Sesa Goa and Sterlite: A Starlight Marriage?
Moneylife Digital Team 27 February 2012

A mega merger between Sesa Goa and Sterlite is likely to negatively impact its shareholders

The mega merger plans announced by the Vedanta Group (Vedanta) of its two listed Indian entities—Sterlite and Sesa Goa—is bad news for domestic shareholders and the markets. The much awaited announcement stated that Vedanta is merging of its two entities—Sterlite and Sesa Goa—into one, now rechristened as Sesa Sterlite. The shareholders of the merged entity will foot the massive bill. We had given a brief of the merger over here: http://www.moneylife.in/article/vedanta-to-merge-sesa-goa-sterlite-to-create-20-billion-entity/23908.html

According to InGovern, an independent advisory firm, “The transfer of Cairn India’s stake to Sesa is taking place at cost with no profits to Vedanta. 38.5% of Cairn was acquired by Vedanta for $5.79 billion last year.” According to the company, Sesa Sterlite, the new entity would be acquiring its huge debt and will be servicing it. Effectively, Vedanta has dumped its massive debts on the two listed entities at the cost of its Indian shareholders. According to Dipen Shah of Kotak Securities, “Sesa Goa would be paying approximately 11% premium to acquire Cairn India from Vedanta Resources over its acquisition price for 20.1% stake in Cairn India which nullifies the earlier stated gain to large extent.”

Vedanta will transfer 70.5% shareholding in Vedanta Aluminium (VAL) to Sesa for new 72 million shares of Sesa. Sterlite owns the remaining 29.5% of Vedanta Aluminium and this would mean that Sesa Sterlite will now own the entire company. In the same report, InGovern states, “risks associated with VAL transferred from shareholders of Vedanta PLC to shareholders of Sterlite and Sesa Goa. This risk transfer may not be adequately compensated for shareholders of Sterlite and Sesa Goa.” It must be noted that VAL is a loss-making entity with zero operating earnings, wherein Vedanta had given a Rs2,300 crore loan to VAL at an interest rate of 10%. VAL posted Rs2,000 crore losses in the first nine months of 2012 due to non-availability of captive resources like bauxite and coal. In other words, Vedanta has essentially paired a loss-making entity (VAL), with a profit-making entity (Sesa Sterlite) in order to pare off the parent company’s (Vedanta) debt. The restructuring hasn’t accounted for this kind of risk.

InGovern further states, “Sesa will issue 72 million shares to the shareholders of VAL, the equity valuation of VAL is Rs2,332 crore. At this, VAL has an enterprise value of approximately $6 billion with zero EBITDA. The management commented that they have been conservative in valuing VAL as they have not considered operations of captive bauxite mines for the next three years. The management also commented that the replacement value of VAL assets is higher than $6 billion”. With no earnings in sight, VAL’s future, and by extension the future of the merged entity Sesa Sterlite, would have to depend on the having the Orissa bauxite mining ban revoked. VAL has aluminium smelting capacity up to 1.25 million tonnes. Last year, Orissa Mining Corporation, the Indian JV partner with Vedanta, had filed a petition against the Supreme Court order, to revoke the mining ban. The ban was imposed by the government on environmental concerns. If the ban is not revoked, there is a risk that shareholders of the merged entity would have grossly overpaid for VAL, which has virtually zero operating profits.

In additional to the Cairn India and VAL deals, Vedanta will transfer its 94.8% shareholding in Madras Aluminium Company (MALCO), whose principal assets are its 3.6% shareholding in Sterlite Industries, to Sesa for new shares of Sesa. According to InGovern, “This is at a 24% premium to the valuation of its principal assets—its 3.6% shareholding of Sterlite—the value of which comes to Rs1,435 crore.” Here too, shareholders of Sesa Goa and Sterlite are overpaying.

Following the restructuring, Sesa Sterlite will be in charge of the Indian operations and Vedanta will discontinue being part of the Indian operations. Vedanta, it must be noted, is listed on the London Stock Exchange and headquartered in London. All this responsibility will now fall under the new entity—Sesa Sterlite. It remains to be seen how the new entity deals with the restructured companies, let alone service its gargantuan debt. With the parent company taking a back-seat, it is left to these entities to figure out ways to create cash to not only pay off its newly-acquired debts but also continue the business.

Analysts in the financial circles have remarked that the deal favours Sterlite shareholders, as Sterlite will be obtaining shares of Sesa Goa, while the biggest beneficiary is, of course, Vedanta, whose debt obligations will fall by $6 billion, from $9 billion to $3 billion.

According to Vedanta, it stated, “The consolidation is expected to lead to significant synergies, including economies of scale, more efficient movement of group cash, improved allocation of capital and corporate cost savings including tax efficiencies”. However, Dipen Shah thinks otherwise. He chimes in, “no reasonable operational synergies are visible to us in the merger” and that there will be “limited financial and taxation synergies likely.”

Billionaire owner of Vedanta, Anil Agarwal, had told a TV channel, “If you look at the diversified company and the pure play, diversified has 30%-40% more value. So it was simplifying the process, creating more value for shareholders.” Sesa Goa’s stock tanked by around 10% while Sterlite has declined only by 2.5% on Monday (27th February).

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