MANY A SPILL BETWEEN THE CUP AND THE LIP

Yesterday we all bore witness to the announcement of one of the largest acquisitions involving purchase of shares and majority control of an Indian company, namely Cairn India, by a foreign resident.

The transaction contemplates Cairn India’s parent Cairn UK which presently holds ~ 62% of the paid up equity capital of the former, divesting 40% to 51% of the equity in favour of the Anil Aggarwal led, UK based, Vedanta Group for an aggregate consideration of USD 6.65 bn to USD 8.48 bn. The transaction thus values Cairn India’s business at Rs. 405 per share i.e. Rs. 77,800 crores approximately.

The Vedanta Group, through its group companies would also make the mandatory open offer for 20% of the equity capital of Cairn India as required by the Takeover Code. Subject to completion of the open offer and receipt of requisite statutory and regulatory approvals, the acquisition would seal Mr. Anil Aggarwal’s entry into the liquid counterpart of his global mining and extraction empire.

Well so far so good.

The purpose of my writing this is not to give a factual rehash of the transaction which I am sure anyone having the least bit of interest would have encountered in any of the plethora of publications and dailies…the purpose here is to add my spice to what seems like an otherwise plain recipe of a corporate takeover.

Things are seldom what they seem and things seldom play out the way one would expect. Two lessons all of us have learnt the hard way from the professor Mr. Life. Applying the aforesaid to the instant case, I would be terribly surprised if this transaction sails through without so much of a glitch. It is, after all, from the onset shrouded by a range of factors and circumstances which make it a favoured candidate to evolve into a mish-mash of regulatory, legal and competitive considerations, which could transform the whole transaction into an entirely different organism than what it was when it commenced.

So following is the lead cast of the players (read factors) that could play spoil sport in Vedanta & Cairn’s party:

1.      Non-compete fee???

What is the basis of computation of the non-compete fee of Rs. 50 in the total agreed price of Rs. 405 per share? On an aggregate basis the non-compete consideration works out to anything from USD 850mn to over USD 1 bn. Ostensibly, the non-compete fees is being paid to Cairn UK in consideration for Cairn UK agreeing to refrain from participating in oil & gas activities competing with Cairn India in the territories of India, Sri Lanka, Pakistan and Bhutan for a period of three years. However, what defies logic is that such a quantum of non-compete fees is paid in a transaction which is essentially an assignment of Cairn India’s upstream assets in Rajasthan, KG Basin etc. The valuation of Cairn India arises on account of its stake in the producing blocks in the Barmer District, which have been appraised with significant oil reserves and are slated to produce 175,000 bpd by 2012. It follows from the above, that any valuation so ascribed to Cairn India ought to be paid alike to Cairn UK as well as the other minority investors of Cairn India. Dividing the price of Rs. 405 per share between non-compete fees (Rs. 50) and share purchase consideration of Rs. 355 clearly seems like a device to avoid payment of full value to the minority shareholders under the mandatory open offer. While the Takeover code provides for payment of non-compete fees of upto 25% of the share price to the promoters of the company, the regulators have off late woken up to the misuse of this provision to deprive the minority from the full value of the shares in such situations. This is exactly the reason that the proposed amendments to the Takeover Code provide for abolition of the non-compete fee concept and require equal treatment (in terms of offer price) to the promoters and minority shareholders.

I suspect that for this reason alone, the transaction is sure to run into rough weather with the regulators, whether it be at the instance of certain frustrated minority stake holders or on account of a suo moto cognizance of the issue by SEBI.

2.      Government Approval

The typical production sharing contract for upstream assets contain the provision requiring any assignment of participating interest by a stake holder in the block to be done only after obtaining prior approval of the government. In this case, while the stake holder in the various blocks of Cairn, remains Cairn India, it is likely that the corporate veil may be lifted to bring this provision into operation. In effect, the participating interest has been transferred to Vedanta by Cairn UK by transferring majority stake and management control of the SPV (Cairn India) which was formed for the purpose of owning and operating the Indian assets. Cairn UK has thus ventured to do indirectly what it could not have done directly. Combined with the fact that the allocation of oil & gas blocks under the bidding process is sensitive to the track record and credentials of the bidders, a question may also be raised as to the competence of Vedanta insofar as functioning as an operator of oil & gas upstream assets is concerned. The representatives of Cairn UK and Vedanta would thus have to lobby hard in the corridors of MOP&NG to ensure this does not become a major stumbling block in the consummation of the transaction.

3.      ONGC

Cairn India occupies the position of ‘operator’ in most of its Indian upstream assets. While behemoths like ONGC are also partners in assets such as the Rajasthan blocks, the operatorship has been held and carried out by Cairn India under the aegis of Cairn UK owing to Cairn UK’s credentials for operating and developing major hydrocarbon assets globally. For the operatorship to be handed over to a new player indirectly by transferring ownership and management control of the SPV, and more so to a player with nil prior experience in the hydrocarbon exploration and production space may not sit well with ONGC. ONGC is sure to object to the transaction and flex its PSU muscle to extract its pound of flesh before it allows the transition to go through.

4.      Competition

Last but certainly not the least is the reactionary steps (both explicit and tacit) which would be taken  by the Indian private sector majors i.e. Reliance and Essar in response to this transaction. One of the most prolific onshore finds in the recent past of the country’s oil & gas exploration history has been acquired by a relative outsider (albeit Indian) under their watch. The acquisition propels Anil Aggarwal as a major player in the Indian oil & gas space, a domain which was hitherto closely protected and cordoned off to new private entrants. Mukesh Ambani, sitting with truckloads of cash in the RIL balance sheet would surely have not minded bringing this prize under his fold. It will thus be interesting to see how these majors react to the developments and whether they resort to an explicitly aggressive approach of making a counter bid for the company, or generate sufficient propaganda to stall the transaction and frustrate both Aggarwal and Cairn UK out of the deal.

It is surely going to be an interesting few months which will follow yesterday’s major announcement. All of us can but venture a guess on how this whole thing will play out…but one thing is for certain. In the unforgettable words of Sherlock Holmes, ‘the game is surely afoot’….