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A Loan That Sowed Seeds Of Vedanta-Cairn India Merger

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The script of the merger between Vedanta Ltd and Cairn India Ltd was written in July 2014, when the latter extended a loan of $1.25 billion the former without taking prior approval from the shareholders.

The stock of Cairn India had taken a beating after its largest minority stake holder Life Insurance Corporation criticized the company for the related party transaction between the two companies. The management of Cairn India escaped legal action as the company had extended the loan to Vedanta Ltd before the enactment of the new government guidelines of related party transactions, which forbid a company to extend a loan or any cash payment to a related party without seeking the approval of shareholders.

However, at that time the management of Vedanta Ltd told investors and analysts that the money borrowed by Vedanta Ltd at a floating rate of 3 per cent plus Libor gave  significantly higher return to Cairn India compared to the fixed deposit of same tenor. Interestingly, the loan was extended at a time when Cairn India was itself sitting on an investment cycle of $3 billion dollar to improve its oil exploration capacity.

Even if the company did not have any significant capital expenditure plans, it should have paid higher dividend to its stakeholders. Cairn India Ltd paid a dividend of 90 per cent in March 2015 on the face value of Rs 10 per share. The dividend could have been much higher if the company had decided to distribute the excess cash among its shareholders.

However, Just eleven months later, when the borrowing company (Vedanta Ltd) was supposed to repay its debt to the lending company, the management announced the merger between the two companies, converting the debt of Vedanta resources liable to be paid with interest to Cairn India into cash for the merged entity.

In lieu of the merger, the shareholders of Cairn India have received only one stock of Vedanta Ltd, which was trading at a bonus of Rs 184 at the time of merger. In addition, Cairn India shareholders will get a Rs 10 face value preferential share as a sweetener.

If the merger between the two entities took place in June 2014 when the price of crude oil was above $100 per barrel, the value of Cairn India’s share was  Rs 366, whereas the share of Vedanta Ltd was selling for Rs 290 per unit.

While the share price of Cairn India has come down due to cyclic slowdown in the price of crude oil, the fall in the price of Vedanta Ltd is because raw material crunch that is unlikely to be resolved anytime soon. Vedanta is operating its Jharsugda aluminum facility at a mere 25 per cent of installed capacity. The company had set up this facility with an investment of Rs 52,000 crore.

Interestingly the London listed Vedanta Resource Plc that is the holding company of India listed Vedanta Ltd and Cairn India, saw a downgrade in April this year by Standards & Poor’s as the rating agency questioned the London listed miner’s ability to meet its financial obligations.

For the year ended 31 March 2014, the Vedanta Group earned $12.9 billion and had an operating profit of $4.5 billion. Vedanta Resources Plc had gross debts of nearly $17 billion (Rs 1,08,905 crore) at the end of the last financial year. After the merger, the consolidated debt of Vedanta Resources Plc is likely to come down significantly.

On the other hand the investors of Cairn India ltd will now be exposed to the environmental and legal risks associated with the mining sector. investors who bought Cairn India's shares just to be part of the crude oil play in the international market may have to exit the company as pure crude oil business is any day a safer and more profitable bet than mining anywhere in the world.

The only good thing from a Cairn India shareholder’s perspective is that in case the company loses the tax liability case against the government which would make it liable to pay over Rs 20,000 crore, the company will benefit from the larger balance sheet of the merged entity.

Following Cairn India, Vedanta will now look to merge with its other majority holding companies like Balco and Hindustan Zinc, making the parent company an even larger entity. One will have to keep a close watch to see who benefits in the future, the management or the shareholders.