THE Cairn-Vedanta deal may have upset shareholders of both the Indian companies involved — Cairn India and Sesa Goa whose shares fell between 6% and 9% — while their UK-listed parents — Cairn Energy Plc and Vedanta Resource Plc — gained. The deal indeed raises certain concerns about these two Indian companies. However, long-term investors should not act based on the market reaction on Monday.
The promoters of the oil exploration company do appear to have made a killing, selling off their controlling stake in Cairn India, without sharing the spoils with local retail investors. Cairn India’s shares were hammered on Monday with record volumes — a testimony of the disappointment this caused among retail shareholders. As a new promoter group gains control without any attractive exit route for retail shareholders, those hoping to stay invested in the company for the long haul will have to live with worries about Vedanta Group’s lack of experience in the oil industry and its stretched balance sheet.
For Sesa Goa, which will pick up a 20% equity stake in Cairn India by investing over $3 billion, the longer-term perspective doesn’t appear as bad as its 9% fall on Monday leads one to believe. The company had nearly $1.5 billion of cash and equivalents at the end of March 2010. Its relatively unleveraged balance sheet as well as strong operating cashflows will enable the company to fund the transaction effortlessly.
The management has strictly maintained that the company’s growth plans in iron ore business won’t get hampered due to this deal. The deal will be earnings-accretive for Sesa Goa as Cairn India continues to ramp up its production, while a future stake sale can unlock value. Cairn India, which has raised production from its Rajasthan fields to 120,000 barrels per day from close to 17,500 bpd in the March 2010 quarter, is set to attain the target of 175,000 bpd by 2012. The company is hopeful of ultimately moving up to 240,000 bpd depending on government approvals. The company had $0.55 billion of cash on hand and $0.74 billion of unutilised loan facility at the end of June 2010 in addition to growing cashflows from operations to fund its expansion plans. The exit option for Cairn India’s retail shareholders will come at Rs 355 per share, although Cairn Energy Plc nicked a 14% higher price — Rs 50 premium for agreeing not to compete in India, Sri Lanka, Bhutan and Pakistan. The open offer price of Rs 355 per share is barely higher than the scrip’s average price in the first fortnight of August 2010 and effectively means that the scrip will remain range-bound in the coming months between Rs 355 and Rs 310, which appears to be its fair value.Although the Vedanta Group is planning to replicate the success of BHP Billiton by entering the oil production business after mining, the analyst community is concerned about its lack of familiarity with the new business. The oil exploration business has become an extremely hightech industry over the past few years with oil prices staying high and new discoveries becoming difficult.
Although the deal signals a disappointment for shareholders of both Cairn India and Sesa Goa, the long-term view should remain stable for both. For Sesa Goa it is a strategic investment, which puts to use its surplus cash. The existing strong management team at Cairn India can take care of the concerns of its shareholders over the entry of new owners who are inexperienced. One needs to also watch how institutional investors — particularly Petronas of Malaysia, which holds 14.9% in Cairn India — react to the deal and the ensuing open offer.
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