Vedanta Ltd - Stock Valuation and Financial Performance

Vedanta received bids for 125.5 crore shares in reverse book building process instead of 134 Cr (90% of total minority shares) required for successful delisting process. This lead to failure of delisting

Vedanta received maximum bids at less than Rs. 160/share (mostly mutual fund managers), and a substantial lot at Rs. 320/share (LIC).

LIC bid at Rs. 320/share, its evaluation of fair price for Vedanta. In 2015, LIC had agreed to Cairn India –Vedanta merger wherein it received Vedanta’s shares but there was a tussle before the deal was finalized. So this time it bid at its desired price versus average fund manager to put a tough fight to protect its interest in the company.

The situation was interesting wherein MFs bid Rs. 160/share so that delisting is a success and company goes private and one gets Rs. 160/share. If they bid at full price of Rs. 300/share, the delisting would have failed (as promoter will not find it attractive to take company private). This failure in delisting can cause price to fall back to 80/share in the short term as arbitrageurs who invested for delisting reward will sell off their shares aggressively in the market. LIC being a long term shareholder, it didn’t have a problem if delisting fails and price falls back to Rs. 80/share in the interim.  (In long term, price reflect fair value of a company)

We believe that the price of Vedanta may go below Rs. 100 temporarily as short term shareholders will exit. But hopefully, the price may recover back to Rs. 100-110/share as the metals prices are firming up and restocking is causing volume uptick too.

If you hold Vedanta, please ensure you do not average and do not hold more than 2% of portfolio. Even if the stock is cheap, the business cyclicality and promoters’ governance track record make it a risky investment. There will be several better opportunities in the market to make a return or earn back losses from this stock.

Vedanta's delisting offer bids can be seen here.

https://www.bseindia.com/markets/publicIssues/BSEBidDetails_ACQ.aspx?flag=ec&Scripcode=5255

Out of the total 15 Cr shares have received bids. Total minority shares are 134 Cr. Promoter needs atleast 120Cr bids. Based on current stats i.e. 7th Oct, 1.55 PM, 80% of bids have come at Rs. 145/share. Current sell off will not have any impact if company gets delisted.

Delisting process

In our previous analyst note we had shared that the promoter (VRL UK) of Vedanta Ltd. (Listed entity) has declared de-listing of Vedanta Ltd from Indian stock exchange.

The pricing (undervalued) and timing (cyclical low) of the delisting appears to be short-changing minority shareholders.

However, SEBI has created rules to protect minority shareholder interest through Delisting regulations 2003.

As per regulations, Promoter entity will have to call for bids via reverse book building process. Investors are free to bid their desired price. Investors’ median bid price is arrived at and if promoters find the price reasonable they will accept till they acquire 90% stake in the company. Last 10% investor stake will be given 1 year to tender their shares at same price as final exit price or they have approach court for final price.

If the promoters do not find investors median price lucrative, they will announce counter offer. If investors are willing to accept counter offer, that will become the final exit price.

While the process is laid out by the regulators, the difficult part is what price to bid for in reverse book building process. Irrespective of what you bid, final price will be decided by median price of all minority investors.

Large part of this price will be decided by institutions like MFs and insurance companies. LIC (~6%), HDFC MF (3%) and ICICI MF (4.81%) are few of the large institutions as per latest shareholding pattern.

Valuation

Assuming Hindustan Zinc’s (HZL) Rs. 107/share for every Vedanta’s share, current price of Vedanta is Rs. 30/share. If we exclude HZL’s cash and operating profit, Vedanta today has 44,000 Cr in debt and 14,000 Cr in profit before interest and tax. At current price of Rs. 137/share, Vedanta Ltd core business trades at ~5x P/E ratio of normal year earning.

Given the uncertainty as to when this normalized earning would comeback, let us assign 10-12X we get fair value of around 170-200/share. This is assuming the company remains in downcycle for a while. We recommend to bid for Rs. 200/share for Vedanta share in reverse book building process.

