, the net cash flow from operating activities of Vedanta are increasing, yet the cash equivalents depict negative value. Hence, it is short of cash.

The Table showing the Cairn India financials indicates that net cash from operating activities has been decreasing over the years. Total cash equivalents are positive and indicate good health of the company.

The financials show that the major reason for the merger being the cash reserves with Cairn India might not be feasible in the near future as the net cash flow from operating activities has been decreasing over the years.

The following graphics show what shareholders stand to gain from the merger.

They also provide an analysis of what the outcomes could be, depending on whether the synergies materialise or not.

Conclusion

The stock offer will:

— Reduce the pay offs for the original Vedanta Ltd. shareholders

— Expose original shareholders of Cairn India to risk in case the synergies don’t materialise

Also, a stock offer sends two powerful signals to the market:

— The acquirer’s shares are overvalued

— The acquirer’s management lacks confidence in the acquisition and is trying to hedge the bet by offering stocks

In both the cases, there is plenty of reason to expect that the company’s stock will fall.

We believe that the deal won’t be a successful merger owing to the above arguments. Hence, we vote against the merger.

(Shruti Choudhary and Shalini Bhardwaj, second year students of PGPM 2014-16 batch at IIM Indore, are the winners of the case study contest)