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Cairn India (CAIR)
Energy
Wheels of the deal could soon begin to roll. The finance ministry’s stated view on
the separation of pending legal issues from the proposed transfer of ownership of Cairn
increases the likelihood of the proposed Cairn-Vedanta deal, in our view. A
postponement of the royalty issue (to be decided later through arbitration, for example)
may be a short-term positive. The stock may trade up on high crude prices on
completion of the deal. We would look at selling into strength as Cairn’s normalized
fair valuation is far lower.
Finance ministry’s view—separation of legal issues from the proposed transfer of ownership
As per media reports, the ministry of finance has stated that the proposed transfer of ownership in
Cairn India should be viewed independent of pending legal issues. It has also stated, “Since there
is a dispute between the parties regarding the interpretation of the provisions of the contract, the
government of India cannot be seen using this opportunity to settle pending disputes in its own
favour.” We note that the ministry of oil and natural gas (MoPNG) had circulated a draft note to
other ministries to seek their views on the deal. The MoPNG will send the final note to the Cabinet
Committee on Economic Affairs (CCEA) once the views of all the ministries have been received.
We see the finance ministry’s views as increasing the likelihood of completion of the deal, which
has been delayed pending government approval.
Not much to gain for minority shareholders from the proposed deal
We do not see any meaningful upside for minority shareholders irrespective of the outcome of the
proposed deal. Exhibit 1 gives the potential upside/downside for the minority shareholders under
various scenarios. We compute the maximum value for a minority shareholder at (1) `355/share if
all her shares get accepted in the open-offer or (2) `350/share assuming (1) the deal takes place as
per the original agreement, (2) Petronas does not participate in the open offer and (3) 12-month
DCF-based fair valuation of Cairn at `317. We highlight that the fair value of Cairn India would
reduce by `66/share in case royalty is treated as a cost-recoverable item (deducted from revenues
computation of profit petroleum) as opposed to ONGC paying 100% of the royalty currently and
as per the contention of CNE and VED.
Higher crude prices could lead to upside to near-term earnings but not to valuations
We do not rule out upside to earnings of Cairn India from higher crude oil prices in the near term.
However, we would highlight that near-term crude prices are not material for valuations of Cairn.
We note that our fair value of Cairn India increases by a modest `10/share even if we assume
US$10/bbl higher crude oil price assumption for FY2012-13E. The Cairn stock is currently
discounting US$94/bbl crude oil price in perpetuity
We explain the impact on minority shareholders under various possible outcomes below:
` The deal happens as per the original agreement. We compute the likely fair value for
CAIR stock for a minority shareholder at `337 in our base-case scenario assuming (1)
successful completion of Cairn-Vedanta deal and (2) participation of Petronas in the open
offer. However, the weighted average price for a minority shareholder would increase to
`350 if Petronas was not to participate in the open offer. We do not see meaningful
upside for minority shareholders in this scenario given that the stock is trading at `349.
` The deal happens upon acceptance of conditions imposed by the oil ministry. We
highlight that our fair valuation of Cairn would decline by `66 if it were to include royalty
for cost recovery. Under this scenario, the likely fair value for Cairn’s minority shareholder
would be at `306 in case of participation of Petronas in the open offer and it would
increase to `343 if Petronas was not to participate in the open offer.
` The deal falls through due to the royalty issue. We expect Cairn stock to trade up for
some time given high crude oil prices currently. However, we would use any spurt in the
stock price to sell the stock. Our 12-month DCF-based fair valuation of `317 is based on
crude oil price assumption of US$95/bbl, US$90/bbl and US$/85/bbl in FY2012E,
FY2013E and FY2014E. We assume a 2% increase in crude oil prices in perpetuity beyond
FY2014E. A section of the street may find the stock inexpensive on FY2012E earnings
based on current high crude oil prices. We estimate FY2012E EPS at `57 based on crude
oil (Dated Brent) price of US$95/bbl. Our FY2012E EPS would increase to `69 on
US$110/bbl crude oil price.
