Event Update - Sesa Sterlite merger: Complex structure veils 'VAL'ue dilution - PINC Research

Complex structure veils 'VAL'ue dilution

Vedanta Group has proposed consolidation of its group structure by merging Sesa Goa, Sterlite Industries, Vedanta Aluminium Ltd. (VAL) and MALCO to form 'Sesa Sterlite'. Further, it proposes to transfer its 38.8% stake in Cairn India to Sesa Goa together with the associated debt of USD5.9bn, at nominal cost of USD1, which is independent of the above merger.

Along with simplification of group structure & removal of cross-holdings, the management expects cost synergies of Rs10bn p.a. from the merger from lower cost of capital, tax efficiency etc. Further, Vedanta group intends to create a global diversified natural resources major (globally 7th largest) through this consolidation.

Sterlite will merge into Sesa Goa at a swap ratio of 0.6x to create Sesa Sterlite (swap ratio is slightly favourable to Sterlite shareholders). Further, VAL and MALCO would be merged into Sesa Sterlite by issuance of 72.3mn and 78.7mn shares respectively valuing VAL at USD473mn and MALCO at USD363mn.

Vedanta PLC would transfer 38.8% stake in Cairn India to Sesa Goa at a nominal consideration of USD1 and associated acquisition debt of USD5.9bn (USD2.8bn of debt and USD3.1bn of ICD). This transaction is independent of Sesa-Sterlite merger.

OUTLOOK AND RECOMMENDATION

We believe that the proposed merger is unfavourable for Sesa and, to a smaller extent, Sterlite minorities as it increases exposure of Sesa Sterlite in loss-making and highly levered VAL and would result in conversion of Rs96bn of debt/ quasi-equity given by Sterlite to VAL into equity. Further, the equity valuation of USD473mn (EV of USD6.1bn) for VAL is high as VAL struggles to turn profitable given lack of captive bauxite and high cost of coal.

Size unlikely to provide any significant benefit as we don't see any convincing reason for another resource conglomerate in the group (Vedanta PLC being one).

Additional 38.8% stake in Cairn India for USD5.9bn values Cairn India at Rs390/share, 3% premium to CMP. Since we value stake in Cairn India at a 15% disc. to CMP, we see this transfer as value dilutive for Sesa Sterlite.

This transaction, in our opinion, is more lucrative for Vedanta PLC as it reduces their exposure to loss making VAL, while raising stake in profitable Sterlite, Sesa Goa and HZL. Further, they deleverage their balance sheet by transferring USD2.8bn of debt and creating an inter-company loan of USD3.1bn to Sesa Sterlite for their 38.8% stake in Cairn India.

We expect the merger to be EPS dilutive for Sesa (16% and 6% for FY13E & FY14E respectively) on slightly unfavourable swap ratio, & increased debt burden.

The proposed merger is value dilutive for Sesa Goa and Sterlite as proposed Sesa Sterlite is trading at a higher multiple of 4.1x FY13E EV/EBITDA compared with 4.1x for Sterlite Inds., 2.5x for Sesa Goa and 3.8x for combined Sesa + Sterlite.

We see this transaction as unfavourable for Sesa Goa and Sterlite's minority shareholders. We maintain REDUCE on Sesa Goa (CMP Rs208) with SOTP-based revised target price of Rs188 (Rs227 earlier) for Sesa Sterlite. We also maintain REDUCE on Sterlite Industries (CMP Rs121) with a revised target price of Rs113 (0.6x fair value of Sesa Sterlite) - Rs114 earlier.

Source : Equity Bulls

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