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Vedanta Limited Delisting Failure

Vedanta Limited delisting has been a closely followed event by investors. It has left many wondering whether the capital market participants follow the rules that they are supposed to. While some have enhanced their reputation through this saga, many others have diminished theirs.

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Vedanta Limited is one of the giants of Indian mining and metal ecosystem. Vedanta Limited attracted heightened interest in the investment community when its promoter entity, Vedanta Resources owned by Anil Agarwal, disclosed its desire to take the company private. The delisting attempt has failed and the article discusses what led to it and what we can expect going forward.

Vedanta Limited is the largest natural resources company in India with leading producer of Zinc, Lead, Silver, Oil & Gas, Iron Ore, Aluminium, Copper and Power. While most of its revenue comes from India, where it is a leader in many of the segments listed above, it also has presence in South Africa, Namibia and Australia. Below chart explains the structure of Vedanta Limited in a succinct manner.

Vedanta Limited is a dominant player in India for most of the segments that it has presence in. This can be verified from the below illustrations.

Financials We provide below some of the key metrics of Vedanta Limited over the last few years.

Not only does the company have strong financial metrics in the past, we expect company will continue to improve on these metrics. Better financial metrics will be driven by growing demand of the natural resources that Vedanta Limited produces. This is collaborated by Wood Mackenzie, one of the leading research houses.

Vedanta is also looking to get involved in Thermal coal by bidding for coal mines as India opens up the coal sector to private participation. Hence, Vedanta will continue to expand the natural resource segments in which it operates in India.

Vedanta is a compelling cash machine for its owners as can be seen from the strong EBIDTA number earlier in the article and FCF (Free Cash Flow) post Capex below. Beside strong market share and efficient operations, company also has high growth possibilities. Company continues to incur high Growth Capex to build on these opportunities. Despite the high capex, company continues to deliver very robust FCF (Free Cash Flow), dividend (earlier in the article) and a conservative Net Debt/EBIDTA.

How would one value such strong, growing and self-sustaining cash generating machine? Let us look at how its promoter, Anil Agarwal, valued the business.

Delisting offer 
On May 12, 2020 Vedanta Limited disclosed that its promoter entity, Vedanta Resources Limited (VRL), has expressed its intention to acquire all shares of the company and delist it from Indian bourses and subsequently from NYSE as well. VRL itself had been delisted in the 2019 from London bourses and it had become a private company of its promoter, Anil Agarwal. Thus began the heightened interest in the company and what its promoter will do.

Shareholder Vote
In a Special Resolution by postal ballot, 93.3% of all shareholders and 84.3% of public shareholders approved to delist the shares of Vedanta (VL).

With the approval by shareholders, delisting process kicked off in high gear. There are many steps to the delisting process but the key ones for this article include:

* Letter of Offer: A public announcement of delisting along with promoter’s initial offer.
* Delisting outcome: This is a combination of:
 - Bidding Period: Period during which shareholders will participate in Reverse Book Building process and specify the price at which they are willing to sell their shares to the promoters.
- Discovery of final price: The price at which eligible bids take promoter holdings to 90% of the total paid up equity capital.

Promoter’s initial offer
Promoter’s made their initial offer on 29th Sept, 2020 at 87.50/share. Floor price calculated by PWC as per the delisting regulations was 87.25/share. Market price on 29th Sept, 2020 was 140/sh.

Preparation for taking the company private began in Q4 FY 2020. Management took a significant onetime charge of 17,386 Crs in FY 2020. This made it difficult for a lay person to understand the true profitability of the company. Above charge brought down the profitability and book value of the company. The numbers shown below exclude the exceptional charge that was taken as they do not impact the underlying value of the company.

Vedanta is in natural resources industry with wide variation from year to year. Hence, we will look at the valuation by looking at the business results over multiple years:

We can confidently conclude that promoter initial offer significantly undervalued the company. Just the dividend over the last four years is more than 70% of the offer price that was offered to shareholders!

Delisting outcome 
The last day of the reverse book building process was as action packed as the penultimate scene of a good action movie. In the morning, LIC chairman gave an interview saying that company will not be tendering shares at less than 320/share which they thought was the fair price. Anil Agarwal, Chairman of Vedanta Resources, during the afternoon interview mentioned that delisting process is looking good and company is likely to get the 90% they want to complete the delisting.

However, when all was said and done, promoters found that they didn’t have the minimum number of shares to take the company private. Hence, the delisting failed.

Why Vedanta’s delisting failed?
In India delisting of a company fails for many reasons. Most of them are related to investors demanding a much higher valuation for letting the company go private.

