>CAIRN INDIA: Disappointing deal

■ Vedanta to acquire 51-60% stake in Cairn India: Cairn Energy is expected to sell 40-51% of its stake in Cairn India (it currently has 62.4%) to Vedanta Resources for a consideration of US$6.65bn-US$8.48bn, implying per share value of Rs405. This includes Rs50/share of non-compete fee paid to Cairn Energy for not engaging in E&P operations in Bhutan, India, Sri Lanka and Pakistan for a period of three years. At the acquisition price of Rs405/share, Vedanta has valued Cairn India at ~US$24/boe (2P+2C). Post the open offer (additional 20% at Rs355/share) Vedanta would hold 51%-60% of Cairn India. Cairn Energy’s stake in Cairn India, on the other hand, would reduce to 21.6%-10.6% (fully diluted basis) depending upon the open offer
response.

■ Open offer lower at Rs355/share; lower than our expectations: Given a non-compete fee of Rs50/share, the open offer price has been fixed at Rs355/share. We see limited rationale in paying a non-compete fee for a commoditised business and hence believe that the deal is unfavourable from minority shareholder’s point of view. This differential treatment, we reckon, has been the primary reason for the stock’s correction by over 6% in trade yesterday. While concerned, we expect company fundamentals to provide support at the current levels.

■ Fundamentals intact; management’s lack of sectoral experience a concern: We continue to remain excited about the exploration prospects in the Rajasthan basin, especially the Balmer Hill formation where we expect upgrade in recovery factor going forward. Additionally, prospective exploration resource base of 2.5bn boe (10% recovery) in the Rajasthan block would provide the necessary leg up to resources going forward. However, given the lack of experience of the new management (Vedanta) in running oil & gas operations, we believe that the stock could reflect the above concerns going forward.

■ Downgrade to HOLD: While maintaining our 12-month target price of Rs380, we downgrade the stock from BUY to HOLD, mainly on two counts a) the stock is likely to be range bound given deal closure by 1QCY11 b) concerns on the lack of experience of the new management in handling E&P operations is likely to impact valuation in the medium term. We would however highlight that Vedanta management has delivered superior operational performance in assets acquired historically (Sesa Goa, Hindustan Zinc).

To read the full report: CAIRN INDIA