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Cairn-Vedanta Deal Gets
Conditional Approval
Quick Comment: Cabinet Committee of Economic
Affairs (CCEA) today gave conditional approval for the
Cairn-Vedanta deal, which was announced in August
2010. The two most important conditions are: 1) Royalty
to be made cost recoverable on its Rajasthan fields; and
2) The ongoing arbitration case related to cess must be
withdrawn. Additionally, the Oil Minister commented that
it has to be accepted that there will be no litigation
related to the above conditions.
Our view: Although the deal is approved conditionally,
Cairn India’s board is yet to decide on whether to accept
these conditions. While Cairn Energy and Vedanta
control ~80% of voting rights, we believe that Board of
directors and minority shareholders may not accept
these conditions. In its recent earning releases, the
company has explicitly communicated that its board
would not accept any pre-conditions related that would
affect the value of the business negatively.
Potential impact on Cairn India: Assuming royalty to
be cost recoverable, our price target would be lower by
13% or Rs58 to Rs371 still implying upside of 20%. We
see earnings downside of ~18% for F2012 and ~19% for
F2013. Withdrawal of cess arbitration will not have any
impact as we already assume Cairn to pay cess
Stock already discounting the outcome; we remain
positive: At current levels, the stock is discounting oil
price of US$80/bbl (with royalty). Even assuming royalty,
valuations for F2012e would still be attractive at a P/E of
7x, EV/EBITDA of 4.1, and FCF yield of 13.9%, still
among the cheapest globally.
Impact on Sesa Goa: Assuming the deal goes through,
we would view this overall as negative for the stock. Our
price target would be lowered by ~7% and earnings
could go down by ~4.5% for F2012 and 5% for F2013.
However, the sentimental relief is that its investment of
18.5% in Cairn India would not end up being just a
strategic one and instead the Vedanta Group would take
control of Cairn once its stake is increased to 58% post
the deal completion
Arbitration Cess related to production in from
Rajasthan fields
Cairn has stated that the Rajasthan Production Sharing
Contract (PSC) does not specifically mention that it will be
liable to pay any cess on its crude oil. However, the Ministry of
Petroleum has notified Cairn that the Rajasthan block will be
liable to pay cess, which is currently Rs2,500/ton. Cairn has
been paying the cess under protest, but the issue is currently
under arbitration. We already we assume Cairn pays a cess of
Rs2,500/ton so even if the arbitration is withdrawn this will not
have any impact on our estimates.
Cairn India: Valuation Based on Net Asset Value
To derive our base, bear and bull cases for Cairn India, we use
an NAV valuation based on sum-of-parts and DCF for
individual fields. We then add the NAV of the total resources to
NAV of reserves to arrive at the base case valuation.
Reserves: We use a DCF methodology to assess the cash
flow of individual fields owned by Cairn India based on its 2P
reserves. For our base case, we use an 11% cost of capital for
the life of the fields and a beta of 0.82x (Exhibit 11). We
calculate EV-based NAV at ~US$15.7bn. We use long-term oil
price assumption of US$90/bbl.
We estimate Rajasthan Core NAV to be at US$10.3bn
(Rs240/share) excluding EOR potential, which we estimate is
another US$2.3bn (Rs53/share) assuming it adds 30kb/d to
overall production taking plateau to 240kb/d and increasing
reserve life to ~12years. Overall, we estimate Rajasthan NAV
to be at Rs293/share including the EOR production. We value
NAV for Ravva and Gauri at US$115mn, or Rs7.1/share.
Resources: We value the company’s contingent resources on
the basis of the imputed NAV/boe (US$/boe) based on our
level of conviction. For the Rajasthan other fields and
Rajasthan Exploration upside and KG Basin resources, we
have used EV/BOE of US$9.7/bbl as we await more clarity
from the company on the field exploration and development
plan. Based on this, we compute a value of US$3bn
(Rs62/share) for these resources.
Net Cash: We estimate the company to end F2012e year with
net cash of US$2.6bn including the dividend payout
(Rs62/share) which we add to our NAV.
Overall, we arrive at a net asset value of US$18.3bn, which
equates to Rs429/share.
Risks to Price Target
We see the following risks to our price target:
• Crude volatility: Global crude prices are cyclical and volatile,
so Cairn’s earnings, too, may correlate with sector cyclicality.
• Price of Rajasthan crude: Could be limited by its viscous
nature, which would lower realizations relative to Brent.
