Does Vedanta Show the Right Path?
Vedanta Ltd, a conglomerate in the metals and mining business, has announced the separation of its various business units into independent entities. Presently, the single legal entity is an agglomeration of many distinct businesses that are either directly carried on by it or by various subsidiaries.
Vedanta, before acquiring its present identity that sounds like a monastery or a religious outfit, was known as Sterlite Industries. Its origin was in telecom cables and fibre optics, which later enveloped copper and other minerals.
The entity currently has interests in aluminium, oil and gas, power, steel and ferrous material, base metals (copper) and zinc. The stated intention is to make each vertical a separate company and the present shareholders of Vedanta Ltd would hold shares directly in the five new entities in the same proportion in which it is currently held in Vedanta Ltd.
Vedanta Ltd is owned by the promoters (Anil and Navin Agarwal) to the extent of 68.72% and the rest is by the public. The promoters’ holding is held outside the country and the group has some international business as well, though the Indian component dominates in the overall size.
Sterlite struck gold when it bought Hindustan Zinc Ltd (HZL) in 2002 when the government disinvested a portion of its stake. The 64.92% stake cost Rs1,101.5 crore. This is, by far, the most prized asset in the basket and more details would be unpacked later in this article.
Sterlite also acquired Bharat Aluminium Company Ltd (Balco), another public sector unit (PSU) disinvested around the same time.
In 2014, Sterlite merged into Vedanta Ltd, which had other businesses, and formed the monolith that currently is envisaging the split as mentioned above.
Vedanta has been in the news for the overhang of debt. It has been spotlighted for funnelling out money as dividends of an inordinate proportion unseen in corporate annals, and for the attempt to carry out a contentious transaction that would load debt into an operating entity like HZL and enrich the promoter entity where the debt is piled up.
As mentioned earlier, HZL is verily the crown jewel. Its profit before interest and taxes (PBIT) of Rs13,917 crore in FY22-23 is more than the combined PBIT of the rest of the five businesses, of aluminium (Rs3,257 crore), oil and gas (Rs5,203 crore), power (Rs294 crore), base metals (Rs1,243 crore) and steel and ferrous products (Rs770 crore).
HZL is also independently listed though it has little floating stock, as between Vedanta Ltd and the government of India, the combined holding is 94.56%. The government stake is treated as a public holding to ensure the continued listing of the shares, though it is never traded.
The importance of HZL is also to be appreciated from the angle of the market-cap. HZL, despite its floating stock of only 5.44%, is valued at Rs1,30,000 crore. The 64.92% held by Vedanta Ltd is worth Rs84,500 crore. The market-cap of Vedanta Ltd itself is Rs82,000 crore! (Market-cap figures are as of 29 September 2023)
The above phenomenon may be quite inexplicable, but drives home the point that a conglomerate that encompasses diverse businesses usually suffers a big discount in valuation.
In Vedanta’s case, the difference is quite egregious and perhaps a reflection of its governance practices as well, where the promoter has been raiding the company’s coffers to fund the repayment of loans at the holding company overseas.
In the six years from FY17-18 to FY22-23, cumulatively, Vedanta Ltd paid a dividend of Rs98,168 crore when its cumulative consolidated profits from all its business was only Rs81,377 crore! An incredible feat for any corporate.
In FY22-23 alone, Vedanta paid Rs41,149 as dividend when its consolidated profit was Rs14,503 crore! An equation that will stump any chartered accountant (CA)! As the promoters hold 68.11% in the company, they lined their pockets considerably by virtually pillaging the company.
In the five-year period between FY17-18 and FY22-23, the fixed assets of the consolidated entity virtually stagnated and the increase was only equal to replenishing the annual depletion through depreciation. Rs95,470 crore moved to Rs1,11,041 crore in the five-year period.
The proposed restructuring is expected to create individual listed entities for the five verticals being, aluminium, oil and gas, power, steel and ferrous materials and base metals (copper).
Vedanta Ltd will remain listed as the sixth entity and would continue to hold the cash cow, HZL. It is also likely to be the vehicle for the new ventures of the group like silicon wafers.
It is reasonable to surmise that the promoters of Vedanta have little time to defuse the ticking debt bomb. Even if they choose to dilute at the level of Vedanta Ltd, where they hold a sizeable stake of 68.11%, the valuation will be a challenge.
By separating the diverse businesses, there is greater ease of disposing or diluting the stake in one or more of the businesses. There is also the complexity of taxation in conglomerate structures where the cash on divestment of any of the business would be trapped in the company, raising the challenge of piping it upwards to the shareholders.
The case for splitting is obvious. The indications, as per the documents shared with the stock exchanges, is that the split will be a vertical one that would result in the shareholding in each of the companies to be a mirror image of the current shareholding in Vedanta Ltd.