Few market experts, including a corporate governance advisory firm SES, have suggested 250-325/share as fair price to bid for. But it appears this price would lead to calling off delisting by promoters. If that happens, you can continue to hold your shares.

You are free to choose Rs. 200-325 as your bid price in reverse book building process.

In the end, if final exit price is higher, you will get better price irrespective of your bid price. However, if bid price is lower, you will have to accept lower price in worst case (likely to be in range of 155-170/share as per market positioning*).

P.S. If the company is successful in buying over 90% shares, it can delist and will not be available for trading. In that case, investors will end up holding non-tradable securities. They will have to write to the company for buying back the shares at final exit price. It is better to tender shares after final price is arrived at and promoters have accepted the same. You will receive proceeds 10 days after the delisting date.

*We reverse calculated how market price is calculating odds of getting delisted as well as reverse calculated from funds raised by the promoter entity to delist Vedanta Ltd.

Vedanta has received shareholders’ approval (93%) on de-listing proposal offered by the promoters. The likely reason for the approval is because of the reverse book building process that will allow shareholders to bid higher price for tendering their shares. Floor price has no meaning as discovered prices can be much higher than floor price. (in past, some cases were 70-100% higher)

Reverse book building is similar to a reverse auction process. In this process, shareholders bid their own price for tendering their shares; this is supposed to be above the floor price to get highest possible price. The acquirer accepts the price of all the shareholders until their shareholding reaches 90%. Rest of shareholders continue to hold the company shares.

If the shareholders’ bids are not acceptable to the acquirer, he would either reject the delisting process or he give a counteroffer to shareholders. Usually counteroffer can’t be less than the book value of the company. (Book value Consolidated Rs. 148/share; Standalone Rs. 180/share)

Vedanta will announce dates for reverse book building process, tentatively it will be in July. We will share what you investors need to do and what could be a good price range you can get your shares tendered which also will be accepted by the acquirer.

Vedanta has filed the following statement on the exchanges.

“Promoter Vedanta Resources to meet on May 18 to decide on de-listing of the company. Vedanta Resources has expressed its intention to acquire all public shareholding of the company. As on date, the Public Shareholders hold 169.1 crore equity shares aggregating to 48.94 percent of the paid-up equity share capital. Vedanta Resources to consequently voluntarily delist Vedanta from the Equity Shares from BSE and NSE.”

For Vedanta’s de-listing to go through, it requires Board of Directors’ approval and minority shareholder’s approval.

Currently minority shareholders own ~50% of Vedanta including American Depository Receipt holders. It has to get 66% approval for going ahead with de-listing. Today’s stock price is very low versus its replacement cost. This makes the chances of getting majority vote “in favour of de-listing” difficult.

We believe the current de-listing price is purposely put out for negotiations. From past experiences, if the promoter is determined for delisting, it will have to sweeten the deal by adding one-time dividend and increasing the price for de-listing. 

Our opinion is that current price offered for de-listing may get revised upwards. If the majority of the 50% minority investor approve the deal, you will have to surrender the shares and accept the offer on the table.

Current dividend may continue as Vedanta being promoter’s only operational entity it is the only source of dividends to service its debt in promoter entity. We wouldn’t recommend buying a stock just for dividends. The stock price may remain subdued for long if commodity cycle doesn’t come back in hurry.  

Vedanta, Cairn India and Vedanta Resources PLC together with its subsidiaries on 14 June 2015, announced a merger between Vedanta and Cairn India. As per the scheme, minority shareholders of Cairn India will receive for each equity shares held, one equity share in Vedanta of face value of Re. 1 each and one 7.5% redeemable preference share (RPS) in Vedanta with a face value of Rs 10. No shares will be issued to Vedanta or any of its subsidiaries for their shareholding in Cairn India. Approximately 75.20 Cr of each of equity shares and RPS will be issued to the minority shareholders of Cairn India by Vedanta pursuant to the merger. Post completion of the transaction, Vedanta PLC ownership in Vedanta is expected to decrease to 50.1% from its current 62.9% shareholding. Cairn India minority shareholders will own 20.2% and Vedanta minority shareholders will own a 29.7% stake in the enlarged entity. The transaction is expected to be tax-neutral for Vedanta, Cairn India and their shareholders under Indian law. Vedanta would further consider consolidation of some of its wholly owned foreign subsidiaries. Vedanta will continue to be listed on the BSE and NSE, with American Depository Shares (ADS) listed on the New York Stock Exchange (NYSE), and Vedanta PLC will continue to be premium listed on the London Stock Exchange (LSE). Cairn India's BSE and NSE listings will be cancelled following completion of the transaction. The management expects the transaction to complete by Mar 2016.

