Cairn-Vedanta deal boost for ONGC

The conditional approval will hit Cairn India’s asset valuations and undermine those of Sesa Goa.

The Cairn-Vedanta deal getting conditional approval from the Cabinet Committee of Economic Affairs (CCEA) should pave the way for its completion, though the conditions will impact Cairn India’s valuations.

While the clause on royalty payment being made cost-recoverable is likely to impact valuations by Rs 50-55 per share, the withdrawal of arbitration proceedings on cess payments will mean a hit to the tune Rs 15-20 per share, taking the total impact to Rs 65-75 per share. Analysts have revised their targets in the region of Rs 270-300 per share. Given the fall in asset values, Elara Securities’ analyst Alok Deshpande believes the stock will trend downwards in the medium term, with approval by the Cairn India board acting as a further dampener. The stock delivered just nine per cent over the past year, due to lack of clarity on the royalty issue and the government delay on the go-ahead.
 

ROYALTY HICCUP
	FY11	FY12E
Net Sales	10,278	15,011
% growth	533.3	46.0
Ebitda	8,523	12,486
Margin (%)	82.9	83.2
Net profit	6,334	10,623
% growth	502.7	67.7
P/E	9.8	5.8
In Rs crore unless otherwise indicated E: Estimates  Source: Capitaline, Edelweiss Securities

The government go-ahead, with conditions, will have a big impact not only on Cairn India, Cairn Energy Plc and Vedanta but also Sesa Goa, Sterlite and Oil and Natural Gas Corporation (ONGC). The key change for Cairn India is on the royalty payment and the cess issues. Analysts believe if royalties were made cost-recoverable and Cairn India were to foot the 70 per cent share of royalty payment, Cairn India’s net asset value would fall 14 per cent to Rs 337 per share, with crude oil prices at $100 per barrel. What’s more, Cairn will be reimbursing ONGC for past royalty payments made by the latter for Cairn’s share. On the cess issue, Cairn India is likely to continue to foot Rs 2,500 (plus surcharge) per tonne of crude oil.

The conditional approval is a positive for Vedanta, analysts say. To complete the acquisition, the revised agreement between Cairn and Vedanta had already led to removal of the non-compete fee. This meant the price offered by Vedanta came down to Rs 355 a share, equal to what was being offered to the minority shareholders of Cairn India. By a Nirmal Bang report, Cairn India is now being valued at $14.93 billion (Rs 67,000 crore), a reduction of 9.35 per cent over the previous value of $16.47 bn (Rs 74,000 crore).

“The deal offers a ray of hope for the Vedanta Group in India and its group company, Sterlite, an underperformer due to the legal/regulatory issues,” says Amit Agarwal, analyst, Religare Securities. Sterlite’s share may thus see some rally. Its other group company, Sesa Goa, that took a stake in Cairn, will be negatively impacted due to the downward revision in Cairn’s valuations. Analysts suggest Sesa Goa, down 15 per cent in the past six months on account of duty on iron ore exports and volume growth concerns, can correct four-five per cent from current levels.

The biggest beneficiary of the conditional approval to Cairn-Vedanta is ONGC. The company till now has been paying the entire royalty burden, with the 2010-11 share being Rs 1,300 crore on revenue of Rs 3,877 crore. The conditional approval and the revised agreement would see ONGC’s royalty burden being reduced by around $700 million, show Religare research estimates. It would add Rs 2.50 a share to ONGC’s 2011-12 earnings per share of Rs 30.5. Further, it will stand to gain from recovering the past royalty payments. This is a big boost for its coming follow-on public offer.

“The government’s oil subsidy sharing policy may determine the future course of ONGC performance,” states Jagannadham Thunuguntla, strategist and head of research, SMC Global Securities.