Vedanta demerger- value unlocking or red flag for investors?

Summary

Recent news of Vedanta's demerger into 6 different entities have created euphoria for the company, resulted in fresh buying and increase in positivity for company. However there are many hidden insights inside this action. We would simply understand this in the article

Recently, Chairman of Vedanta resources announced that the Vedanta limited, parent company of the group would demerge into 6 different public companies, which are-

1. Vedanta Aluminium: Vedanta Aluminium is one of the world’s leading producers of aluminium and largest aluminium producer in India with a capacity of 2.3 mtpa and a 40% market share in India’s aluminium industry. The company formerly knew as Bharat Aluminium Company Limited (BALCO) which formed as PSU in 1965 but In 2001 Govt. of India disinvested 51% shares of BALCO to Sterlite Industries Limited a subsidiary of Vedanta Limited.

2. Vedanta oil and gas: Vedanta Limited's Oil & Gas operations comprise the assets of Cairn contributing over 26% of India's annual production, as India's largest private sector crude oil producer. On 11 April 2017, Vedanta Limited announced the merger with Cairn India, unanimously recommended by the independent directors, at both Vedanta Limited and Cairn India

3. Vedanta Power: Vedanta is one of India’s largest private sector power generators.

The company’s power business include Talwandi Sabo Power Limited (TSPL), a wholly-owned subsidiary of Vedanta Ltd which signed a power purchase agreement with the Punjab State Power Corporation Limited (PSPCL). Till now TSPL supplied 6399 Million Units to PSPCL.

4. Vedanta Steel and Ferrous: Vedanta entered the steel business through acquisition of 90% stake in ESL Steel Limited (ESL) In June 2018 previously, ESL, an Integrated Steel Producer, was incorporated in 2006 as a Public Limited Company with operations in Bokaro. Currently, operations are commissioned at a capacity of 1.5 MT per annum.

5. Vedanta base metals: It comprised of processing, mining and refining of 3 base metals- Zinc, Lead and Silver. The most prominent is Zinc where operations comprise Hindustan Zinc Limited in India and the assets of Zinc International across Namibia, South Africa and Ireland. Currently Vedanta ownes 64.9% of the share capital of HZL (Hindustan Zinc Limited), while the Government of India remains an equity partner and holds a 29.5% stake.

6. Vedanta Limited: Parent company of Vedanta, Consist of Hindustan Zinc, Semiconductor business, display business and Vedanta stainless

Purpose of Potential demerger of the company-

According to the chairman, Mr Anil Agrawal “the demerger of Vedanta was aimed at building a simplified corporate structure that would appeal to focused investors. Separate listed companies for each vertical should boost the valuations of revenue streams that typically have slightly different business cycles and competitive dynamics despite sharing the broader industry classification of commodities and natural resources”

So according to him, the demerger of company would allow investors to invest in that sectors of Vedanta that would be seen appealing to them, as to invest in whole Vedanta group.

So the question arises, why the group is not seen appealing to investors so that it needed an demerger? Is Vedanta demerging just for their own profits or to unlock value to their shareholders? Let’s discuss

Cripping debt of Vedanta group-

In 2023, Vedanta’s total long term debt stood at 66,628 Crores, increase of almost 40% from last vear borrowing of 53,583 Crores. Against this the Net profit stood at 14,503 Crores, decrease of 45% from last year’s net profit of 23,710 Crores.

The operating cash flow of company stood strong against the net profit at consistent 33,000 Crores.

However despite the strong numbers, why company took much loan and for what purpose?

The answer lies in Cash flow statement, mainly the borrowings which Vedanta took later year were much given to shareholders as dividends, with whopping 41000 Crores, which makes dividend pay-out ratio of 357%, meaning against profit of 14000 Crores, Vedanta gave 41000 Crores as dividends.

So why Vedanta give 3 times more dividend as net profits to shareholders, the reason mainly is to repay loans worth $400 Million of Vedanta resources, parent company of Vedanta which were due on May and June 2023.

As Vedanta resources does not have enough cash at that time, It used the dividend route of Vedanta Limited in India to generate cash. As 68% of holdings of Vedanta limited are with Vedanta resources, it siphoned cash through the route.