We highlight that the fair value of Cairn India would reduce by `66/share in case royalty is
treated as a cost-recoverable item (deducted from revenues computation of profit
petroleum) as opposed to ONGC paying 100% of the royalty currently and as per the
contention of CNE and VED. VED is unlikely to proceed with the deal in this case since it
has bid a certain price (`405) for CNE’s stake on the premise that Cairn India will not bear
royalty on its share of oil production from the Rajasthan block.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cairn India (CAIR)
Energy
Wheels of the deal could soon begin to roll. The finance ministry’s stated view on
the separation of pending legal issues from the proposed transfer of ownership of Cairn
increases the likelihood of the proposed Cairn-Vedanta deal, in our view. A
postponement of the royalty issue (to be decided later through arbitration, for example)
may be a short-term positive. The stock may trade up on high crude prices on
completion of the deal. We would look at selling into strength as Cairn’s normalized
fair valuation is far lower.
Finance ministry’s view—separation of legal issues from the proposed transfer of ownership
As per media reports, the ministry of finance has stated that the proposed transfer of ownership in
Cairn India should be viewed independent of pending legal issues. It has also stated, “Since there
is a dispute between the parties regarding the interpretation of the provisions of the contract, the
government of India cannot be seen using this opportunity to settle pending disputes in its own
favour.” We note that the ministry of oil and natural gas (MoPNG) had circulated a draft note to
other ministries to seek their views on the deal. The MoPNG will send the final note to the Cabinet
Committee on Economic Affairs (CCEA) once the views of all the ministries have been received.
We see the finance ministry’s views as increasing the likelihood of completion of the deal, which
has been delayed pending government approval.
Not much to gain for minority shareholders from the proposed deal
We do not see any meaningful upside for minority shareholders irrespective of the outcome of the
proposed deal. Exhibit 1 gives the potential upside/downside for the minority shareholders under
various scenarios. We compute the maximum value for a minority shareholder at (1) `355/share if
all her shares get accepted in the open-offer or (2) `350/share assuming (1) the deal takes place as
per the original agreement, (2) Petronas does not participate in the open offer and (3) 12-month
DCF-based fair valuation of Cairn at `317. We highlight that the fair value of Cairn India would
reduce by `66/share in case royalty is treated as a cost-recoverable item (deducted from revenues
computation of profit petroleum) as opposed to ONGC paying 100% of the royalty currently and
as per the contention of CNE and VED.
Higher crude prices could lead to upside to near-term earnings but not to valuations
We do not rule out upside to earnings of Cairn India from higher crude oil prices in the near term.
However, we would highlight that near-term crude prices are not material for valuations of Cairn.
We note that our fair value of Cairn India increases by a modest `10/share even if we assume
US$10/bbl higher crude oil price assumption for FY2012-13E. The Cairn stock is currently
discounting US$94/bbl crude oil price in perpetuity
We explain the impact on minority shareholders under various possible outcomes below:
` The deal happens as per the original agreement. We compute the likely fair value for
CAIR stock for a minority shareholder at `337 in our base-case scenario assuming (1)
successful completion of Cairn-Vedanta deal and (2) participation of Petronas in the open
offer. However, the weighted average price for a minority shareholder would increase to
`350 if Petronas was not to participate in the open offer. We do not see meaningful
upside for minority shareholders in this scenario given that the stock is trading at `349.
` The deal happens upon acceptance of conditions imposed by the oil ministry. We
highlight that our fair valuation of Cairn would decline by `66 if it were to include royalty
for cost recovery. Under this scenario, the likely fair value for Cairn’s minority shareholder
would be at `306 in case of participation of Petronas in the open offer and it would
increase to `343 if Petronas was not to participate in the open offer.
` The deal falls through due to the royalty issue. We expect Cairn stock to trade up for
some time given high crude oil prices currently. However, we would use any spurt in the
stock price to sell the stock. Our 12-month DCF-based fair valuation of `317 is based on
crude oil price assumption of US$95/bbl, US$90/bbl and US$/85/bbl in FY2012E,
FY2013E and FY2014E. We assume a 2% increase in crude oil prices in perpetuity beyond
FY2014E. A section of the street may find the stock inexpensive on FY2012E earnings
based on current high crude oil prices. We estimate FY2012E EPS at `57 based on crude
oil (Dated Brent) price of US$95/bbl. Our FY2012E EPS would increase to `69 on
US$110/bbl crude oil price.
We highlight that the fair value of Cairn India would reduce by `66/share in case royalty is
treated as a cost-recoverable item (deducted from revenues computation of profit
petroleum) as opposed to ONGC paying 100% of the royalty currently and as per the
contention of CNE and VED. VED is unlikely to proceed with the deal in this case since it
has bid a certain price (`405) for CNE’s stake on the premise that Cairn India will not bear
royalty on its share of oil production from the Rajasthan block.
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