20 Aug 2015 20:41 IST

The Cairn-Vedanta Case

Should Cairn India merge with Vedanta?

Is the deal good for shareholders of Cairn India or not?

In June 2015, India’s biggest diversified natural resources company, Vedanta Resources plc, announced plans to merge two of its businesses — India’s largest private miner, Vedanta Ltd (Vedanta), and oil and gas exploration and production firm Cairn India Ltd. The merger, through a ₹146.12-billion (₹14,612 crore) all-share deal, would create India’s largest diversified natural resources company. The move was intended to cut debt at Vedanta and simplify the group structure of Vedanta Resources.

In September 2013, Vedanta Resources merged its various subsidiaries such as Sesa Goa, Sterlite Industries, Madras Aluminium Co, Sterlite Energy, and Vedanta Aluminium into one entity — Sesa Sterlite (Refer to Figure I for holding structure of Vedanta Resources). In February 2015, Sesa Sterlite was renamed Vedanta Ltd., to achieve a better alignment with the Vedanta group. On March 31, 2015, the 58.9 per cent stake in Cairn India purchased by Vedanta Resources in 2011 was transferred to Vedanta (see Chart on ‘Holding Structure’).

 

For the financial year ended March 31, 2015, Vedanta had a standalone debt of ₹376.36 billion, with consolidated revenues of ₹733.64 billion. For the same period Cairn India had cash and cash equivalent of ₹170 billion, with revenues of ₹152.48 billion. Vedanta’s debt issues were attributable to regulatory hurdles and weak commodity prices, which hit the cash-flows of group companies.

Anil Agarwal, Chairman, Vedanta Resources, said in January 2015 that the company was considering merging the cash-cows Cairn India and Hindustan Zinc Ltd., a subsidiary of Vedanta Resources, into the flagship Vedanta Group to create a global natural resources giant to combat global rivals BHP Billiton and Rio Tinto.

SYNERGIES

The merger would give Vedanta, which had been struggling to reduce its debt, access to cash held by Cairn India. It would also make Vedanta Resources less complex, with its subsidiaries coming down to four from nine in 2011.

As far as Cairn India was concerned, the deal would help diversify earnings from oil and gas to electricity and an array of commodities from copper to zinc to aluminum. The shareholders of Cairn India would also gain from Vedanta’s asset base and output-increase forecast compared with Cairn India’s moderate output-growth plan (see ‘Gains from the deal’ Table).

The deal was backed by the independent directors on the Vedanta and Cairn India boards and was subject to regulatory approval. It is expected to close by March 2016.

 

HURDLES

The deal faced a major obstacle by way of litigation related to tax claims on Cairn Energy UK. The lawsuit could prevent shareholders of Cairn India from exchanging their shares, though they could still vote in favor of the merger.

The deal came in for severe criticism from the minority shareholders of Cairn India. They said that, while Vedanta would be able to reduce its debt, the deal would not benefit Cairn India much. Moreover, the minority shareholders of Cairn India would inherit Vedanta’s legacy issues associated with Vedanta Aluminum Ltd, such as problems with refinery expansion in Odisha, charges of human rights violation at the Lanjigarh refinery and challenges over Vedanta’s bauxite mining plans in Odisha.

According to industry sources, Life Insurance Corporation of India (LIC), one of the largest institutional shareholders with a 9.1 per cent stake in Cairn India, would seek clarifications on the exact nature of the deal and how cash reserves from Cairn India would be used to cut debt at Vedanta. Another minority shareholder and independent Scottish oil and gas exploration and production company, Cairn Energy, with a 10 per cent stake in Cairn India, also had to vote to approve the merger. Experts said the voting by LIC and Cairn Energy in favor of the merger would be crucial in deciding the fate of the merger.

The meltdown in the Chinese market, which led to a decrease in global commodity prices, hit the possibility of a Vedanta-Cairn merger. It was reported that Vedanta’s share price would drop more sharply than that of Cairn India if commodity prices remained weak or declined further. Industry experts felt that, in such a situation, there was the possibility of the minority shareholders of Cairn voting against the merger.

A WIN-WIN DEAL?

Some mutual fund advisors felt that the Vedanta-Cairn India merger was a win-win solution for both the companies. While Vedanta would get access to Cairn India’s cash reserves and could retire its debt, Cairn India’s shareholders would benefit from Vedanta’s ₹82.59-billion cost-saving plan (marketing and procurement benefits). Once the merger was completed, it would also simplify the Vedanta group’s complex structure.

Proxy advisory firm Institutional Investor Advisory Services (IiAS) also described the proposed merger as “fair”. The combined entity would have a diversified product portfolio, which would enable Cairn India to ride the cyclical downturn of oil prices and result in stable cash-flows for it. In addition, Cairn India would get access to Vedanta’s low-cost, longer life-cycle assets.

 

On the other hand, some analysts said Cairn India’s shareholders would get a raw deal from the merger. They felt the company’s share prices had declined in February 2015 owing to weak global crude oil prices. Before the merger was announced in June 2015, shares of Vedanta Ltd stood at ₹181.25, while Cairn India’s shares for the same period were trading at ₹236.98.

Soon after the merger was announced in June 2015, shares of Cairn India rose by 3.5 per cent to ₹187.15 on the Bombay Stock Exchange, while Vedanta’s shares rose by 2.8 per cent to ₹189.2. However, after a few hours, Cairn India was down 2 per cent at ₹177, while Vedanta was down 1.4 per cent at ₹181.5. The share price also reflected that the Vedanta-Cairn India merger buzz was being negatively viewed by Cairn India’s shareholders.

CRUX OF THE PROBLEM

Advisory firms and mutual fund experts felt that Vedanta’s merger with Cairn India was meant to tackle its debt issues and possibly create a global natural resources giant to rival BHP Billiton and Rio Tinto. However, the deal met with huge resistance from Cairn India’s minority shareholders, who felt that only Vedanta would benefit from the merger and that Cairn India would end up inheriting the problems of Vedanta, which was fighting environmental activists over an aluminum project in Odisha.

THE CHALLENGE

Chairman Agarwal, however, maintained that the deal would also benefit Cairn India and would simplify Vedanta Resources’ group structure. Now, imagine you are a mutual fund manager and have been asked to vote on the Vedanta-Cairn India merger. Share your views on how you would vote on this issue. Justify your decision with logical reasoning.

As Vedanta and Cairn India are real companies, you may gather additional information on their current merger plans through secondary research.

This case study was developed at ICFAI Business School (IBS) by Hadiya Faheem (freelance case writer) and GV Muralidhara (Dean-Case Research Centre).



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