This method is more minority investor-friendly compared to the structured split done in the past by L&T, and the Bajaj group which was aped by a few others like the Rane group and Sundaram Finance. Recently, ITC controversially came up with a split structure for the hive off of its hotel venture.
A structured demerger leads to increasing the promoter holding at the operating entity level, while maintaining the overall economic stake of the minority investors. Clearly, the minority is short-changed in such structures and the cases were discussed with data in a previous article.
In the instant case, as the promoters hold 68.11% in Vedanta Ltd, the need for such a contrived structure is obviated.
Yet, there is a catch. The prized possession in the portfolio is HZL. The 64.92% in HZL was acquired at a cost of Rs1,101.50 crore in 2002 when the government disinvested.
In the 10-year period from 2014 till the latest FY2023, HZL has cumulatively earned a profit after tax of Rs83,721 crore. And, hold your breath, the dividends taken out of it in the same period is Rs1,03,492 crore!
The 64.92% held by Vedanta Ltd netted it a dividend over the same period of Rs67,187 crore.
And the government of India received, for its 29.54% holding, Rs30,571 crore. Just remember that the disinvestment of 64.92% in 2002 netted them Rs1,101.50 crore!
HZL will continue in the fold of Vedanta Ltd as a subsidiary, the same status as of date. The minority investors would get no direct access to the value of HZL, except through their holding in Vedanta Ltd.
Vedanta Ltd has signalled its intentions to set up a foundry for making semi-conductors at a possible cost of US$20bn (billion) in Dholera (Gujarat). Even if the operations are set up as a subsidiary, the profits of HZL would be diverted to fund the foundry and not expand the operations of HZL.
In the 10-year period since 2014, HZL’s fixed assets have grown by a measly Rs9,000 crore, at the net block level. It is a milch cow to further the group’s aggressive investment plans in other areas.
Many minority investors in Vedanta Ltd would be unwilling to test their fortunes in unknown ventures like fab making. They would be happier to get their pro rata interest in HZL in exchange for their holding in the parent.
Vedanta has chosen a path professedly to improve the valuation discount currently suffered by the conglomerate. While the chosen path may help some part of the gulf to be bridged, the key is letting the value of HZL flow to the public investors.
Even among other conglomerates like Reliance Industries, M&M or L&T, Vedanta has the lowest PE ratio of 9.46. While M&M is a low 14.97, RIL is higher at 24.47 and L&T much better at 32.78. Adani Enterprises is an outlier at an astronomical 102.79!
Given the standoff between Vedanta Ltd and the government on acquiring the residual holdings of the latter, the only way to improve the market float in HZL is to give away the pro rata number of the holdings in HZL to the public shareholders of Vedanta Ltd.
This, of course, is a pipe dream as Vedanta will lose its control over HZL as its holdings will fall by almost 21% bringing it below the magical 51% that every promoter seeks.
The impact of the restructuring will unfold only over a period of time when the new entities are formed and the process of transferring the business is completed.
Reliance Industries may be the next one to look at a structure that helps to list its two key ventures, telecom and retail, which are currently under the parent as subsidiaries.
Will they follow the path shown by Vedanta Ltd or do a structured split, or find a completely new way to do it?
Perhaps the answer may be found in Vedanta only!
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies)
5 months ago
To push through mergers, promoter says 1 + 1 = 3 and minority shareholders have to unwillingly accept the maths as regulator seems not to be doing what they ought to do. Sometime later, the same promoter says 2 - 1 - 1 = 1. Synergies and value unlocking are fancy words that are used to fool the minority shareholder. I am surprised, whether the government was not aware of the ways to withdraw the same amount of dividends from HZL. Was the cash reserve served on plate in the name of disinvestment?
5 months ago
5 months ago
The "Independent Directors" of the Vedanta companies have much to answer for.
5 months ago
The core issue is that Agarwal and Vedanta plc are buried under a mountain of debt; not just debt but very high cost debt (e.g. 12.75% on a USD bond!!) reflecting their junk grade credit rating. All these gymnastics are aimed at enabling Agarwal to siphon out funds from the operating companies in India to pay off his overseas debt. Witness the ridiculous "brand fee" paid by Vedanta companies for the Vedanta brand name!! In reality, the operative companies should receive money for the damage done to them by association. Asset stripping and income stripping at its most egregious.
Kamal Garg
Replied to david.rasquinha comment 5 months ago
Agree with the observation. Let's see how this entire saga unfolds.
5 months ago
When is this going to happen after this the original company shares will decrease in value but by how much one does not know
5 months ago
DOES IT make sense to acquire HZL shares & divest one holdings in VEDL
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