The IBS-BLoC case study challenge “Should Cairn India merge with Vedanta?” received an encouraging response for a complex finance case. Students from top Indian institutions sent in over 50 entries. The case described a current and complex merger situation, posing before students a financial management problem.
Many participants were able to understand the underlying financial issues that are an inevitable part of any merger and gave their verdict based on keen research. While only a few entries made it to the winners and runners-up slots, many others offered interesting solutions and opinions as they debated ‘in favour’ and ‘against’ the merger.
We share with you some of the highlights of the recommendations made by students on the Vedanta & Cairn merger issue.
In favour
Assuming Vedanta and Cairn merge, the net debt at standalone level (and wholly-owned subsidiaries) will decline to ₹611 billion/₹578 billion for FY2016/17E compared to ₹845 billion/₹827 billion in a pre-merger situation. The merger can facilitate loan repayment by Twin Star Mauritius Holdings Ltd to Vedanta Resources Plc, thereby easing the high leverage at the parent entity.
Anju and Ajay Kumar, MBA (First Year), DOMS NIT TRICHY
Against
Minority Shareholders of Cairn India will get one share in Vedanta Ltd. and one 7.5 per cent redeemable preference share with face value of ₹10. On September 15, Vedanta Ltd closed at ₹96.5 (a 66.65 per cent drop from a 52-week high) while Cairn India was at ₹145.1 (56 per cent drop from a 52-week high). Thus a shareholder looses around ₹50. Preference shares redeemable after 18 months will benefit shareholders to the extent of ₹10.75, which is not a good compensation for a company that has no long-term debt and cash that is available (cash, loan & advances) worth ₹18,701 crore, which could be shared with Vedanta Ltd in case of merger.
Annamalai AN and Naveen R S, MBA (Second Year), Bharathidasan Institute of Management Trichy
In favour
When the mining division’s profit declines due to higher energy prices, the exploration division’s profit would rise, and thus it could act like a hedge for Vedanta. Vedanta could get direct access to Cairn's cash surplus, which otherwise was possible only by up-streaming dividends. Lower leverage and improved liquidity would help it to finance its debt, thus pushing up its credit score, which would get them credit once again. Interest coverage ratio, which measures the margin of safety a company has for paying interest during a given period for Vedanta is 1.54, which is very low. By merging, the interest coverage ratio would increase, increasing the company’s ability to pay interest on its debt.
Bharatkumar Subnis and Ramya Gangolli, Business Policy and Strategic Management, SDMIMD, Mysore
Against
Cairn India had cash and cash equivalents of ₹170 billion, with revenues of ₹152.48 billion. Needless to say, Vedanta will benefit from Cairn’s cash reserves post-merger and the expansion plans, if any, for Cairn will take a backseat. A similar rationale was given by Anil Agarwal, Chairman of Vedanta, when he announced the merger of Sesa Goa and Sterlite in 2013. The consolidation saw the transfer of Vedanta’s direct holding of 38.8 per cent in Cairn India Ltd (Cairn India) to Sesa Goa, together with the associated debt of $5.9 billion, at cost. The debt has increased manifold thereafter, owing to falling commodity prices.
Arunima and Abhisekh, Great Lakes Institute Of Management Chennai
Against
The income-tax department has claimed ₹20,495 crore from Cairn India as withholding tax on alleged capital gains made by its erstwhile promoter, Cairn Energy, when it sold the company to Vedanta at $8.67 billion in 2011. The department is still adamant that it will defend the tax claim, even after the merger.
Smita Rastogi and Pramod Verma, Jaipuria Lucknow
In favour
The asset turnover ratio of Cairn India is 21 per cent compared with 35 per cent for Vedanta. Vedanta has a strong focus on operational excellence and high asset utilisation to deliver top quartile cost performance and strong cash-flow. The acquisition will give Cairn India access to the managerial skills of Vedanta for better operational efficiency. Further, it will create significant economies of scale. It should be noted that the fall in stock prices of Cairn India is not just due to oil prices, but also because of other company-specific factors such as operational inefficiency.
Tuhin Harit and Rohit Cyril, PGDM, Indian School of Business Hyderabad
In favour
This merger will enable both Vedanta and Cairn India to compete against giants like Rio Tinto and BHP Billiton, which otherwise would not have been a possibility, keeping in view the size and the financial backing that the latter have.