However things were not looking good ahead as Moody downgraded the rating from Caa1 to Caa2 in March of 2023, which forced company to pay $ 2 Billion of their existing $9.7 Billion Debt ahead of time. Recently S&P also downgraded the ratings from B- to CCC and placed it under "creditwatch with negative implications"

But Now it faces next challenge of repayment of $ 2 Billion of debt for next year. Recent year alone the group paid 5500 Crores as Interests on Loan. The global increase in borrowing costs gave new challenges to the firm,. Several bonds of the group are currently trading below 75 cents on the dollar

With rising borrowings, downgrade of ratings and hefty discount on prices of bonds, what path remained with Vedanta- Demerger

What is Demerger?

According to Google, demerger is the separation of a large company into two or more smaller organizations, particularly as the dissolution of an earlier merger.

Why companies demerge?

1. Tax benefits

2. Improved strategic focus

3. Improved profitability

4.  Cash injection

In Vedanta’s case, company says that they want to improve strategic focus and it would help companies to focus more on operations

But it is not the full case…

Vedanta is aggressive on expansions, and want more cash to increase their production levels and portfolio, for this, they need large amount of surplus cash, but due to recent activities of near brink of repayment default and constant rating cuts, they are facing difficulties to take loans, and low rating of credit means they have to pay extra interest for new debts

The potential demerger would help company to take loans individually, where they would focus upon individual small companies and show their portfolio to lenders for potential credit. It could happen that management could show all the debt to Vedanta Limited's books which is parent company and keep nil debt to their subsidiaries, which would show their better financial health and could easily take credit at much less costs.

But is this type of demerger successful?

For this, let’s take example of past two big conglomerates in India, Anil Ambani’s Reliance and Kishor Biyani’s Future Retail

After the successful demerger of Reliance, Anil Ambani got hands in new age companies- Reliance Power, Reliance Communications, Reliance Infra, Reliance capital and much more. Anil Ambani was very much bullish on expansion of business to various verticals, for that it took hefty loans on infrastructure development and buyout of companies, He also purchased companies which are not related to business, such as Reliance naval and engineering.

However things where not looking good when he defaulted on various debt repayments and soon started demerging and selling different verticals of the company, just to take more loans, but at last, the companies failed and soon went to bankruptcy.

For kishor Biyani’s Future retail, The problems started due to excessive restructuring and demerging of the business units, it was mainly due to The speed of expansion, acquisition of more retail assets left the company burdened with huge debt. Later company sold their business units to recover money and COVID-19 further crippled the company’s financials which then later, went to solvency and further took over by reliance retail.

We can see from above case that split ups of companies could not sustain much in the future.

So what is in the mind of promotors behind the demerger?

For this, we have to look upon past at year 2020, when Vedanta announced their plan to make company private. The motive behind was for to have more control over the business and to easily transfer funds around their companies without much intervention.

Vedanta announced buyback at rate of Rs. 87.5, Which was announced during the bottom made by stock during COVID-19. But the market soon started to recover and share price increased substantially, which ultimately cancelled the offer

Now when their delisting failed, promotors started to buy shares from open market

From the shareholding pattern, promotors holding started increasing from 50.14% to 68.11% in nearly 3 years. They have purchased shares at much higher prices that their delisting quote, which suggests that promotors knew that intrinsic value of stock is much higher and they deliberately misguided their own shareholders.

In recent news also, Vedanta was seen guilty of providing false information to the public, two of them recent is Foxconn semiconductor deal and Asset purchase by Hindustan Zinc, both were shown as positive for company but the deal soon cancelled or could not gone further

Technicals of Vedanta limited

Before the news, price of Vedanta limited was in downtrend, touching the critical support of Rs. 208, if that support could have been broken, we would have seen COVID time price levels, With next support at Rs. 160 and at Rs. 133. but after the news, we have seen fresh buying in the stock, mainly by the retailers. The next resistance for stock would be at Rs. 235 which is 50 SMA, followed by Rs. 243 and Rs. 260.

It is uncertain that the current price levels would sustain or not after the news as the price movement was surely because of news.

It is not recommended to have fresh entry on stock at current levels, if traders want to enter, they can at Price of Rs. 243 with high volumes.

Conclusion

With may red flags, we can judge that main cause of vedanta’s demerger is not for value unlocking. With high debts piling up and almost all pledged shares, it is uncertain for vedanta’s future to be bright in near future