Salvika Jajoria
Samhita Reddy
For Vedanta
Better cash fungibility and improvement in balance sheet : The proposed merger will give Vedanta access to the cash flows of Cairn India, which could be used to pay off the former’s standalone debts, thus improving its capital structure. This merger could also act as a hedging deal for Vedanta. When profits in the mining industry decline due to the increase in energy prices, there can be an increase in the oil and gas division.
The merger will result in a write-off of goodwill related to this acquisition, which will lead to a 7-22 per cent rise in earnings per share due to a fall in goodwill amortisation charge.
Simplified corporate structure : Vedanta has repeatedly claimed that the merger isn’t for refinancing its debt, but for simplifying and consolidating its corporate structure.
Vedanta’s position in India : Vedanta’s strategy is “To deliver growth, long-term value and sustainable development through diversified portfolio of large, long-life, low-cost assets.” By going ahead with this deal, Vedanta will become India’s largest diversified natural resources company.
It will also benefit from Cairn’s long experience in discovering, exploring and operating oil production assets in India along with ONGC, Central and State Governments, regulators and other key industry players. Also, Cairn India is capable of developing oil and gas resources at lower costs. This deal will further solidify Vedanta’s position in Rajasthan’s private core sector by adding oil and gas to its portfolio, along with zinc.
For Cairn
Analysts argue that this merger might be a raw deal for the subsidiary. Our analysis of the impact of this merger for Cairn is as follows:
Low valuation: The fair exchange ratio between the parent and its subsidiary has been agreed upon as 1:1 (which was 1:8 in 2012), given the fact that Cairn India has extended an $1.25 billion inter-company loan to the parent company. The undervaluation of the company is due to the constant misuse of its rich cash-flows by the parent company. Thus, Vedanta is getting Cairn India at a good price which is beneficial for it, but not the minority shareholders.
Access to low-cost, long-life assets : On the bright side, Cairn India will get access to the low-cost and longer-life assets of Vedanta, which will help it ride through the cyclical downturn of oil and gas sector and lead to stability in the cash flows. Cairn India might also have to pay out dividends if it does not go ahead with deal because of its rich cash flows.
Diversified Commodity Mix: The merger stands to position Vedanta Ltd as India’s leading diversified resources company, capable of competing with global giants like BHP Billiton and Rio Tinto. This would benefit both the parties; it will give Vedanta a diversified portfolio, ranging from metal to oil exploration, and help de-risk its earnings volatility in an economic slowdown, allocate capital to projects with better returns, build a stronger balance sheet and lower overall cost of capital.
As for Cairn India, it would be able to ride the cyclical downturn of oil prices and result in better shareholder returns. It would also get access to Vedanta’s low-cost, longer life-cycle metal and mining assets.
Environmental issues: The environmental degradation accusations being faced by the parent company will affect the share prices of Cairn India.
VRIN Analysis
Conclusion
From the above VRIN (Valuable, Rare, Inimitable, Non-substitutable) framework, it is clear that both the companies stand to gain sustainable competitive advantages from this deal. The valuation of Cairn can be argued to be fair, keeping in view the advantages that the firm will gain from this merger. Thus, in our view, this merger should take place.
(Samhitha and Salvika, students of PGPM 2014-16, IIM Bangalore, are the fifth runners-up in the case study contest)