What the management thinks about this merger?

Anil Agarwal, Chairman Vedanta Resources PLC: “The merger of Cairn India and Vedanta marks a significant step towards achieving our long-term vision of a simplified group structure... and creation of long-term sustainable value”

Mayank Ashar, CEO Cairn India: “This deal is good for Cairn because today we have reliance only on a single commodity and our fortunes go up and down based on the commodity, which is quite volatile. The strategic rationale for this is that we go from a single commodity exposure to being part of India's national resource champion. What it allows the Cairn shareholders to do is swap a single commodity exposure to multiple commodities. The Vedanta asset portfolio is world class, good quality and long life assets. Also, Cairn brand, investment plans and management remain unchanged. We are also looking at how to enhance our portfolio of growth. This transaction gives us confidence to invest in the long haul.”

Tom Albanese, CEO Vedanta Resources PLC: “The capital expenditure for Cairn has been reduced significantly but that was independent of any merger consideration. It was entirely based upon the drop in oil prices. We had planned projects assuming crude at $85 a barrel and those plans were not robust at $50-60 a barrel. That led to a reduction in capital expenditure. Cairn's management has said they are hopeful of continuing to grow. They have to take their calls. They are also coming up with the largest project in Cairn's history, an EOR (Enhanced Oil Recovery) project. The strategy for Cairn will not change with this merger.”

What we think about the merger?

1.      Cairn India is more undervalued as compared to Vedanta Ltd. (erstwhile Sesa Sterlite Ltd). Cairn India currently trades at 4 times operating profit & 0.6 times book value. Since the company is merged at swap ratio of 1:1.04, this deal is definitely a positive for Vedanta Ltd shareholders and negative for Cairn India minority shareholders.

2.      To justify the merger, additional 7.5% Redeemable preference shares do not take care of the undervaluation of Cairn India. Premium over last traded price is very low as compared to actual valuation of the company even at low crude oil prices.

3.      We agree with the company's argument that a consolidated entity will be more stable on earnings front as a result of diversification of operations. This is evident in companies like BHP Billiton & Rio Tinto which have stable EBIT margins despite downturn in one or two commodities due to diversified operations in multiple commodities like Iron-ore, copper, aluminium, petroleum.

4.      Vedanta is likely to emerge as more stable entity post-merger especially as we expect Cairn cash holding to decrease balance sheet risk of Vedanta Ltd. This will reduce cost of equity & cost of debt of the company.

5.      Vedanta Ltd may look for profitable opportunities to invest using cash of Cairn India as Cairn India did not invest in new fields due to depressed oil prices. This can probably derisk Cairn India’s shareholders exposure to single commodity risk.

6.      Vedanta is likely to focus on Hind. Zinc and Balco and consolidate its investments into single entity. This eases the management’s capital allocation decision in a profitable manner.

7.      While Vedanta has been very opportunistic in merging Cairn India, we do not see this as a corporate governance issue. However, due to depressed Cairn India share price, the minority shareholders of Cairn India stand to lose in this deal as opposed to Vedanta Ltd minority shareholders.

8.      However, we believe that with shares of Vedanta Ltd. one has de-risked his exposure from single commodity (Oil & gas in this case) to diversified natural resources. This is one of the benefits for Cairn India investors.

9.      Also, we expect that other minority shareholders like LIC & Cairn Energy can oppose the merger terms and demand higher consideration. However, for now it’s highly uncertain how the deal materializes.

After conference call with the management we will re-visit our Vedanta Ltd valuation and inform what investors should do.