Sterlite merger with Sesa Goa worries shareholders

Vedanta Group, a metals and mining conglomerate, is planning to merge Sterlite with its subsidiary company, Sesa Goa. Before getting into the details of the merger and its implication let us understand the structure of the various businesses under the Vedanta Group. The chart given below provides clarity on the various holdings.

Vedanta, the parent group, has three major holdings companies Sterlite (54.6 per cent), Sesa Goa (55.1 per cent) and Cairn India (38.5 per cent). Sesa Goa also holds 20 per cent stake in Cairn India. Both the stakes, after the restructuring plan goes through, will transfer to Sterlite that will hold 58.8 per cent in Cairn India.

The moot question that comes across is why is the company doing so?

According to the management, they want to align, simplify and restructure its different businesses under one roof. However, we believe there is no synergy between Sesa Goa and Sterlite as both are into different businesses. Sesa Goa is into iron ore (ferrous) mining whereas Sterlite is into non ferrous metal.  Therefore the merger can also be one of the ways to repay some of the debt obligations looming large on the balance-sheet of the parent company i.e. the Vedanta Group. The Vedanta Group as of September 2011 had debts of USD 10 billion which includes the debt used to finance the Cairn India acquisition.

Sterlite has a strong balance-sheet and therefore one can expect a major portion of the earnings to be used to service the debt. By merging Sesa Goa and Cairn India the group company will get cash and bank balance of these companies which will give them more leverage to raise further funds. Further, the company can collect dividend payouts from these subsidiaries which can be used to service their interest obligations. Vedanta’s debt covenants are all-restrictive which means the debt has been given on some conditions and if those conditions or covenants get triggered, there could be an impact on the ratings.

Moreover, this restructuring is to de-leverage its balance-sheet for a further fund-raising programme. The Vedanta Group was recently in the news to acquire the remaining stake of its subsidiaries Bharat Aluminum and Hindustan Zinc. For that it will need a huge sum of money. Also, it has its own huge capex programmes. This will in turn result into additional debt burden and the gross debt could rise by 70-80 per cent of the current debts in the books. That will definitely not be sustainable.

Moody recently downgraded the company’s debt from Ba3 to Ba2 after the acquisition of Cairn. Fearing further downgrades, the company is prudently going ahead with this restructuring plan.

In the table mentioned below, except for the parent company, the debt to equity ratio of the other companies is on a comfortable level. Moreover, the other companies are also sitting on good cash levels by making good profits. Sesa Goa has a current market capitalisation of around Rs 21,441 crore and Sterlite Rs 43,158 crore.