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The restructuring at London-based Vedanta Resources, which had been promised for some time now, finally came into effect last month. Vedanta Resources merged its bigger group company, Sterlite Industries, with the smaller iron ore miner, Sesa Goa, to create a new entity called Sesa Sterlite. It also demerged its oil and gas and aluminium businesses and incorporated them in the new entity.
These changes have created the world's seventh largest global diversified natural resources company by earnings before interest, tax, depreciation and amortisation (Ebitda). What's more, the overhaul has made the diversified conglomerate with its varied interest more immune to fluctuations due to commodity price variations. Metal prices have been languishing for some time now due to the slump in demand from China and the prolonged economic slowdown in Europe. In the quarter ended March, the contribution of the traditional mining division to Vedanta Resources steeply declined, leaving the company to depend on its oil and gas business, where earnings increased to $2.4 billion in oil and gas from $713 million in the same quarter in the previous year to buoy profits.
In that sense, the new structure is designed to help Sesa Sterlite decrease the impact of metal price fluctuations on earnings and create a steady source of income. After the merger, the company in a statement said Sesa Sterlite would be a low-cost metal producer and miner with close proximity to high-growth markets. The statement added the new entity would be a cash-generative business supported by a strong balance sheet.
However, the good news for Sesa Sterlite ends there. With the oil and gas business it has now got, the new entity would also inherit almost 87 per cent of Vedanta Resources debt of $16.59 billion, which the company had accumulated in order to fund its purchase of Cairn India in 2011. In other words, a debt of Rs 102,675.51 crore ( at current valuations) would get transferred to Sesa Sterlite once it is listed. With most of the companies under its ambit not doing too well, analysts say repayment of this debt won't be easy.
In addition, Sesa Sterlite will be the holding company for all Vedanta Resources companies except Kankola Copper Mines in Zambia. The new entity will include Zinc International, Talwandi Sabo Power, Australian Copper mines, and power divisions of Vedanta Aluminium and MALCO, besides Cairn India and Hindustan Zinc where it will hold 58.9 per cent and 64.9 per cent, respectively. Sesa Sterlite will also hold 51 per cent in Balco and Western Cluster in Liberia, which can be raised to 100 per cent.
In the earlier structure, Sterlite Industries operated the aluminium business (Balco), zinc business (Hindustan Zinc and Zinc International), copper business (its smelter in Tuticorin) and commercial energy projects in Odisha (Sterlite Energy). Sesa Goa, on the other hand, was only into iron ore mining and exporting with operations in Goa and Karnataka in India and in Liberia in West Africa. Recently, the company had also diversified into producing pig iron and metallurgical coke.
At the time of the overhaul proposal in February last year, Vedanta Resources had stated that the bulk of the Ebitda contribution for the new entity, nearly 40 per cent, would come from its oil and gas business, 29 per cent from Hindustan Zinc and the rest from from copper, silver, aluminium and energy businesses.
However, lower commodity prices have altered that equation. The weak market pushed down Vedanta's Ebitda from its mining divisions in every category bar aluminium in the first quarter of the year. The diversified miner reported a slight dip in pre-tax profit for the year to March from $ 1.74 billion to $ 1.7 billion on revenues that rose from $14 billion to $ 14.9 billion.
At present cash-rich Cairn India and Hindustan Zinc are the only two subsidiaries that can help lower the Sesa Sterlite debt. As of June 30, Hindustan Zinc had cash reserves worth Rs 22,000 crore, while Cairn India had cash reserves close to Rs 15,000 crore. Hindustan Zinc could help the new entity generate another Rs 4,000-5,000 crore per annum if the government, which holds 29.5 per cent in the company, decides to sell its stake. A proposal in this regard is pending before the Cabinet Committee on Economic Affairs and it is expected to be taken up soon.
"The company (Sesa Sterlite) needs sole ownership and the government needs the money. So, this looks like the right time for the stake sale to happen," says Giriraj Daga, senior analyst with Nirmal Bang Institutional Equities. "It (the government) can also negotiate for higher price," he adds.
Analysts have their hopes pinned on the stake sale as apart from Hindustan Zinc and Cairn India, none of the other assets with Sesa Sterlite is seen as significant contributors to the Ebitda in the near-term. The iron ore assets of Sesa Sterlite have been hit by the ban on mining in Goa while the loss-making Vedanta Aluminium has been further crippled by unavailability of captive coal and bauxite mines. Other companies are also unlikely to help shore up earnings in the face of slowing demand for metals.
The new entity may face another challenge from the depreciating rupee which is set to increase the company's debt burden. In this scenario, the future for the new entity certainly looks far less brighter than what was proposed during the restructuring deal. Analysts say even if the company succeeds in generating cash flow to lower its debt, there will be challenges aplenty on the operational front.