Indrajit Sil and Abhijeet Mondal, PGPM, IBS Gurgaon
In favour
Based on the stock situation, it is a positive for both. In anticipation of the deal, various brokerage houses, including Kotak Equities, Macquarie Research and Bank of America-Merrill Lynch came out with ‘Buy’ or ‘Outperform’ recommendations on Vedanta target prices. According to the adjusted merger ratio, a Cairn India shareholder will get 104 shares of Vedanta for every 100 shares held.
M Veena Prasanna and Preethi Kasi, MBA (first year), DOMS, NIT Trichy
Against
Vedanta Ltd has consistently violated the Forest Conservation Act (FCA), the Forest Rights Act (FRA), the Environment Protection Act (EPA) and the Orissa Forest Act, often in active collusion with the State officials. Allowing mining… by depriving two tribal groups of their rights over the proposed mining site to benefit a private company would shake the faith of the people in the laws of the land.
Rahul Tarekar and Shabnam Khan, PGDM, VJIM-Hyderabad
In favour
Cairn India has high-quality assets in its portfolio. For example, the Mangala oil field is the largest onshore field in India and is one of the key assets of the company. Cairn also owns asset in the Krishna-Godavari Basin. While Cairn has developed expertise in the field of oil and gas exploration, it lacks diversification beyond this field. The merger would benefit both Vedanta and Cairn in diversification of their business segments.
Aravinth Kanna P and Sidharrth S, PGPM, IIM Ahmedabad
Against
Based on news reports, two minority shareholders (LIC and Cairn UK) have said they will agree to the merger only if the deal is sweetened. However, to give a higher return to minority shareholders without diluting control, the value derived from the redeemable preference shares would have to be increased. A higher outflow to the preference shareholders would be warranted. This defeats the intrinsic benefit of the proposed merger, which is greater cash availability to finance debt. Due to this development, Standard & Poor (S&P) has expressed uncertainty over the proposed merger. As on September 10, 2015 , S&P placed Vedanta plc’s ‘BB-foreign currency long-term corporate credit rating’ and ‘BB-long term issue ratings on the company's guaranteed notes and loans’ on CreditWatch with negative implications.
Ashish Guneta and Neelesh Agrawal, PGPM, IIM Bangalore
In favour
From a long-term perspective and Cairn India shareholder's point of view, a merger with Vedanta is always a good option, primarily because unused cash on the books of Cairn India will be used and, therefore, some earnings would emerge out of this usage, which would ultimately lead to shareholder value creation. Second, the growth prospects that the combined entity can achieve would be fairy-tale figures for Cairn India if operated individually. Last, Cairn India, rather than looking for short-term gains through premium on share exchanges, should look forward to long-term gains from the combined entity.
Ishwar C Jangle, MMS (Finance), JBIMS Mumbai
In favour
India’s dependence on oil imports is 80 per cent and the global oil crisis gives Cairn India an opportunity to leverage India’s oil needs. Also, the fall in oil prices contributes to a fall in share prices of Cairn India. DuPont Analysis points out that the merger will bring the utilisation of resources of both the companies to full efficiency and benefit them.
Ruchi Jain and Derrick Keith, PGDM, SDMIMD MYSORE
Against
There is a risk of the Vedanta Group misallocating capital, should its integration of Cairn India prove successful. With high levels of debt and an aggressive capital expenditure programme, Vedanta Group might prioritise its immediate needs over the long-term potential that exists at Cairn India.
Surabhi Sharma and Dikshit Wadhwa, IMT Ghaziabad
In favour
There may be some shareholders who no longer wish to continue as shareholders of Vedanta Ltd. and instead receive cash. But the cash component has been taken care by Vedanta by offering preference shares on which fixed amount of dividend is certain to be received. Moreover, over and above this they can exit preference shareholding position within 30 days from issuance as per statement by company made in BSE filing.
Swapnil Deshmane and Ragesh Chavan, JBIMS Mumbai
Neutral
The correlation between oil and gas index and metal index over a long term (10 years) is 0.76 which means that both the sectors are highly correlated; the risk therefore is not going to be diversified by merging Vedanta Ltd with Cairn India. The covariances of the aforementioned index with Sensex are 0.30and 0.24 respectively. Thus, both sectors are less volatile in comparison with the market and, in turn, yielding stable return. Technically, if Vedanta wants to diversify its risk exposure and attain synergy, it should merge with a company whose correlation with its stock price is negative. This is unlikely to happen in the case of Cairn India.
Nishi Shah, Programme in rural management, Institute of Rural Management Anand