Dealmakers await verdict in Vedanta-Cairn Review

The Deal LLC
By Laura Board, Jun-10-2011


Any day now the Indian government will rule on Vedanta Resources plc's $9.6 billion acquisition of a controlling stake in Cairn India Ltd.

A verdict could end months of uncertainty about a 10-month-old energy deal that has been closely followed by aspiring investors who are increasingly skittish about india's "regulatory growing pains," as one observer politely puts it. The London-based, India-focused mining group's purchase of up to 60% of Cairn India, mainly from 62.25% owner Cairn Energy plc, was always going to face scrutiny as it ranked as the country's largest-ever oil and gas transaction. A dispute between the target and state-owned Oil and Natural Gas Corp. Ltd. over royalty payments from the jointly owned Barmer oilfields in Rajasthan, northern India, however, has complicated matters.

Although the bidder has secured 18.5% of Cairn India through two separate transactions, its August agreement to buy the Cairn Energy stake remains in limbo. That's largely because a 1995 arrangement - drawn up to entice a foreign partner with drilling expertise - makes ONGC liable for 100% of the royalty payments from the Barmer fields while its owns only 30% of the assets. That made sense at the time but after production began in August 2009 the oilfields quickly became India's most productive onshore site, with 240,000 barrels per day of expected peak output.

Just before the Vedanta-Cairn deal, ONGC demanded that royalty payments be recast as an operational cost allowing it to recover them from revenuer, rather than paying them out of its share of the profit. "No one expected Cairn to strike black gold or the volume of it," said Bundeep Singh Rangar, Chairman of India-focused Consultancy IndusView. "The math has worked against ONGC and the resumption of the liability for 100% of royalty payments would be a huge burden on the exchequer."

In early April the government appointed a ministerial panel led by Finance Minister Pranab Mukherjee to review the Vedanta-Cairn Energy transaction and the royalties dispute, after India's highest-ranking lawyer and its petroleum minister had called for a change to the royalties arrangement. The panel reportedly concluded at the end of May that Cairn India should share the royalty burden with ONGC. It hasn't confirmed its findings and the final decision lies with the Cabinet Committee on economic Affairs, which is expected to rule in coming days.

High-level government involvement from multiple departments, as well as the economic rather than antitrust emphasis of the review, has surprised M&A practitioners, said Kirkland & Ellis LLP's San Francisco-based partner Abrar Hussain. "For all the progress that India has made and all the transactions that are being done, this is a vestige of the pre-early 1990s, when every regulator wanted to get on the bandwagon and there were mountains of red tape," he said. "It seems like India has regulatory growing pains." The rapid growth of the Indian economy means the regulatory regime is a work in progress. "India is very comfortable with putting the regulation on the book and then correcting it as the process moves forward rather than having fully baked regulation on the book that's fully thought through," Hussain said.

Mr. Rangar draws comfort from the fact that the Indian government seems intent on avoiding the type of long, drawn-out litigation Vodafone Group plc experienced over the tax treatment in its 2007 purchase of a controlling stake in Hutchison Essar Ltd. "There's a huge requirement for foreign direct investment into India," he said. "By delaying the decision [on Vedanta-Cairn] they are fine-tuning a proposition that they can support within the proper legal framework. It's a bit of a wait-and-watch, but hopefully we're at the end of that phase."

Vedanta and Cairn Energy have become accustomed to waiting and watching, recently extending a revised May 20 deadline indefinitely. The probable changes to Barmer royalties arrangements could cost Vedanta-Cairn India millions of dollars, and the companies may yet face litigation from minority investors in Cairn India angry about a change to a lucrative arrangement.

Yet the sharp rise in the price of oil since the August deal, from under $80 per barrel to almost $120, bolsters the case for change. Indeed, many investors who were initially mystified by Vedanta's sudden diversification from mining into oil and gas now support the transaction. Credit Suisse Group analysts noted recently that strong oil prices mean the deal could boost Vedanta Resources' earnings by about 30%.

"A successful deal will also be positive for sentiment towards the Indian business environment," they added. Hussain fears the government may put the bonus back onto the companies to decide if they want to proceed rather than issuing a clear decision. That would be a mistake, he said. "I think the government has to act and has to act decisively as everyone's looking at this deal," he said.