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What should Cairn Shareholders do?


Posted on 22-Jun-2015 Comments  7

The Cairn India merger with Vedanta Group looks prima facie beneficial to the owners of Cairn India. Apart from a 1:1 swap ratio (Cairn India shareholders get 1 share of Vedanta for every 1 share of Cairn India held), there is an additional sweetener in the form of a preference share. Shareholders of Cairn India will also get 1 preference share of par value Rs.10/- bearing an annual coupon of 7.5%. This preference share will be redeemable at the end of 18 months.  There are 4 key considerations behind this merger...

 

One is indebted and the other is cash rich


That is probably the theme of the merger. One needs to understand that the Vedanta group along with its existing subsidiaries has an overall net debt of close to $12.4 billion. That is likely to substantially damage the leverage of their balance sheet and also its standing in the market. On the other hand, Cairn India and Hindustan Zinc (another company acquired by Vedanta) have a combined cash reserve of $8.3 billion. Unless these companies are merged into Vedanta, the group does not get the benefits of using the cash to defray its debt. To that extent it is likely to be accretive for the Vedanta Group and negative for Cairn India shareholders.

 

Cairn India has a contingent liability of $3.2 billion


This liability pertains to the period 2006-07 when Cairn UK had made capital gains from the sale of shares and Cairn India had failed to deduct withholding tax at that point of time. The liability of $3.2 billion pertains to the tax not deducted, penalty and the interest. Of course, the primary liability is of Cairn UK and not of Cairn India. But the secondary liability belongs to Cairn India. Effectively, when Cairn India merges into Vedanta, the contingent liability of $3.2 billion also gets transferred to Vedanta. Of course, Cairn UK has disputed this liability and is likely to get a favourable verdict. But the fact is that as of now, this contingent liability does rest in the books of Cairn India.

 

There is an angle of crashing oil prices


We all are aware of that. Prices of crude oil have crashed from $115 / barrel to $45 per barrel before settling at the current rate of around $60-65 / barrel. The swap valuation was fixed considering a price of $60 / barrel. One can argue that is closer to the lower end of the range but there are two aspects one needs to take cognizance of. Firstly, oil mergers have historically happened at low oil prices and rarely when prices are high. Secondly, the way OPEC, US and Russia are flooding the market with supplies, it looks unlikely that oil could see a sharp bounce in the foreseeable future. If oil settles at closer to $40 / barrel, as many traders are giving as possible estimates, then Cairn may find it difficult to get a reasonable valuation because the market will be flooded with a supply of oil assets.

 

The future of commodities


Shareholders of Cairn India need to understand what the global commodity industry is coming to. It looks like pure, single commodity plays will find it increasingly hard to survive. Vedanta now spans aluminium, zinc, copper, iron ore and oil. It is this kind of a spread that commodity giants like Broken Hill Proprietary and Rio Tinto have focused on. To that extent shareholders of Cairn India will get to participate in a much more diversified menu of commodities as a result of this merger.

 

What should Cairn India shareholders do?


Shareholders need to note that the entire process of merger will be completed only by the fourth quarter of fiscal 2016. The merger also requires the approval of the High Court and the Ministry of Petroleum. Additionally, the two key minority shareholders of Cairn India viz. Cairn UK and LIC will have a major say. The question is whether the deal will be sweetened a little further by Vedanta?

Can Vedanta improve the swap ratio? This looks unlikely. Vedanta PLC is listed in the Premium Listing segment on the London Stock Exchange. This segment is only open to trading and investment holding companies. Post the share swap, Vedanta PLC will dilute its stake in Vedanta Ltd to 50.1%. If their holding goes below 50%, then Vedanta PLC loses out on its Premium Listing as well as the concomitant benefits. Of course, there is a possibility that the terms of the preference share may be sweetened, but that may not be really substantial.

For shareholders of Cairn India, it is a good opportunity to move up the diversified commodities curve. Cairn India may have corrected sharply but so has Vedanta. Before the world is glutted with oil assets, Cairn India shareholders actually have a good opportunity to exit the pure oil space. In the medium to long run, it will be certainly beneficial for Cairn India shareholders. 

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Thangarasu

Posted on 6/22/2015 4:30:21 PM

Its more useful for investor, The message is very clear and easily understandable. thanks trade plus team.

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t s dhandapani

Posted on 6/22/2015 5:33:21 PM

thanks for the advise.

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Arun Kumar

Posted on 6/23/2015 10:34:51 AM

very Useful info and very Clear .Thank Q and i Appreciate the way of Working ....Awesomee

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A

Posted on 6/25/2015 1:23:37 PM

Guess the message cant be explained better than this. Excellently drafted....

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Sukanya

Posted on 6/26/2015 4:10:41 PM

few questions..it is said that it would take almost a year to have the process completed. so would it be wise to buy the shares now or should we wait for some more time to see how much more it could fall? The next concern is the tax obligation.. can we buy in spite of this?

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Tradeplus Admin

Posted on 6/29/2015 10:08:05 AM

Hi Sukanya ! In this particular case, the stock price is unlikely to fall substantially from these levels as Cairn will be moving from a pure oil play to a full commodity play. Also as an investor you will observe that the price of Cairn and Vedanta will move in tandem. The price of Cairn will be marginally higher than Vedanta because apart from 1:1 share ratio, the shareholders of Vedanta will also get a preference share bearing 7.5% interest.The tax dispute pertains to Cairn UK and not to Cairn India. The Indian company only had an indirect responsibility to withhold tax. The liability still rests on Cairn UK as the gains were made by Cairn UK. To that extent, Cairn India has nothing much to worry about. Also if the government has to get tough on Cairn, it will have to get tough on Vodafone and Nokia also. Under the circumstances, that looks unlikely

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surender

Posted on 8/30/2015 10:50:48 PM

the above information is very useful thanks for informationsurender

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