Workers stand, bottom right, as iron ore is transported and dropped into stockpiles in the Ferroport yard at the Acu Port in Sao Joao da Barra, Brazil. (Photographer: Dado Galdieri/Bloomberg)

Is Vedanta’s Investment In Anglo American A Governance Issue?

Vedanta Ltd. sparked corporate governance concerns after buying an interest in South African miner Anglo American Plc from the Indian group’s controlling shareholder and billionaire Anil Agarwal’s family trust.

Cairn India Holdings, fully owned subsidiary of Vedanta, paid Volcan Investments, which is also the group’s parent, $200 million, or Rs 1,431 crore, for an interest in Anglo American in December, according to a note to its earnings filing. The company will invest Rs 2,000 crore more in the miner, 19 percent owned by Agarwal, in the next 20 months.

The transaction raises serious corporate governance concerns since Vedanta through its foreign subsidiary is now financing a promoter entity, according to Amit Dixit, research analyst and assistant vice president at Edelweiss Institutional Equities Research. It’s not an optimal utilisation of shareholders’ money, he said.

Investors are worried, at least going by the stock reaction. Shares of the metals-to-mining company dropped as much as 18.04 percent, the most in more than a decade, to fall to their lowest since September 2016 on early trading on Friday.

Is Vedanta’s Investment In Anglo American A Governance Issue?

Agarwal, who holds stake in Anglo American in his personal capacity, has said earlier that the miner’s combination with Vedanta’s Zinc unit would have been a good match.

But the company, which met analyst estimates in the third quarter, brushed aside questions from analysts about whether this was a prelude to a potential broader deal with Anglo American, insisting that this was part of cash management.

Cairn India Holdings invested its surplus cash in Anglo American, which was better than investing into any of the low-return foreign currency fixed deposits, Srinivasan Venkatakrishnan, chief executive at Vedanta Resources, said in a conference call with analysts. “Also, the company’s subsidiary made some gains on mark to market basis given the gains of underlying security – Anglo American shares.”

But Rakesh Arora of Go India Advisors underscored the risks. “Assuming that the surplus is for the short term and these funds will be required for future growth, is it right to invest in a risky asset? More so if a downturn was to happen in commodities, Cairn will not only have lower income, they might lose money on this cash investment too,” he said. “Not the best corporate governance either.”

Shares of Anglo American have risen 17 percent from January but a consensus of 31 analysts tracked by Bloomberg estimate a downside of around 2 percent. Venkatakrishnan said the downside remains limited. Vedanta also said that the ownership of the underlying shares, and the associated voting Interest, remained with Volcan.

Arora said Vedanta has treated cash flows between group companies casually and that has led to lower valuations compared with peers. “It was assumed that a simplification of the group structure would solve this corporate governance issue.”

Brokerage View

Macquarie

  • December quarter’s Ebitda was below expectation led by loss at aluminium division.
  • Purchase in economic interest in Anglo American from parent should raise capital allocation risks.
  • Vedanta cut 2018-19 volume guidance for oil and zinc international division.
  • Maintained ‘Outperform’; cut target price to Rs 223 from Rs 260.

CLSA

  • Ebitda rose sequentially but was a miss mainly led by zinc.
  • Related party transaction raises concerns on use of cash.
  • Concerns are likely to drag down Vedanta’s valuations as well.
  • Downgraded to ‘sell’ from ‘buy’; cut target price to Rs 170 from Rs 250.

Motilal Oswal

  1. Ebitda was in line, but mark-to-market gains lead to net profit beat.
  2. Related-party transaction will lead to de-rating.
  3. Transaction appears at arm’s length but the counter party risk is high because the parent drives its value from Vedanta and is highly leveraged.
  4. Downgraded to ‘Sell’ from ‘buy’; cut target price to Rs 170 from Rs 230.

Agarwal’s Investment And What Cairn India Gets

Motilal Oswal laid out the structure of the investment:

  • Volcan initially acquired shares and voting rights of over 12 percent in Anglo American—increased stake later to 19 percent.
  • Pays a 4.125 percent per annum coupon.
  • Retains the first 10 percent upside on the shares.

Volcan will the flexibility to settle the structure in shares or cash at the prevailing price of the underlying shares of Anglo American’s shares, according to Motilal Oswal. In the event where share price is higher than reference prices, the structure will be unwound as Volcan will return all Anglo American’s shares to Cairn India.

The brokerage said the reference price for the structure and the price at which Volcan buys shares would be set using 15-day volume weighted average price starting Jan. 31.

Also read: Q3 Results: Vedanta’s Profit Hit By Lower Copper Production