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Muscled out
As widely anticipated, the Cabinet Committee has set cost recoverability of royalty
and withdrawal of arbitration on cess as pre-requisites for government approval of
the Cairn-Vedanta deal. Should Cairn India agree, it will lower EPS by 10-20% and
fair value by 20% but should finally align itself with the government and ONGC in
exploiting the full potential of Rajasthan Basin. We will review our EPS and target
for consequent downgrades but note that even on the changed contract terms, the
stock is US$90/bbl long term Brent (spot at US$112/bbl) and trades at ~8x PE.
Conditional approval to Cairn Vedanta deal. The Cabinet Committee of Economic
Affairs (CCEA) has accorded a conditional approval to Cairn-Vedanta deal. The CCEA
has directed that the government would clear the deal only if Cairn agrees to make the
royalty payable by ONGC (20% of well head value on a cum-royalty basis) costrecoverable and also withdraw its arbitration case on cess. While this had been
recommended by an earlier Group of Ministers and an endorsement by the CCEA was
widely expected, this still confirms the near term worst case outcome for Cairn India.
Spot light on the 8-member Cairn India board. With the two Cairn Energy
directors and two independent directors that also serve on Vedanta’s board potentially
classified as interested parties, the decision may well come down to the two Cairn
India executive directors (Rahul Dhir, Indrajit Banerjee) and the two un-conflicted
independent directors. While Cairn India has highlighted before that they would not
accept conditions that were value detrimental, the hard stance of the government may
leave them with little choice; indeed a shareholders vote may be the easiest way out.
EPS, NAV impact. We currently assume no royalty payments by Cairn and assume
Rs2,500/tonne as cess inline with the payments made by Cairn under-protest. Should
royalty become cost recoverable, we estimate a ~20% cut to FY12-13 EPS but a lesser
7-10% reduction in FY14-16 as it cuts into the government’s profit sharing. We also
estimate a ~20% cut to our US$90/bbl based fair value to Rs315/sh as royalty
payments and a cess of Rs2,500/tonne is forced on Cairn. These terms will also cut
leverage of Cairn’s NAV to crude to Rs30-35/sh for every US$10/bbl cf. Rs40-50/sh.
An alignment of interests will be helpful longer term. The near term headwind
aside, this change in contract terms may finally align the government (which was
unhappy on cess) and ONGC (which was unhappy on royalty) with Cairn and help
exploit the full potential of the Rajasthan basin. For example, Mangala output could
ramp-up from 125kpd to 150kbpd soon if approvals come taking output beyond
175kbpd by end-2011. Cairn should be able to intensity its development at Bhagyam,
Aishwarya, Barmer, EOR and exploration (2.5bn boe in place) in Rajasthan. Indeed, our
conversations suggest that production here may well rise to ~300kbpd over time.
Greater clarity on Cairn India’s forward path. This should help Cairn plan its
strategic path with greater clarity; notably building growth options and deployment of
free cashflow. Even under these adverse terms, the stock is pricing in US$90/bbl as
long term Brent (cf. spot of US$112/bbl), which suggests that the stock may be
building in this worst case. We remain constructive on Cairn’s long term potential
(resource base, production growth, cashflow, leverage to oil price, valuations). Further,
at ~8x PE, earnings based valuations remain reasonable under the changed terms.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Muscled out
As widely anticipated, the Cabinet Committee has set cost recoverability of royalty
and withdrawal of arbitration on cess as pre-requisites for government approval of
the Cairn-Vedanta deal. Should Cairn India agree, it will lower EPS by 10-20% and
fair value by 20% but should finally align itself with the government and ONGC in
exploiting the full potential of Rajasthan Basin. We will review our EPS and target
for consequent downgrades but note that even on the changed contract terms, the
stock is US$90/bbl long term Brent (spot at US$112/bbl) and trades at ~8x PE.
Conditional approval to Cairn Vedanta deal. The Cabinet Committee of Economic
Affairs (CCEA) has accorded a conditional approval to Cairn-Vedanta deal. The CCEA
has directed that the government would clear the deal only if Cairn agrees to make the
royalty payable by ONGC (20% of well head value on a cum-royalty basis) costrecoverable and also withdraw its arbitration case on cess. While this had been
recommended by an earlier Group of Ministers and an endorsement by the CCEA was
widely expected, this still confirms the near term worst case outcome for Cairn India.
Spot light on the 8-member Cairn India board. With the two Cairn Energy
directors and two independent directors that also serve on Vedanta’s board potentially
classified as interested parties, the decision may well come down to the two Cairn
India executive directors (Rahul Dhir, Indrajit Banerjee) and the two un-conflicted
independent directors. While Cairn India has highlighted before that they would not
accept conditions that were value detrimental, the hard stance of the government may
leave them with little choice; indeed a shareholders vote may be the easiest way out.
EPS, NAV impact. We currently assume no royalty payments by Cairn and assume
Rs2,500/tonne as cess inline with the payments made by Cairn under-protest. Should
royalty become cost recoverable, we estimate a ~20% cut to FY12-13 EPS but a lesser
7-10% reduction in FY14-16 as it cuts into the government’s profit sharing. We also
estimate a ~20% cut to our US$90/bbl based fair value to Rs315/sh as royalty
payments and a cess of Rs2,500/tonne is forced on Cairn. These terms will also cut
leverage of Cairn’s NAV to crude to Rs30-35/sh for every US$10/bbl cf. Rs40-50/sh.
An alignment of interests will be helpful longer term. The near term headwind
aside, this change in contract terms may finally align the government (which was
unhappy on cess) and ONGC (which was unhappy on royalty) with Cairn and help
exploit the full potential of the Rajasthan basin. For example, Mangala output could
ramp-up from 125kpd to 150kbpd soon if approvals come taking output beyond
175kbpd by end-2011. Cairn should be able to intensity its development at Bhagyam,
Aishwarya, Barmer, EOR and exploration (2.5bn boe in place) in Rajasthan. Indeed, our
conversations suggest that production here may well rise to ~300kbpd over time.
Greater clarity on Cairn India’s forward path. This should help Cairn plan its
strategic path with greater clarity; notably building growth options and deployment of
free cashflow. Even under these adverse terms, the stock is pricing in US$90/bbl as
long term Brent (cf. spot of US$112/bbl), which suggests that the stock may be
building in this worst case. We remain constructive on Cairn’s long term potential
(resource base, production growth, cashflow, leverage to oil price, valuations). Further,
at ~8x PE, earnings based valuations remain reasonable under the changed terms.
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