•Delay in Government Approvals: Production ramp-up could
be delayed, if government approvals don’t come through as
expected.
•Royalty to be made cost recoverable: If royalty is made cost
recoverable, our price target will be lowered by ~Rs58/share.
Sesa Goa: Valuation Methodology
Our price target is Rs386 and is based on a sum of the parts.
The iron ore business: We value Dempo (Rs92/share) and
Sesa’s iron ore (Rs239) operations ex-Dempo separately,
using a two-phase Discounted cash flow (DCF) model. We
assume an explicit phase of 12 years based on existing
reserves (i.e., we expect all reserves to be consumed by
FY2020).
We assume a reserve base for Sesa Goa of 300 mt, which
includes Dempo’s 100mt of reserves. Our long-term iron ore
fines price (real terms, CFR China for 62% Fe grade)
assumption is 83US$/t.
The coke and pig iron businesses (Rs22/share): Here we
use an explicit phase of four years and a terminal growth rate of
2%. We also value Sesa’s stake in Cairn at Rs33/share.
Risks to Price Target
Iron ore price risk: A slump in steel production coupled with a
spurt in iron ore production in China and an increase in iron
ore exports from India could lower iron ore prices and put our
price target at risk.
Export tax increase: Recently there has been increasing
speculation regarding a possible increase in export taxes. The
possible implications for Sesa depend on whether it and other
mining companies can pass on this cost to the buyers. If this
increase were to be split equally between the buyers and
sellers, then we see negative impact on Sesa’s earnings.
Low mine life: Based on our F12 production forecast, the
company will have about 14 years of mine life left beginning 12.
This is low by the general standard of 18-20 years for typical
mining companies globally.
Morgan Stanley & Co. Limited is acting as financial adviser and
sponsor to Vedanta Resources PLC (“Vedanta”) on Vedanta
Group's proposed acquisition of 51% to 60% of Cairn India
Limited ("Cairn India"), as announced on 16 August 2010.
Morgan Stanley & Co. International plc. is also Corporate
Broker to Vedanta.
This report was prepared solely upon information generally
available to the public. No representation is made that it is
accurate and complete. This report is not a recommendation
or an offer to buy or sell the securities mentioned. Please refer
to the notes at the end of this report
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cairn-Vedanta Deal Gets
Conditional Approval
Quick Comment: Cabinet Committee of Economic
Affairs (CCEA) today gave conditional approval for the
Cairn-Vedanta deal, which was announced in August
2010. The two most important conditions are: 1) Royalty
to be made cost recoverable on its Rajasthan fields; and
2) The ongoing arbitration case related to cess must be
withdrawn. Additionally, the Oil Minister commented that
it has to be accepted that there will be no litigation
related to the above conditions.
Our view: Although the deal is approved conditionally,
Cairn India’s board is yet to decide on whether to accept
these conditions. While Cairn Energy and Vedanta
control ~80% of voting rights, we believe that Board of
directors and minority shareholders may not accept
these conditions. In its recent earning releases, the
company has explicitly communicated that its board
would not accept any pre-conditions related that would
affect the value of the business negatively.
Potential impact on Cairn India: Assuming royalty to
be cost recoverable, our price target would be lower by
13% or Rs58 to Rs371 still implying upside of 20%. We
see earnings downside of ~18% for F2012 and ~19% for
F2013. Withdrawal of cess arbitration will not have any
impact as we already assume Cairn to pay cess
Stock already discounting the outcome; we remain
positive: At current levels, the stock is discounting oil
price of US$80/bbl (with royalty). Even assuming royalty,
valuations for F2012e would still be attractive at a P/E of
7x, EV/EBITDA of 4.1, and FCF yield of 13.9%, still
among the cheapest globally.
Impact on Sesa Goa: Assuming the deal goes through,
we would view this overall as negative for the stock. Our
price target would be lowered by ~7% and earnings
could go down by ~4.5% for F2012 and 5% for F2013.
However, the sentimental relief is that its investment of
18.5% in Cairn India would not end up being just a
strategic one and instead the Vedanta Group would take
control of Cairn once its stake is increased to 58% post
the deal completion
Arbitration Cess related to production in from
Rajasthan fields
Cairn has stated that the Rajasthan Production Sharing
Contract (PSC) does not specifically mention that it will be
liable to pay any cess on its crude oil. However, the Ministry of
Petroleum has notified Cairn that the Rajasthan block will be
liable to pay cess, which is currently Rs2,500/ton. Cairn has
been paying the cess under protest, but the issue is currently
under arbitration. We already we assume Cairn pays a cess of
Rs2,500/ton so even if the arbitration is withdrawn this will not
have any impact on our estimates.
