Cairn India: A remarkable low risk, high returns investment option

In the biggest-ever domestic takeover in the oil and gas space, Vedanta Resources Plc has announced the buyout of controlling stake of 51% in oil explorer Cairn India from its parent company – Cairn Energy Plc. Sesa Goa, Vedanta’s iron ore mining company in India will hold a 20% stake in Cairn India, while the balance 31-40% will be held directly by the parent group.

The stock prices of both Sesa Goa and Cairn India crashed today due to fears of regulatory hurdles and huge cash outgo which the promoters will have to shell out. The deal, though at a 32% premium to the street’s expectations, holds remarkable long term benefits for both Cairn and Sesa Goa. For Cairn, in particular, the advantage of having one of the largest mining and commodities conglomerate as the main promoter augurs well for further expansions and growth. Cairn India has anyway good long term prospects given the size and potential of the oil exploration assets which it owns. The change of ownership certainly does not have any negative implications as Vedanta will be the second- largest mining firm in the world, after BHP Billiton, to also have an interest in oil. Moreover even if we assume that further expansions and growth opportunities take time to materialize, the immediate trigger of an open offer as per SEBI guidelines should rekindle interest in the stock in the near future. Hence the current downturn provides an excellent opportunity for investors to buy into this stock.

As a part of the deal, the promoters will get Rs.405 per share, including a non-compete fee of Rs.50 per share. This non-compete fee is in lieu of a commitment, not to enter into oil and gas business in India, Pakistan, Bhutan and Sri Lanka for three years.
The non-promoter shareholders, with over 71 crore shares amounting to a 37.64 per cent equity, will be entitled to Rs.355 per share. However if we go by the past precedent set by SEBI in the takeover of Mysore Cements by Heidelberg, Vedanta will also have to offer the additional Rs 50, non-compete fee to the minority shareholders. This open offer of Rs 405 for the balance equity shares will provide a decent upside from the current levels of Rs 333. Keeping in mind the new takeover norms proposed by the Achutan Committee the acceptance ratio in such an offer will be hundred percent for minority shareholders who tender their shares. This implies a nearly assured upside potential of about 22 percent for investors who buy this stock at current or lower levels. The only risks are of regulatory approvals not going through, objections from ONGC if any, Achutan Committee recommendations not getting accepted and SEBI agreeing on not including the non-compete fee to be compensated to the minority shareholders. Chances of any of the above hurdles becoming a possibility are fairly remote. Moreover as mentioned earlier the downside in this stock is anyway limited keeping its strong fundamentals in mind and even if the deal does not work out the way we are anticipating, we are optimistic on the return prospects on this stock in the long run keeping its growth prospects and the strong promoter group in mind.