How should one now view and play Sesa Goa and Cairns India ?
Markets have been excited for a few days by the Vedanta Group buying out the controlling stake in Cairns India from a subsidiary of Cairns Energy….. Cairns India had raced away to a new High of Rs 368 yesterday morning….. then came the press release by the Vedanta Group announcing this takeover in detail
My initial reaction was one of anger and worry that, as feared, Anil Agarwal of Vedanta was using Sesa Goa Cash for the Group
The Markets reacted sharply and Sesa Goa dropped over 8% to Rs 321 while Cairns India dropped over 6% to Rs 333
The takeover is by the Vedanta Group in this manner
Vedanta Resources plc will acquire 51% Equity Stake in Cairns India from a subsidiary of Cairns Energy at Rs 355/share + Rs 50/share as Non Compete Fee for Three Years
Sesa Goa, a Vedanta Group Company will tender for 20 % Equity Stake from the remaining Cairns India Shareholders at Rs 355/share… this is the mandatory Open Offer
In case Sesa Goa receives less than 20% then Vedanta will make up the difference at cost… that’s Rs 405/share
My immediate concern is what will be the Impact on Sesa Goa as it has been my pet recommendation for several years now and recently very strongly from July 2008 cum bonus and cum split at Rs 3200 (that’s Rs 160 ex)…. On April 8, 2010, Sesa Goa zoomed to an all time high of Rs 494 for a FV Rs 1 Share as Iron Ore Prices crossed US $ 140/t
This acqusition will cost over US $ 9 Billion of which Sesa Goa will be investing from it’s cash resources US $ 3 Billion for a 20% stake…. it does not even have this on it’s Balance Sheet currently !….. The Drop in Share Prices of both Sesa Goa and Cairn India reflect the concerns that Investors have on Vedanta’s Corporate Governance and Credibility
Let’s have a quick look at whether such a reaction is a precursor to a further drop in the share prices of both
This is not an overnight acqusition….. negotiations must have commenced months ago with Cairns Group…. connect this with the uptick in Cairns India’s Share Price…. it moved from a range of Rs 150-Rs 200 a year ago, to Rs 200-250 and then from Rs 250-Rs 300 and yesterday zoomed to a High of Rs 368 before reacting to close at Rs 333
So what is Sesa Goa’s role in this Acquisition
Vedanta simply wants US $ 3 Billion from Sesa Goa….it would have created a ruckus to simply borrow all of this inter group…so part of the acquisition of Cairns India to the extent of 20% of the Equity Capital of Cairns India that,’coincidentally’ amounts to US $ 3 billion is to be shown as an Investment in the Books of Sesa Goa
Cairns India has a Share Capital (FV Rs 10)of Rs 1897.34 crs…. 20% of this is Rs 379.5 crs thats 37.95 crs number of Shares… to be exact 379496447 shares…. at Rs 355 that’s Rs 13471 crs…. at the agreed Exchange rate of US $ 1=Rs 46.765 that’s US $ 2.88 Billion…. This is expected to come in from the mandatory open offer of 20% that needs to be made to remaining shareholders….. any shortfall will be purchased from Vedanta’s 51% acquisition… but at a higher price of Rs 405, that’s Vedanta’s cost
So Sesa Goa’s Balance Sheet will merely reflect a movement on the Assets side from Cash to Investments after cashing out on existing Investments to fund this Stake
But the standalone Balance Sheet of Sesa Goa at March 31, 2010 does not support US $ 3 Billion!
Here’s how Sesa Goa looks at March 31,2010
Networth : Rs 7209 crs = Equity Rs 83 crs + Reserves Rs 7126 crs
Represented by : Rs 580 crs Fixed Assets + Rs 5479 crs Investments + Rs 3076 crs Net Current Assets – Rs 1926 crs Loans = Rs 7209 crs
Where is the US $ 3 Billion Cash or @ Rs 13500 crs on the Books of Sesa Goa ! ?….. It’s Balance Sheet Size for total Capital employed is Rs 9135 crs ! (Networth + Loans) !
