A lot of price damage has happened since the Cairn-Vedanta merger was first announced nearly a year ago. For Vedanta it was almost a desperate situation as its leverage was getting out of hand. The merger would have helped Vedanta use up the cash resources of Cairn India to defray a part of its debt. Cairn India also stood to benefit from the merger. Oil prices were headed down and valuations of oil companies could only get worse over time as a supply of desperate oil assets flooded the market. That is something Cairn was always aware of.
Secondly, Cairn UK had a $2 billion tax dispute against its name and that was always going to depress valuations. Lastly, the future of the commodity game was in getting out of individual commodities and broad-basing into a wider spread of commodities. Global players like Broken Hill Proprietary of Australia and Rio Tinto of Zimbabwe exactly belonged to this category. Vedanta with its interests in copper, zinc, iron ore and oil was Cairn’s best bet to broaden itself into a commodity supermarket.
Where did the deal get stuck?
The problems for Vedanta started off with a new amendment to the M&A rules which called for a specific approval from the large minority shareholders of the target company. In the case of Cairn India, the two large minority shareholders were LIC and Cairn UK, both with around 9% stake in the company. Hence, the merger would not be able to get through without the approval of these two entities. In the case of Cairn UK, the objection stemmed from the fact that it would prefer to remain a pure oil play and did not see great merit in becoming a commodity supermarket. In the case of LIC, the objection purely stemmed from the pricing, which LIC felt was weighted in favour of Vedanta. So what could make the merger go through?
Vedanta will have to sweeten the deal…
It stands to reason that Vedanta is quite desperate to see the merger with Cairn through. The other cash-rich company that Vedanta acquired was Hindustan Zinc. But in case of HZL, being a government company, the requisite approvals were never going to come in easily. Hence Vedanta’s plans of using the cash reserves of HZL have already come to naught. The only other option left is Cairn India. With its multi-billion dollar cash pool and little by way of future investments, Cairn India may be the ideal candidate for Vedanta to expedite the merger.
Vedanta also realizes that time may be running out. Already US is operating at about 48% shale capacity and that does not augur too well for supply of oil. If there are constraints on oil supply, then the oil price could get back to $70/ barrel, which is the price that the OPEC was anyways looking for. But then it would also mean that oil price calculations done a year ago may be irrelevant and it may call for a fresh look at the merger. Vedanta will want to avoid that.
How exactly will the deal be sweetened?
There are a variety of ways the deal can be sweetened and at this point of time it is not clear as to what strategy Vedanta will adopt. But we can take a few pointers. Since the merger is being effected through a stock swap, the ratio can be modified to make it more favourable to the shareholders of Cairn India. That should largely satisfy LIC and Cairn UK. But it may not be that simple in reality. Vedanta has the status of a premium holding company on the London Stock Exchange, which calls for the holding company to retain at least a 51% stake in the group companies. As of the last swap, the dilution had already taken the share of the UK based holding company to close to 51%. Thus Vedanta will not be able to sweeten the swap ratio without diluting its stake below 51%. Vedanta is unlikely to allow that and hence an improvement in the swap ratio looks difficult.
Remember, shareholders of Cairn India also get an attached preference share which is going to yield 7.5% interest. Vedanta may probably have some leeway either to increase the percentage of preference shares issued or tweaking the interest payable on the preference shares.
Will the merger go through?
In a nutshell, both Vedanta and Cairn India realize that they will be better off with the merger. Surviving stand-alone is going to be difficult for both the companies. What the two key shareholders, LIC and Cairn UK realize is that they have a marginally higher bargaining power due to a possible bounce in oil prices. For Vedanta, the sooner the cash of Cairn India can be utilized to defray its debt, the better. Paying a slight premium via a sweetener should not be a deal breaker. In all probabilities, the deal will be sweetened and eventually fructify.
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