Cairn India - Arithmetically speaking:: Kotak Sec

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Cairn India (CAIR)
Energy
Arithmetically speaking. We see the recent correction in CAIR stock as a good trading
opportunity given (1) 5-11% potential upside from current levels assuming successful
completion of the ongoing transaction and (2) likely momentum in the Cairn-Vedanta
deal from CNE’s recent application to government for approval of ownership transfer in
three producing blocks. Key downside risk stems from any unfavorable development on
the royalty issue, although it is unlikely in our view.

CAIR stock offers moderate upside assuming successful completion of Cairn-Vedanta deal
Exhibit 1 shows a 5-11% upside for Cairn India stock from current levels based on our weighted
average price computations. We compute the likely fair value for CAIR stock for a minority
shareholder at `328 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 of CAIR stock for a minority shareholder increases to `348, if we were to assume nonparticipation
of Petronas in the open offer.

Stock trading near 12-month fair value of `298 without factoring the ongoing transaction
We compute 12-month DCF-based fair valuation of CAIR at `298 (see Exhibit 2). We use 1.43 bn
bbls of recoverable reserves from the key Rajasthan block in our earnings model and factor in a
2% per annum increase in crude price beyond FY2014E in perpetuity. We note that our fair
valuation of `298 assumes cess payment at `2,575/ton. Our fair valuation of the stock would
increase to `317 if we assume that Cairn will have to bear cess at `927/ton and it would increase
to `331 if we assume that Cairn will not have to bear any cess (see Exhibit 3).

Recent application for government approval would likely expedite the transaction
We rule out further delays in Cairn-Vedanta transaction given Cairn Energy’s recent application to
government seeking approval for transfer of control to Vedanta Resources in its three producing
properties, including the key Rajasthan block. We note that Cairn had earlier applied for
government approval for transfer of ownership to Vedanta in the NELP blocks only. The MoPNG
secretary has recently stated that government will take a final decision on the ongoing transaction
by end-February 2011.

PSC to likely favor CAIR on royalty issue
We believe that PSC of the Rajasthan block will favor Cairn India, as it explicitly mentions that the
licensor (ONGC) will bear royalty for the entire production of oil. We do not factor in any royalty
payment for Cairn’s share of crude oil production from the Rajasthan block in our fair valuation of
the stock. However, we compute an impact of `58/share in the unlikely scenario of CAIR India
royalty on its share of crude oil produced from the Rajasthan block.