28 June 2011

Goldman Sachs:: Cairn-Vedanta deal re-negotiated; clarity on royalties issue is key

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Cairn-Vedanta deal re-negotiated; clarity on royalties issue is key
News
Cairn Energy Plc has restructured its proposed sale of 40% in Cairn India to
Vedanta Resources, in which it has agreed to remove the non-compete
provision of Rs50/share. Cairn Energy and Vedanta have now agreed to
complete the deal in two tranches — a first tranche of a 10% stake to be
sold to Vedanta by July 11, 2011; and a second tranche of 30% subject to
receipt of the necessary approvals from the Government of India, which
are required as it would make Vedanta a majority shareholder in Cairn
India. According to Cairn Energy Plc, the value of the 40% stake sale would
now be US$6.02bn, compared with US$6.65bn before. Completion of the
first tranche, combined with the 10.4% stake bought from Petronas, would
validate the already completed process of open offer for Cairn India shares.
Analysis
In our view, removal of the non-compete provision stems from a lack of
clarity over the issue of royalties payments for Rajasthan Block (developed
jointly with ONGC), which we believe could remain an overhang. Cairn
India stock has fallen 13% since announcement of the proposed original
deal in August 2010, while crude oil prices have risen 40% or so. It is also
not clear whether Cairn India would be required to pay royalties “under
protest” (like cess) during any arbitration process. We also believe clarity
on Cairn India’s long-term growth strategy under a new parent would be
important for investors — particularly in light of the substantial annual free
cash flow of US$2.5bn-US$3.0bn we estimate for the company from FY12E
and the absence of stated or clear investment opportunities.
Implications
We maintain our Neutral rating on Cairn India and our 12-month NAVbased Rs405 target price as we await clarity on the royalty issue. In the
worst case scenario in which Cairn must pay 20% royalties for its share of
production, we estimate NAV impact of Rs62/share. The stock currently
implies long-term Brent of US$66/bbl from FY13E onward. Key risks: 1)
delay in Rajasthan ramp-up; 2) any adverse regulatory developments.
INVESTMENT LIST MEMBERSHIP
Neutral
 
 
Coverage View:  Neutral

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