Sesa-Sterlite merger: What it means for investors

The first step of the restructuring, which will entail the merger of Sterlite industries into Sesa Goa in a share swap ratio of 5:3, on the face of it, looks attractive for Sterlite shareholders. This is because five shares in Sterlite are worth Rs 593 at current market prices, while three shares in the Sesa Goa are valued at Rs 682.

However, it can be argued that Sterlite Industries is under-valued in the market, trading as it does at a PE of just 5.4 times trailing 12-month earnings, while Sesa Goa trades at 6.6 times. This is despite Sterlite's more diverse range of businesses including aluminium, copper, zinc and power (apart from by products such as gold and silver). In contrast, Sesa Goa only has iron ore assets which are subject to business uncertainties too. Sterlite also owns a valuable asset in its controlling stake in Hindustan Zinc. Sterlite's investment in Hindustan Zinc alone is worth Rs 110 a share. This tilts the scales in favour of Sesa's shareholders as opposed to Sterlite's. At the end of the proposed transaction, Sesa Sterlite will be a diversified mining company with interests in oil, zinc, iron ore, aluminium copper and energy. This broad product mix (in different geographies) could provide some defence against the volatility inherent in commodity price cycles and regulatory risks inherent to mining.

But weighed against this, Sesa and Sterlite have combined debt levels of Rs 20,000 crore. Including Cairn India, debt levels for the combined entity are likely to tip over the Rs 50,000 crore -mark. To service this will require a steady stream of cash.

At a macro level, putting all three entities — Sterlite (Hindustan Zinc), Sesa Goa and Cairn India (along with the acquisition) together — works to Vedanta's advantage. It can tap or at-least leverage the rich cash reserves and free cash-flow of the Indian zinc operations to service debt. More than a merger to rationalise its holdings, this is a merger of necessity for Vedanta's pack of companies which are likely to get very cash-hungry in the next five years.

But for investors, this could mean a more opaque company which is harder to value. After all, even in the past, Sterlite Industries has traded at a discount to pure-play miners with copper or aluminium assets. With this holding company structure and debt to boot, Sesa Sterlite may still trade at a discount to global mining giants with more focussed operations.

COMMENT NOW