It’s an irony of sorts.
For Cairn India shareholders, this is a bit of a disappointment, though a positive for Vedanta. Cairn India's onshore oil assets are the best in class and from that perspective it’s a disappointment for its shareholders. But Vedanta will get access to cash generating assets of Cairn India which will go a long way in repairing its balance sheet.
Let’s look at valuations.
The Cairn India stock would have been somewhere in the vicinity of Rs 280-300, if there was no tax overhang. With the tax overhang it would amount to around Rs 20,000 crore as a contingent liability, out of which Rs 10,000 crore would be the principle liability. Take that into account and the de-rating, Cairn India has come down. This is a slight disappointment for Cairn India shareholders because the 1:1 swap is clearly saying that you are not discounting one of the highest returns on invested capital in terms of oil and gas assets that Cairn India has. At crude prices of around $45, Cairn India’s oil and gas assets were delivering returns which were much above the cost of capital.
Having said that, all won’t be disappointed.
A core energy investor will be disappointed because he would be getting a lower return on invested capital in terms of the diversified company. Cairn India’s assets were much higher returns on invested capital.
But for investors looking at a diversified commodity exposure, this is good because they will get diversified metal and energy exposure. In India, if you want to invest in commodities then Vedanta is a stock you will like to invest in.
On the other hand, Vedanta shareholders are getting access to a cash generating asset. I will not be surprised to see more follow-ups on other subsidiaries because there is a clear asset liability mis-match in the Vedanta case. They had a lot of gross debt on the balance sheet, but they needed access to the cash generation. And this process is going to help them repair their balance sheet which will mean that you are likely to see a positive shift in the credit rating outlook. So, in the next 12-18 months, the balance sheet will show that their cost of capital is going to go down. The interest cost is going to go down which will mean that there will be an improvement in the overall quality of the balance sheet and this will obviously mean a rerating for the Vedanta stock.
We would like to believe that Vedanta could face difficulties in getting votes from energy focused minority shareholders. However, long-term resource focused investors could take this deal with a pinch of salt. LIC’s vote will be crucial for Vedanta as a favourable vote will most likely enable the merger to go through the voting.
