Why investors should vote against Sesa-Sterlite merger

Just days before shareholders of Sesa Goa meet to consider the merger with Sterlite, advisory firm IIAS has recommended stakeholders of both firms to vote against the merger on grounds of a huge debt burden.

The merger will result in formation of a new entity called Sesa Sterlite, which could demand a valuation of more than $20 billion post the consolidation.The new entity will also get 70.5 percent of Vedanta Aluminium (an unlisted loss-making entity) from the parent company Vedanta Resources, who will in turn get 72 million shares of Sesa Sterlite. Vedanta Aluminium will subsequently be merged in Sesa Sterlite. What this means is that Sterlite will be servicing the debts taken by on Vedanta to acquire the stake from Cairn.

High transfer of debt to the new entity

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The shareholder activist advisory firm has warned that minority investors stand to lose out. It points out that before the merger shareholders of Sterlite and Sesa Goa did not hold any debt of Vedanta Aluminium, Cairn India or Malco, but after the merger revenue may rise 35 percent, but the total debt would rise by 400 percent!. “Additional debt of VAL and Cairn India (total of Rs 50,000 crore) will be transferred to the combined new entity, without fully resolving issues with regard to mining, resulting in the proposal being detrimental to minority shareholders of Sesa Goa and Sterlite,” it said.

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Moreover, Vedanta Aluminum’s mining assets are locked in disputes and litigations with the Indian government. According to the firm, the consolidation of VAL with Sesa Goa and Sterlite would only be favourable to minority shareholders after the necessary clearances and mining approvals have been obtained.

While the merger will help Vedanta save around Rs 1,000 crore every year and Sesa Sterlite will be used as a vehicle for further mergers and acquisitions, the restructuring was necessary to prevent the parent company from breaching a debt covenant, which would have been triggered had commodity prices slipped further, a Firstpost story noted earlier. Even IIAS argues that pre restructuring, Sesa Goa and Sterlite collectively are net cash companies. Post the consolidation of VAL, Cairn India and MALCO, the new entity will have gross debt of Rs 66700 crore.

Vedanata Alumunium’s net losses increased to Rs 2620 crore in GY12 from Rs 960 crore in the tyear-ago period. This means that the company will be largely dependent on external funding including debt and inter corporate deposits to finance its operations.

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Operational hurdles in VAL

That’s not all, Vedanta has been marred with operational issues for the last two years. In August 2010, the ministry of environment and forest denied a forest clearance for Niyamgiri Mines to Orissa Mining Corporation which is one of the prime source to supply bauxite to VAL.This has resulted in the production cost increasing to $2,100 per tonne vis–vis $1,600 per tonne. Given its operational losses, the company’s not going into profit mode for the next couple of years and its massive debt is sure to be serviced by Sesa and Sterlite.

Templeton, which owns a 13 percent stake in Sesa Goa, and is the second largest shareholder in the company after the founders, is also trying to block a planned merger between Sesa Goa and Sterlite Industries, said an Economic Times report earlier this week.

Templeton is worried about VAL’s huge debt burden of Rs 27,564 crore and the uncertainties shrouding the aluminum project. “At the current market price of Sesa Goa and Sterlite, there is an arbitrage opportunity compared to the merger swap ratio of 0.60. The fact that shareholders are not taking the opportunity is a reflection that they are not convinced about the merger, " said the ET Now report.

Last week, IIAS had asked shareholders of Infosys to vote against a resolution seeking the reappointment of its statutory auditors, while some shareholder of Mahindra Satyam protested against the share swap ratio they were offered in the proposed merger with Tech Mahindra.

It is clear that shareholders no longer prefer to remain mum on issues of corporate governance and feel that they must start asking tough questions. Even the Ministry of Corporate Affairs is planning a new set of regulations relating to corporate governance.