Delisting of Vedanta, on the other hand, failed because promoter wanted to take the company private on the cheap. They were trying to take advantage of dislocation in the stock price, caused by Covid 19. Below chart shows how the stock price has moved over the last 3 years. Subsequent chart shows the price movement over more than a decade. It is quite obvious that promoter was trying to take the company private at decadal low.

Decadal low price of Vedanta Limited along with limited financial flexibility of Vedanta Resources (given that the company was taken private in 2019 and has very high debt) made delisting a high risk proposition from the beginning. However, it is interesting to note the role played by some of the leading financial institutions of the country as the delisting saga played out:

* LIC, being the largest shareholder after the promoter shareholder, played a pivotal role in demanding a higher valuation for taking the company private. LIC chairman mentioned that their fair value estimate is 320/share and is the price they will accept for delisting. 

* Many of the other prominent domestic institutions, on the other hand, were only too happy to let the company be taken private at a significant discount to LIC price. In our assessment, these institutions were too worried about the short-term pain (fall in the stock price if delisting fails) rather than the possibility of a higher long-term gain. 

* Some of the sell side research and their target price, around the delisting period, seem dubious at best. A prominent brokerage firm reduced the target price because the book value has come down (note book value came down because company decided to take a big charge in FY 20). To compare book value to target price is to correlate how much money a parent has invested in child’s education to the earning prospect of the child!

Another brokerage firm assigned negative value to all the businesses of Vedanta save one. Only zinc business in India (listed as Hindustan Zinc Ltd) was assigned a positive value. Rest of the businesses were deemed better dead than alive!

Beyond the behaviour of the financial institutions we also found the following noteworthy:

* SEBI delisting rules did help the retail investors as promoters were not able to get to 90% of the shares for delisting purposes.

* During the last day of reverse book building the total number of shares tendered did go above 90% and hence delisting could have gone through. However, a big portion of these shares were later found ineligible. It is not clear who tendered these shares and whether this would construe as manipulating the delisting process. 

* Vedanta Limited took a big charge in FY 2020. Many saw this as a blatant machination to make the financial statements murkier and thereby enable the promoters to take the company private on the cheap 

* The BOD of Vedanta Limited is made up of illustrious Independent Directors (ID). These Independent Directors didn’t cover themselves in glory by their actions (or inactions). These directors remind us of the famous proverb, “Whose bread I eat: his song I sing.”

What can we expect next? 
Vedanta Resources Ltd (VRL), promoter entity, has a very high standalone debt of US $6.7 billion. The main source of income for VRL is through Vedanta Limited (VL), as the chart at the beginning of the article demonstrates.

VRL had raised some of this debt recently to fund the delisting of VL. We expect that this debt will be paid immediately. In addition, VRL will be looking to VL to provide additional funds to service its debt.

We believe that dividend from VL is the most tax efficient way for VRL to fulfil its debt obligation. Hence, we expect significant amount of dividend from VL for FY 21. On 24th October, VL has declared first interim dividend of 9.5/sh. We expect VL will give additional dividend in FY21 to take care of its promoters needs. These dividends will come from VL’s cash flow from operations as well as from the dividends that one of the subsidiary of VL - Hindustan Zinc Ltd (HZL).

HZL on October 20th announced that it will issue dividend of 21.3/sh. This will translate into dividend income of 15.5 for every share of VL. As long as this dividend is passed through to its shareholders, VL won’t be incurring any taxes. Hence, we expect that VL will continue to issue additional dividends to its shareholders. 

Concluding thoughts 
Vedanta Limited delisting has been a closely followed event by investors. It has left many wondering whether the capital market participants follow the rules that they are supposed to. While some have enhanced their reputation through this saga, many others have diminished theirs.

Subsequent actions by Vedanta Limited will determine if their promoters burnish their much maligned reputation. As Warren Buffett has often said, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”

We hope that for their own reputation and the reputation of Indian capital markets, promoters of Vedanta Limited do the right thing.

Disclosure and disclaimer: Rajeev Agrawal is a SEBI Registered Investment Adviser and founder of DoorDarshi Advisors. The article is only for information purposes and shouldn’t be construed as investment advice. DoorDarshi’s founder and its clients may own position in the stocks discussed in this article. They may buy and sell additional stocks without any further disclosures. Please consult your own financial adviser before acting. 

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Rajeev Agrawal

Rajeev Agrawal is the founder of DoorDarshi Advisors, a boutique investment advisory firm working with select investors. DoorDarshi's goal is to identify mispriced opportunities that can deliver superior long-term capital appreciation.

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