The Deal is expected to be done by early Fy 2011
So it’s clear that even FY 11 Cash accruals will be used for the Investment and maybe Sesa Goa may raise fresh debt… in 2009/10 it already has issued 5000 5% Coupon Rate FCCBs and raised US $ 500 M… at March 31, 2010, 755 FCCBs had been converted at the prescribed Rs 346.88 per share at a fixed rate of Rs 48 to One US Dollar…. Funds received from the FCCBs are reflected in Fixed Deposits of Rs 2350 crs reflected in Current Assets
So I extrapolated Sesa Goa Balance Sheet at March 31, 2011… To fund the Investment of Rs 13500 crs in Cairns from Cash Reserves, Sesa Goa’s Networth has to climb from Rs 7209 crs to atleast Rs 15000 crs…. This would be through a combination of FCCB Conversion of @ Rs 1900 crs (Unsecured Loans) and Profits near Rs 6000 crs in the year…. The Assets Side would reflect Fixed Assets of Rs 600 crs + Investments of Rs 13500 crs atleast + Net Current Assets of Rs 1000 crs
And the MD of Sesa Goa, P K Muherjee claims that Sesa Goa Capex will not be affected ! and that the Board of Sesa Goa feels this Investment in Cairns India will be beneficial to Sesa Goa Shareholders and will be immediately EPS accretive !
One Interesting way of Looking at this is that if we assume that Sesa Goa will continue to generate atleast US $ 1 Billion ever year in Cash Profits, this Investment in Cairns India is Three Years of Cash Profits.
The Moot evaluation here is to see how this Investment of US $ 3 Billion will bear fruit for Sesa Goa….. This Evaluation is Interesting as I studied the Potential Earnings Capabilities of Cairns India and it’s Dividend Policy and Potential in the future….. The actual cash inflow as returns to Sesa Goa will be through Dividends from Cairns India… as this being a strategic long term Investment it is unlikely to be sold for Gains in the near future
Cairns India has a current production of @ 45000 barrels of Oil per day (boepd)… it plans to raise this to 125000 boepd and then to 240000 boepd…. at this level of 240000 it will be 25% of India’s Oil Production…. Now One barrel is @ 42 gallons or 159 litres…. thus this would mean 72 Million barrels a year, assuming 300 days of Production… In Q 1 FY 11,the realisation by Cairns was US $ 67/barrel…. taking this realistion, the Annual Revenues for 72 Million Barrels would be US $ 4.8 billion or Rs 23000 crs…. with low production and operating costs Cairns India can be expected to show a Bottomline exceeding US $ One Billion, or near Rs 5000 crs in a few years time…. That’s an EPS Level of over Rs 25…. Dividend Payout should be atleast 20% of this if not more… that’s Rs 5 /share atleast in a few years time
Sesa Goa will hold 37.95 crs shares being 20% of Cairns India’s Equity…. thus it will receive Rs 190 crs as Dividend assuming Rs 5/share Dividend by Cairns…. It has Invested atleast @ Rs 13500 crs ( more if it buys Cairns India shares at Rs 405 from Vedanta)… so the return on Investment is a paltry 1.40% being the Dividend Yeild!…. Of course it will benefit if Cairns India Share Price moves up strongly from the Rs 355 Cost to Sesa Goa…. but this would merely remain a notional gain and cannot reflect in the books….. But will Cairns India move up strongly ?….. If EPS is Rs 25 a few years down the line then on a 15 multiple the Share Price would be Rs 375… and Rs 500 on a 20 multiple
Alternatively Sesa Goa could have used it’s Cash Reserves to generate higher ROI to benefit Shareholders and reward it’s Shareholders with a High Dividend and a higher Valuation for the Company and therefore a Higher Share Price
These Options are now no longer open in the short to medium term as all Monies are to be used for Investment in Cairns India
So how will this affect the Share Price of Sesa Goa !…. I would think in the short term there would be an adverse impact and the share Price could drop below Rs 300
But just hold this thought… even if Other Income figures would not be significant,the PAT from Operations itself could cross Rs 4000 crs atleast…. that’s an EPS of near Rs 45 on Equity of Rs 90 crs (once FCCB’s convert)… Sesa Goa has reacted to Rs 320…. this is just Seven times FY 11 Projected EPS of Rs 45…. and even a lower multiple if the PAT crosses Rs 6000 crs !….. so the downside in Sesa Goa may be limited as long as the profitability levels from Iron Ore Mining and Exports is sustained… albeit on higher volumes and lower margins
So one can hold on to Sesa Goa at current levels of Rs 320 and Cairns India at Rs 333, but keep monitoring developments and Company Performance