Reduce Cairn India - Vedanta Buy - Elara Capital

• Cairn India
• Rating : Reduce
• Target Price : INR315
• Downside : 11%
• CMP : INR355 (as on 13 August 2010)

Vedanta buy - Valuing long-term potential

News: Vedanta to buy 51% in Cairn India

There are media reports that Vedanta is buying a 51% stake in Cairn India from its parent company Cairn Energy which holds 62.4% stake. The deal size is expected to be between USD8.0-8.5bn.

Our take: Deal valuations imply 10-16% upside

- Positive for the stock as even the lower-end of the deal (USD8bn) would value Cairn India at USD15.7bn vs current market cap of USD14.4bn.

- The lower-end valuation would imply per share valuation of INR390 – an upside of ~10% from current levels.

- The higher-end of deal would imply a valuation of INR413 per share – an upside of 16% from current levels.

- What do these valuations imply? – Long-term reserve accretion

- A valuation of USD15.7bn for Cairn India would mean that apart from the valuation of the core producing MBA Rajasthan fields, the company is also getting much higher valuations for its other reserves in the Rajasthan block.

- Apart from the MBA reserves, Cairn has in-place reserves of 1.9bnboe, from which as of now the management has guided towards a 9% recovery. However, the deal valuation would imply a recovery rate of nearly 40.

- Though these recovery rates are very possible as seen from the MBA fields recovery rate of ~50%, we think there is still enough exploration work left to be done on these fields before higher recovery estimates can come into the picture. Thus, we do not see the recovery guidance going upto to 40% in the next 12 months.

Our take on the deal valuation

- If the deal happens, it is obvious that Vedanta is planning to be a long term investor. In that case, we feel the deal valuation is fair, considering our expectations of a reserve upside from other Rajasthan fields in some time in the future.

- As this reserve accretion will be a process spread across the next 3-5 years, we are still a bit apprehensive in assigning 40% recovery rates and thus a very high valuation to these reserves from a 12-month investment time horizon.

- In the short term, we do expect the stock to rally towards the deal valuation upon the official announcement, which is expected on August 16, according to media reports.

Source : Equity Bulls

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