Sterlite Industries, Residual stake buyout of HZL and Balco likely to be earnings accretive::Deutsche bank,

Buyouts likely to be earnings accretive, though fair valuation could take a hit

Sterlite’s long-awaited buyout of the government’s residual stakes in HZL and
Balco is on investor radar screens yet again after media reports that the buyout
could be put on a fast track. Our analysis indicates the residual stake buyouts
are likely to be earnings accretive in the range of 7-13%. However, Sterlite’s
fair valuation could take a hit. If the January 2012 offer is executed, Sterlite’s
fair valuation would be positively affected by 2.6%. If the new potential offer –
implying higher bid prices for HZL (+20%) and Balco (+70%) – is executed,
Sterlite’s fair valuation would be negatively affected by 8.7%, without factoring
in any re-rating on improved cash fungibility. We maintain our Buy rating.

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Improving cash fungibility and efficient tax structure could lead to re-rating
The buyout of residual stakes should mark an important step toward achieving
a more tax-efficient corporate structure and improving cash fungibility across
the group entities, leading to a potential re-rating of the group. The potential
delisting of Hindustan Zinc (HZL) and/or merger into Sesa-Sterlite should give
Sterlite access to INR194bn of cash on HZL’s books (as on 30 June 2012).
Further, it should allow Sterlite to lower its effective tax rate by netting off
accumulated losses across divisions (aluminum, power) against profits in the
zinc division.
Effect on HZL minority shareholders to depend on Sterlite corporate action
While the government stake sale could potentially be completed at a premium
to the current market price, it remains unclear whether similar terms/exit price
will be offered to the minority shareholders of HZL as well. The impact on HZL
minority shareholders will depend on Sterlite’s choice of corporate action at
HZL following the buyout (see page 4).
SOTP-derived target price of INR115/share; risks
We value zinc India at 4.6x FY13E EV/EBITDA, zinc international at 4.1x FY13E
EV/EBITDA, copper at 5x FY13E EV/EBITDA, VAL/Balco at 6x FY13E
EV/EBITDA and the Sesa Goa stake at our target valuations. Key risks:
regulatory risks, coal sourcing and cost as well as mining tax (