Vedanta’s investors fear that their company may become an investment vehicle for the group’s global ambitions and the effect that could have on its financials
A sure way to upset investors is by mixing a listed company’s funds with the promoter group’s businesses. Despite this being common knowledge and several instances where investors have punished companies, Vedanta did just that. The episode is one that leaves you scratching your head, wondering why this decision and if there is a bigger plan afoot.
First, let’s add up the damage. There is that hit to the company’s reputation among investors and the corporate governance issues it raised. Ratings took a knock. Moody’s Investors Service lowered its outlook on Vedanta Resources’ ratings to negative from stable, citing this development as a ‘credit negative’ while also pointing at downside risks to commodity prices.
Then there’s the tangible damage done to valuations. Vedanta’s shares have fallen by 18 percent, or by Rs 13,250 crore, in a matter of days after this revelation.
What irked investors so much? While announcing its results, Vedanta said that its 100 percent subsidiary Cairn India Holdings (Cairn) invested $200 million, or Rs 1,431 crore to acquire an economic interest in Anglo American, with Moody’s stating the total investment to be done by 2020 at $561 million. Cairn acquired this interest from Volcan Investments, the ultimate holding company of Vedanta.
A little bit of history here. Volcan is the investment vehicle of the promoter group, Anil Agarwal and family. Volcan owns a majority stake in Vedanta Resources, the holding company of Vedanta. Vedanta Resources was the investment vehicle of the group, and was listed in London till October 2018. At the time of the delisting announcement, Volcan owned a 66.5 percent stake in Vedanta Resources. In effect, Volcan owns nearly all of Vedanta Resources, which in turn owns a 50.1 percent stake in Vedanta.
In 2017, Volcan had through a structured transaction acquired a 19.6 percent stake in Anglo American (which has increased subsequently) for 3.5 billion pounds for which it issued mandatory exchangeable bonds, as explained in Moody’s release. Volcan has the option to repay the loan and get ownership of the shares or the bonds can be exchanged into Anglo American shares. At present, Volcan owns a 21 percent stake in Anglo American, and it has transferred a 1.8 percent stake (only the economic interest) to Cairn in return for the investment made.
When one looks at the damage this episode caused in relation to the sums involved, one may wonder why go to all this trouble for a $561 million investment to be made over 20 months. In fact, Vedanta did pay out dividend of Rs 10,188 crore (or $1.5 billion and this included dividend distribution tax) in the December quarter. Half this amount would have gone to the parent.
Now, the official reason given in Vedanta’s announcement to the stock exchange is that Cairn was offered this opportunity to invest. It considered and accepted it because the structure provides higher returns compared to other overseas cash management investments that would yield two percent. The investment was made in December 2018. The December quarter results included a mark-to-market profit on this investment. While that meant a loss too could happen, Vedanta’s release to the stock exchange on February 4 clarified that the investment now has full capital and downside protection.
The steep fall in Vedanta’s shares and Moody’s reaction indicates some scepticism about these explanations. When a parent company offers an option, does a subsidiary have a real choice to decline it? The timing is another factor. It comes shortly after delisting Vedanta Resources, when the management had said that Vedanta would now be the main listed vehicle for equity investments providing an exposure to India and Africa.
Then, there is the interview that Agarwal gave to PTI, just a few days before Vedanta’s results were announced and news of this investment emerged. He said he has no intention of retiring as the group needed his risk-taking ability and aggression to grow into a world-class conglomerate.
This statement reiterates his ambition of turning the group into an international mining giant. Could this relatively tiny investment by Cairn be a heads-up to investors that Vedanta is now in action, as the investment vehicle for the group’s global ambitions? In any potential combination with Anglo American, Vedanta’s status as a listed company with a market valuation can play an important role.
Agarwal has maintained that the investment in Anglo American is just that and they are not looking for anything further. But if you take his statement of becoming a global natural resources conglomerate seriously, then this investment fits in with that ambition. Nudging Vedanta into this transaction structure raises the possibility that it could play a bigger role in furthering Agarwal’s ambition or at least part funding it. That is, Vedanta’s equity could be used if a share swap is contemplated or to raise equity and debt funding.
This is all in the realm of speculation but the air will be cleared by 2020. That’s when the structured transaction entered into by Volcan matures. That leaves Vedanta’s shareholders staring at uncertainty till 2020.Investors would have been valuing its shares based on its existing and future cash flows, most of which are tied to its domestic business. Now, they find themselves staring at a possibility of being right in the middle of a large global combination, if the group does indeed embark on that path. There is no way of knowing what the structure could be and the impact it will have on their company’s financial position. That’s an overhang that cannot be shrugged off easily. The sooner clarity emerges the better it is for the stock.