Vedanta Default Risk, Yields Dip on Bets Cairn Deal May Fail
Vedanta Resources Plc’s bond yields and credit default swaps signal the U.K. miner’s plan to buy Cairn Energy Plc’s Indian exploration unit may collapse, helping avert a debt downgrade on the $9.6 billion acquisition.
Bondholders oppose the deal and are confident the purchase will be called off as the companies await approval from the Indian government, according to Aberdeen Asset Management Ltd. and Erste Sparinvest KAG. The yield on Vedanta’s dollar bonds maturing in January 2014 touched a five-month low last week, according to data compiled by Bloomberg. The cost of insuring the company’s debt against default dropped to a nine-month low.
“From bondholders’ perspective, it would be positive if the deal with Cairn doesn’t go through,” said Peter Varga, who helps manage about $200 million of emerging market corporate debt in Vienna at Erste Sparinvest, and holds Vedanta bonds. “Their capital expenditure plans will already ensure higher leverage in the coming years.”
Vedanta, the largest copper producer in India, agreed to borrow $6 billion from a group of eight banks for the acquisition. That will add to its existing $7.3 billion of debt, according to data compiled by Bloomberg. The financing arrangement prompted Fitch Ratings to cut London-based Vedanta’s creditworthiness in August and Standard & Poor’s said Nov. 26 it may follow suit should India approve the acquisition of Cairn India Ltd., the operator of the country’s biggest onshore oilfield.
Emily Dimmock, a spokeswoman for Vedanta, declined to comment when Bloomberg News contacted her by phone in London.
The Vedanta proposal hit a hurdle when state-owned Oil & Natural Gas Corp., Cairn India’s partner in the field in Rajasthan state, said it wants to alter the contract on royalty payments. India’s oil ministry supports ONGC’s demand, while Vedanta and Cairn Energy oppose the change.
Vedanta’s 8.75 percent note due 2014 yielded 5.84 percent on Feb. 15, the lowest since Oct. 7, according to data compiled by Bloomberg. The rate was 5.98 percent today. The cost of insuring the company’s debt against default dropped to 464.8 basis points on Feb. 18, the lowest since May 12, from as high as 670 points reached on Aug. 31, according to data provided by CMA London.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point equals $1,000 a year on a contract protecting $10 million of debt for five years.
“Bondholders now believe the deal may not go through,” said Pierre Faddoul, a credit analyst at Aberdeen Asset Management, which manages about $282 billion globally and doesn’t own Vedanta debt. “The deal would mean taking on large debt and bondholders wouldn’t like that.”
Cairn Energy spokesman David Nisbet said in an e-mail Feb. 18 the company continues to work with India’s government to secure approvals to complete the transaction by April 15.
Cairn India’s shares have declined 4.2 percent to 318.95 rupees in Mumbai since the Aug. 16 announcement. The premium of Vedanta’s bid price to Cairn India’s current share price widened to 27 percent from 22 percent. Vedanta offered Cairn Energy 405 rupees for each share, including a non-compete fee of 50 rupees.
Billionaire Anil Agarwal’s Vedanta, which operates copper and zinc mines and smelts aluminum, has no experience in oil and gas exploration and production. The government said in September that the technical capability of Cairn India’s parent is guaranteed in the production-sharing contracts and would have to be examined in any proposal that brings a change of parent.
Vedanta “is trying to diversify, but that brings with it uncertainty, execution risks, larger debt and higher leverage,” said Erste Sparinvest’s Varga.
S&P rates Vedanta’s debt BB, two notches below investment grade. Moody’s Investors Service ranks Vedanta’s debt Ba1, a level below investment grade, and said Aug. 17 it was reviewing the rating for possible downgrade. Fitch Ratings cut Vedanta to BB+ from its lowest investment grade of BBB-.
“The rating review reflects Moody’s concern that this bold acquisition, in what will be a new business for the group and likely be majority debt-funded, will weaken Vedanta’s overall credit profile,” Alan Greene, senior credit officer at the rating company, said in an Aug. 17 statement.
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.
The miner’s planned purchase of as much as 60 percent of Cairn India includes an open offer by unit Sesa Goa Ltd., India’s biggest iron-ore exporter, for a 20 percent stake from minority shareholders. The final number of shares sold by Cairn Energy will depend on the results of the open offer.
ONGC owns a 30 percent stake in the Rajasthan field and also pays royalty on behalf of its partner as an incentive offered by India to attract overseas oil companies before the government started auctioning fields in 1999. Royalty should be added to the project cost, which the partners are allowed to recover from sales, ONGC says.
Indian oil minister S. Jaipal Reddy supports ONGC’s claim and said Feb. 18 the cabinet may meet in three weeks to take up Vedanta’s proposal. U.K. Prime Minister David Cameron sought early approval of the deal, he said.
“While such pressures are normal, we have to address our own concerns,” Reddy told reporters in New Delhi. “We can’t sacrifice our positions completely just to facilitate a deal. We will see what view the cabinet will take.”
Cameron pressed Indian counterpart Manmohan Singh for a prompt decision, the Financial Times reported Feb. 18, citing a letter by the British leader. Cameron wrote to the Indian Prime Minister to stress the need for greater transparency in the country’s business environment, the newspaper said.
The Indian explorer estimates Cairn India’s share of royalty is 140 billion rupees ($3.1 billion) through the life of the field.
“We have made our stand clear and the ministry is taking up our case,” ONGC Chairman A.K. Hazarika said by telephone Feb. 18. “We have nothing more to add.”
Cairn Energy won’t go back to shareholders to extend the April 15 deadline, Chief Executive Officer Bill Gammell told reporters in New Delhi after meeting with minister Reddy Feb. 18.
Cairn India’s board of directors said any condition linked to the transaction that can negatively affect the company’s valuation cannot be accepted, according to a statement Feb. 10.
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