Pros outweigh cons; merged entity may show strong growth

Vedanta had, in early June 2015, announced that Cairn India was merging with the parent company to create a natural resources conglomerate that would produce everything, from aluminium and copper to crude oil.

Vedanta, which is struggling to pay its debt of ₹77,000 crore, will get access to Cairn’s cash pile of ₹17,000 crore, once the deal goes through. The deal has both positive implications as well as negative repercussions, but the pros far outweigh the cons.

The pros

Debt reduction : The deal will help parent Vedanta Resources reduce its huge debts. As of March 31, 2015, the standalone net debt of Vedanta Limited stands at ₹36,796 crore, while Cairn India has a cash pile of ₹16,867 crore.

Balanced and diversified : The Vedanta Group, after the merger, will become a more balanced and diversified conglomerate. It can hedge the risk by broadening and diversifying its portfolio from metal to oil exploration, rather than relying only on mining .

De-risk earnings volatility : It will also help Vedanta de-risk earnings volatility in an economic slowdown and allocate resources to projects more prudently with better returns, and pare its huge debt. The merger will de-risk Cairn India by providing access to a portfolio of diversified Tier-I, low-cost, long-life assets, to deliver significant near-term growth.

Change in outlook : Moody’s said it would change the outlook on Vedanta Resources from negative to stable, if there was substantial debt reduction and improved operating performance.

Loss consolidation : It would also help Cairn India to consolidate its losses, since it has been struggling from stocks buyout due to decline in oil prices globally. This has led to fall in revenue by 22 per cent and erosion of profits by 64 per cent.The merger will help Cairn spread its risk from volatile oil business to other metals and commodities

The cons

Minority shareholders : They have become important, as new rules framed by market regulator Sebi in May 2013 mandate that any related party mergers and acquisitions (M and A), in order to be operational, should receive more than half the votes of public shareholders in its favour. This means that more than half the public shareholders of Cairn India (40 per cent) should vote to support the deal for the merger to be effective. LIC owns 9 per cent, while Cairn Energy Plc owns 9.8 per cent in Cairn India.

Capital gains : The government has asked Cairn Energy to pay $1.6 billion on an alleged ₹24,500-crore capital gains it booked in 2006 by transferring its assets in India to a new company.

Though there are uncertainties surrounding the proposed merger, the cons are only short-term, whereas it has sustained long-term benefits for both the groups. Therefore, a likely merger is a win-win situation for both.

What it means

The following graphics depict what it would mean for the companies and its shareholders, if the merger goes or falls through. The charts indicate the views of both the companies’ managements and the outlook of their shareholders respectively.

Stock value fluctuations

The share price graphs clearly show that both Vedanta Ltd and Cairn India shares have dropped considerably, — from ₹300 to around ₹98 for Vedanta Ltd., and from ₹340 to around ₹149 for Cairn India.

This reflects that the stock market works on sentiment; and a sense of dissatisfaction or fear, as mentioned in the flowcharts above, has made a lot of investors disinvest their stocks and opt out, instead of getting stuck in a confusing situation.

In the long run, if the merger happens, these stocks would be strengthened further, so defaulting is the last possible option that exists. But the drop seen in the charts suggests the level of fear that investors in both the firms are experiencing.

Conclusion

The merger should take place since it would strengthen both the companies’ fundamentals and benefit them in the future. The series of disinvestments would have made both the firms rethink their merger plans, but the pros clearly outnumber the cons.

Investor concerns may well be short-lived and, until some unlikely global or national crisis crops up, the conglomerate would be one of the strongest firms in India and is likely to show rapid advancement in the long run.

(Abhijeet and Mamta, students of PGDBM in Marketing at Sydenham Institute of Management Studies, Research and Entrepreneurship Education, are the second runners-up in the case study contest)