HIGH STAKES AT PLAY

The global oil and gas space has been experiencing considerable changes over the last few months. One of the predominant reasons is the steep fall in crude oil prices that had a deteriorating impact on the sector globally. A similar level of pain was seen in the Indian oil and gas sector too and Cairn India was not an exception to this phenomenon. The deterioration in crude oil prices pulled the stock price down by more than half in a single year from Rs 378 to Rs 183. However, this is not the end for Cairn India’s shareholders. In recent times, the new promoter, Anil Agrawal, has announced the proposed merger of Cairn Energy and Vedanta. This move is a part of the promoter’s strategy to take benefit of the discounted valuation of its oil and gas business. The instant reaction of large investors and leading brokers was negative.

The proposed merger will be a non-cash deal wherein the shareholders of Cairn India will get one equity share of Vedanta for every one share held. Further, the shareholders of Cairn India will also get one 7.5 per cent redeemable preference share in Vedanta with a face value of Rs 10, redeemable at par after 18 months. The deal is expected to be completed in the first quarter of CY16 and is conditional on Vedanta, Cairn India and Vedanta Plc shareholders’ nod, along with legal, stock exchange and other regulatory approvals. Interestingly, after the completion of this deal, Vedanta Plc’s ownership in Vedanta will get diluted to 50.1 per cent from 62.9 per cent. The minority shareholders of Cairn India will hold 20.2 per cent and the minority shareholders of Vedanta will hold 29.7 per cent in the combined entity.

Market participants are worried about the lower valuation of Cairn India which, with its cash pile up of Rs 17,000 crore, is getting merged with the debt-laden Vedanta which has a debt of Rs 70,000 crore in its books. More importantly, the oil and gas business is a more profitable business than Vedanta’s metal and mining business. Even with crude oil touching its recent low, Cairn India had been earning profits from its operation. Hence the merger will be a disappointment for Cairn India’s minority shareholders who want to take exposure in the oil and gas sector and will end up owning the risk of a huge debt-burdened company along with the risk of global metal underperformance. Contrary to this, Vedanta’s shareholders are definitely going to benefit out of this deal as the company will now have access to the cash-generating assets of Cairn India, which will improve its balance-sheet after the merger and lower its interest cost in the days ahead.

However, the merger process will be not easy for Vedanta as it may face various hurdles in the days ahead. The biggest obstacle will be to get the approval of minority shareholders of Cairn India. As per market regulator SEBI and its new rule since May 2013, any merger and acquisition activity should receive more than half the votes of minority shareholders in its favour. The state-owned insurance company LIC and Cairn Energy Plc own 9.06 and 9.82 per cent in Cairn India, totalling 18.88 per cent in the company. The combined shareholding of these two institutions forms a little less than half of 40.12 per cent minority shareholding in the company. A green flag from LIC and Cairn Energy will become crucial in this merger.
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LIC has raised its concern over the valuation for the merger and the debt of the merged entity. The Vedanta Group has tried at several times to acquire a minority stake in Hindustan Zinc and Balco, which were previously acquired from government. However, the government has not cleared the deal for these residual stakes. Hence it will be interesting to see how LIC will vote for this merger. Further, this deal will require the Ministry of Petroleum’s approval for changing ownership of Cain India’s oil and gas assets as the state-owned petroleum company, Oil & Natural Gas Corporation, has a partnership with Cairn India in a few blocks. Adding further hurdles, the Vedanta Group will also require permission from the Income Tax Department as it has made a demand of Rs 20,000 crore on the company for not deducting tax on alleged capital gains made by its erstwhile promoter, Cairn Energy Plc.

Meanwhile, the Vedanta Group is putting in all its efforts to pass the deal. It has been reported that the officials of Vedanta met their counterparts from LIC to seek their go-ahead. LIC is expected to consider this deal after analysing it in detail. Anil Agarwal also met Petroleum Minister Dharmentda Pradhan to provide clarity on the merger. Further, though many mutual fund companies are not happy with the merger deal, asset management companies may not go against the Vedanta Group as its group companies have invested in various debt schemes of several asset management companies, which may lose business due to resistance.

However, there is definitely bad news for investors who want exposure to high return oil and gas business as they will be getting a lower return after the merger although investors looking for diversified commodity exposure in both metal and oil and gas will find the merged entity as the best investment option across the Indian listed space. As far as Vedanta’s shareholders are concerned, the proposed deal definitely benefits them in both medium and long-term. Cairn India’s shareholders will benefit in the short-term considering the huge contingent liability from the IT Department and the current scenario of crude oil prices. Also, Cairn India’s shareholders will definitely lose high returns as the oil prices are expected to recover in the long run.