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Vedanta Billionaire Agarwal Risks 30% Returns by Mimicking BHP

Mining billionaire Anil Agarwal, who delivered 30 percent gains to shareholders in the past five years, plans to spend $9.6 billion to replicate the strategy of BHP Billiton Ltd., a rival that’s posted smaller returns.

Agarwal’s Vedanta Resources Plc plans to buy a controlling stake in Cairn India Ltd. and get access to the nation’s biggest onshore oilfield. His first foray into petroleum will echo the structure of BHP, the Australian mining company that first ventured into oil in 1967 and delivered average annual gains of 20 percent since 2005.

The acquisition may compromise Vedanta’s growth after the company takes on $6.5 billion in debt to finance the purchase, said Jeremy Cave, an analyst at MF Global Securities Ltd. in London. Standard & Poor’s and Moody’s Investors Service are reviewing Vedanta’s credit ratings, and its shares slid 14 percent in the two weeks following the deal’s announcement.

BHP’s “diversification is spread around the world, whereas Vedanta’s assets are concentrated in India so there’ll be more risk attached,” said Walter Rossini, a fund manager at Aletti Gestielle Sgr SpA in Milan, who helps manage $350 million including shares in Vedanta’s Sterlite Industries and in Cairn India. “From the point of view of a shareholder, I would prefer a bit of the cash on Vedanta’s books comes to me.”

Founding Vedanta

Agarwal, 56, was born in Patna in Bihar state as the son of a cable and wire maker. Leaving school at 15, he took charge of his father’s business before establishing Vedanta in 1976 as a scrap-metal dealership in Mumbai, a job that showed him the importance of raw materials in industry, he said in an August interview in London.

Agarwal began to build his metals empire by acquiring copper-cable producer Shamsher Sterling Corp. from the king of Nepal in 1979, obtaining a bank loan for the $1,070 purchase. Adding Australian copper mines in 1999, aluminum and zinc producers over the next three years and iron-ore exporter Sesa Goa Ltd. for $981 million in 2007, the entrepreneur parlayed his scrap-metal startup into a $30 billion group of companies.

BHP also began as a minerals producer, focusing on silver, lead and zinc before moving into energy, and now has oil and gas operations from the Gulf of Mexico to Pakistan. The expansion proved lucrative, with underlying profit from its petroleum unit almost doubling since 2005. BHP bought Billiton Plc in 2001 for $11.6 billion.

BHP succeeds by buying “very large assets” to supply a significant chunk of a commodity, keeping production costs down and forcing out smaller rivals, said Cave at MF Global.

Financing Costs

Vedanta, which intends to fund part of the Cairn deal with cash from its Sesa Goa unit as well as bank loans, faces higher financing costs in pursuit of an expansion into oil.

Companies with credit ratings below investment grade, such as Vedanta, pay average loan interest margins of 413 basis points over benchmark rates, compared with 307 basis points in 2007, according to data compiled by Bloomberg.

The cost of borrowing for investment-grade companies such as BHP has dropped. BHP, bidding to acquire Potash Corp. of Saskatchewan Inc., is paying a margin of 70 to 140 basis points on a $25 billion one-year loan that can be extended by a year, it said Aug. 20. BHP has cut debt by 41 percent to $3.3 billion.

Vedanta, which agreed in May to pay Anglo American Plc $1.34 billion for zinc mines in Africa and Ireland, is snapping up assets even after announcing a doubling in its share buyback program. The London-based company this year raised its buyback plan to $825 million from $350 million, Agarwal said in Vedanta’s annual report.

Shift to Oil

“Why do a deal?” said Paul Cliff, a London-based analyst at Nomura Holdings Inc., after the Cairn deal was announced. “There is no previous experience in oil and gas. It’s a concern for investors because Vedanta is a metals and mining house with one of the most aggressive organic-growth profiles.”

Vedanta has an $8 billion plan to increase its aluminum smelting and refining capacity sixfold. The company also intends to spend $20 billion in India over four years on mines and power plants, it said in 2008.

“We struggle to identify synergies from the transaction and see little link between Cairn India and Vedanta’s existing energy-generation assets, and we do not view it as a hedge on energy,” Fawzi Hanano, an analyst at UBS AG, said last month.

Worker Protests

Agarwal is no stranger to opposition to his expansion plans. His acquisition of Indian state companies Bharat Aluminium Co. and Hindustan Zinc Ltd. in 2001 prompted protests from opposition parties and workers, who staged a two-month strike on concern the new owner may cut jobs.

“Each time, he has managed to settle” these conflicts, said Jagannadham Thunuguntla, chief strategist at SMC Capitals Ltd. in New Delhi. He has a “very compelling rags-to-riches story that has been tested many times.”

The mining mogul is yet to convince India’s political elite that he’s best-placed to develop the country’s petroleum and mineral riches. The Oil Ministry responded to Vedanta’s Cairn bid by asking state-owned Oil & Natural Gas Corp. to study a counter-offer.

Buying Cairn India would give Vedanta access to Rajasthan’s Mangala oilfield, which produces about 125,000 barrels a day, equivalent to about 19 percent of the country’s annual output.

“India is always hungry for energy and that makes it a big market,” Alex Mathews, head of research at Geojit BNP Paribas Financial Services Ltd. in Kochi, India, said Sept. 7. Still, “investors would be concerned because this is a new business for them. Success is not guaranteed.”

To contact the reporters on this story: Firat Kayakiran in London at fkayakiran@bloomberg.net; Rakteem Katakey in New Delhi at rkatakey@bloomberg.net.

To contact the editor responsible for this story: Amanda Jordan at ajordan11@bloomberg.net.

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