Cairn India: Valuation Based on Net Asset Value
To derive our base, bear and bull cases for Cairn India, we use
an NAV valuation based on sum-of-parts and DCF for
individual fields. We then add the NAV of the total resources to
NAV of reserves to arrive at the base case valuation.
Reserves: We use a DCF methodology to assess the cash
flow of individual fields owned by Cairn India based on its 2P
reserves. For our base case, we use an 11% cost of capital for
the life of the fields and a beta of 0.82x (Exhibit 11). We
calculate EV-based NAV at ~US$15.7bn. We use long-term oil
price assumption of US$90/bbl.
We estimate Rajasthan Core NAV to be at US$10.3bn
(Rs240/share) excluding EOR potential, which we estimate is
another US$2.3bn (Rs53/share) assuming it adds 30kb/d to
overall production taking plateau to 240kb/d and increasing
reserve life to ~12years. Overall, we estimate Rajasthan NAV
to be at Rs293/share including the EOR production. We value
NAV for Ravva and Gauri at US$115mn, or Rs7.1/share.
Resources: We value the company’s contingent resources on
the basis of the imputed NAV/boe (US$/boe) based on our
level of conviction. For the Rajasthan other fields and
Rajasthan Exploration upside and KG Basin resources, we
have used EV/BOE of US$9.7/bbl as we await more clarity
from the company on the field exploration and development
plan. Based on this, we compute a value of US$3bn
(Rs62/share) for these resources.
Net Cash: We estimate the company to end F2012e year with
net cash of US$2.6bn including the dividend payout
(Rs62/share) which we add to our NAV.
Overall, we arrive at a net asset value of US$18.3bn, which
equates to Rs429/share.
Risks to Price Target
We see the following risks to our price target:
• Crude volatility: Global crude prices are cyclical and volatile,
so Cairn’s earnings, too, may correlate with sector cyclicality.
• Price of Rajasthan crude: Could be limited by its viscous
nature, which would lower realizations relative to Brent.
•Delay in Government Approvals: Production ramp-up could
be delayed, if government approvals don’t come through as
expected.
•Royalty to be made cost recoverable: If royalty is made cost
recoverable, our price target will be lowered by ~Rs58/share.
Sesa Goa: Valuation Methodology
Our price target is Rs386 and is based on a sum of the parts.
The iron ore business: We value Dempo (Rs92/share) and
Sesa’s iron ore (Rs239) operations ex-Dempo separately,
using a two-phase Discounted cash flow (DCF) model. We
assume an explicit phase of 12 years based on existing
reserves (i.e., we expect all reserves to be consumed by
FY2020).
We assume a reserve base for Sesa Goa of 300 mt, which
includes Dempo’s 100mt of reserves. Our long-term iron ore
fines price (real terms, CFR China for 62% Fe grade)
assumption is 83US$/t.
The coke and pig iron businesses (Rs22/share): Here we
use an explicit phase of four years and a terminal growth rate of
2%. We also value Sesa’s stake in Cairn at Rs33/share.
Risks to Price Target
Iron ore price risk: A slump in steel production coupled with a
spurt in iron ore production in China and an increase in iron
ore exports from India could lower iron ore prices and put our
price target at risk.
Export tax increase: Recently there has been increasing
speculation regarding a possible increase in export taxes. The
possible implications for Sesa depend on whether it and other
mining companies can pass on this cost to the buyers. If this
increase were to be split equally between the buyers and
sellers, then we see negative impact on Sesa’s earnings.
Low mine life: Based on our F12 production forecast, the
company will have about 14 years of mine life left beginning 12.
This is low by the general standard of 18-20 years for typical
mining companies globally.
Morgan Stanley & Co. Limited is acting as financial adviser and
sponsor to Vedanta Resources PLC (“Vedanta”) on Vedanta
Group's proposed acquisition of 51% to 60% of Cairn India
Limited ("Cairn India"), as announced on 16 August 2010.
Morgan Stanley & Co. International plc. is also Corporate
Broker to Vedanta.
This report was prepared solely upon information generally
available to the public. No representation is made that it is
accurate and complete. This report is not a recommendation
or an offer to buy or sell the securities mentioned. Please refer
to the notes at the end of this report
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