SESA STERLITE MERGER Creating a commodity giant

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1 SECTOR UPDATE SESA STERLITE MERGER Creating a commodity giant India Equity Research Metals and Mining To simplify its corporate structure, the Vedanta Group has announced the merger of Sesa Goa and Sterlite Industries in the ratio of 3:5 to create a commodity giant (Sesa Sterlite). The combined entity will also own 58.9% in Cairn India (by transfer of Vedanta s 38.8% stake in Cairn along with debt of USD 5.9bn) and fully merge VAL and MALCO with itself. Though the merger ratio favours Sterlite shareholders, our negative valuation for VAL lessens this favourable impact. We maintain BUY/SO on Sterlite but reduce target price from INR165 to INR150. However, this does not factor in benefits of potential re rating from scale, diversification and corporate structure simplification. For Sesa Goa shareholders, we believe that benefits of ownership in higher value zinc business are negated by VAL merger and an unfavourable merger ratio. We maintain HOLD recommendation on Sesa with a reduced target price of INR250 (from INR257). Valuation drag of VAL, Cairn mitigated by tax set off We are ascribing a negative valuation of INR44.6bn for VAL against the positive valuation of INR23bn implied in the restructuring. However, with VAL s accumulated losses of INR57bn, available tax set off of ~INR17bn mitigates this drag. Our oil and gas team s fair valuation of Cairn at INR342/share is also lower than the implied valuation of Cairn at INR396/share which also drags down our valuation for Sterlite. Scale, simpler structure key potential positives Post the merger, the entity would be among the top ten diversified commodity plays with a proforma FY13 EBITDA and PAT of USD5.7bn and USD2.3bn respectively. On proforma basis, the merged entity, at current prices, trades at FY13E EV/EBITDA and P/E of ~3.5x and ~5.7x respectively, which is attractive. We see the possibility of a rerating based on scale and simpler structure, but at this stage, we do not assume benefits of the same. Outlook & valuations: Advantage Sterlite; maintain HOLD on Sesa Proforma financials of the combined entity for FY13 and FY14 indicate a 3% EPS cut for both years, led by the interest outgo on the increased debt of USD5.9bn inherited from the Cairn transaction. We maintain our BUY/Sector Outperformer rating/recommendation on Sterlite with revised target price of INR150 (earlier INR165) and maintain HOLD/Sector Performer on Sesa Goa with revised target price of INR 249 (earlier INR 257). Prasad Baji prasad.baji@edelcap.com Navin Sahadeo navin.sahadeo@edelcap.com February 27, 2012 Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

2 Proforma financials of new entity indicate ~3% EPS cut for FY13 FY14 Our estimates of the EPS for Sesa on a pre and post restructuring base show ~3% cut for both FY13E and FY14E. This goes in line with our estimate of a negative valuation impact of the transaction. Table 1: FY13 proforma summary P&L of individual and merged entity (INR mn) Company Sesa Goa Sterlite Cairn India VAL MALCO Sesa Sterlite Ownership by combined entity (%) Revenue 91, , ,367 70,799 3, ,898 EBITDA 31, , ,244 14, ,403 Interest 4,051 10,690 2,055 14,505 44,371 Depreciation 2,122 20,621 18,262 9,373 50,377 Other Income ,260 4,308 26,099 PBT 26, ,135 96,235 (8,933) 1, ,754 Tax 8,596 21,199 6,736 (3,037) ,828 less: minority interest 27,116 63,900 Add : profit of associates 17,900 (1,739) 0 PAT 35,352 71,081 89,499 (5,896) ,027 No. of shares (mn) 869 3,361 2,964 EPS (INR) Change in EPS (%) (2.9) Table 2: FY14 proforma summary P&L of individual and merged entity (INR mn) Company Sesa Goa Sterlite Cairn India VAL MALCO Sesa Sterlite Revenue 98, , ,015 68,086 3, ,624 EBITDA 35, , ,765 14, ,249 Interest 3,531 10,548 1,736 14,505 43,390 Depreciation 2,175 23,803 19,656 9,819 55,452 Other Income ,502 6,443 32,591 PBT 30, ,375 98,816 (9,964) 1, ,998 Tax 10,065 23,866 6,917 (3,388) ,795 Less: minority interest 32,449 70,220 Add : profit of associates 18,380 (1,940) 0 PAT 38,815 78,120 91,899 (6,576) ,983 No. of shares (mn) 869 3,361 2,964 EPS (INR) Change in EPS (%) (3.3), Edelweiss research 2 Edelweiss Securities Limited

3 Table 3: Proforma Balance Sheet as at the end of December 2011 INR mn USD mn Sources of funds Net worth 735,777 14,924 Gross debt 667,170 13,533 Minority interest 270,000 5,477 Deferred tax liability 20, Total 1,692,947 34,340 Uses of funds Net block 790,000 16,024 Goodwill 591,600 12,000 Cash + investments 297,810 6,041 Net working capital 13, Total 1,692,947 34,340 Proforma capital structure pre and post transaction, Edelweiss research The total number of shares outstanding by Sesa Goa would increase from the current 869mn to 2,965mn post the restructuring. Minority investors of Sterlite and Sesa would own equity of 28.4% and 13.2% respectively in the combined entity. Table 4: Pre and post restructuring capital structure Sesa Goa shareholding Pre restructuring Post restructuring No. of shares(mn) % holding No. of shares(mn) % holding Vedanta Resources ("Vedanta") , Existing Sterlite merger Direct 1, Sterlite merger through MALCO Sterlite merger through VAL Investors , Sesa Goa existing Sterlite investors MALCO investors Total , New Sesa shares issued as part of transaction To Sterlite shareholders No. of shares (mn) % holding Vedanta 1,101.0 MALCO 72.6 Investors ,016.4 To MALCO shareholders Vedanta 74.6 Investors To Vedanta for VAL 72.3 Sterlite current shareholding Vedanta 1, MALCO Investors 1, Total 3, , Edelweiss research 3 Edelweiss Securities Limited

4 Strategic rationale of the proposed restructuring Consolidation and simplification of the group structure Creation of scaled up entity (revenues of USD15bn) with a presence across commodities (i) metals : zinc, copper and aluminium (ii) natural resources : iron ore, crude as well as (iii) power leading to possibility of improved valuation multiple and economies of scale Synergy benefits including tax benefits from accumulated losses of VAL. Outlook & valuations: Advantage Sterlite; maintain HOLD on Sesa On a proforma basis, we value the new entity viz. Sesa Sterlite at INR250/share ~3% lower than our existing price target of INR257. For Sterlite, our price target reduces to INR150/share from INR165. We maintain HOLD on Sesa Goa and BUY on Sterlite. The negative impact on valuation is on account of the following: 1. Our equity valuation of Vedanta Aluminium (VAL) is negative INR44.7bn; management is ascribing a positive valuation of INR23.3bn based on DCF and obtaining captive bauxite mines in three years. We are not assuming captive bauxite hence estimate a negative PAT even in FY Higher valuation ascribed by the management to Cairn as compared to our estimates: Our oil and gas research team estimates fair value of Cairn to be INR342/share (CMP: INR381/share) based on long term Brent crude price of USD95/bbl. We have considered the same in our valuation analysis. The implied price of Cairn is INR 395/share in the transfer of the 38.8% stake of Cairn to Sesa Sterlite. However, with VAL s accumulated losses of INR57bn, available tax set off of ~INR17bn mitigates the above drag on valuation. Further, we have considered recurring synergy benefits of INR 1bn in the merger. 4 Edelweiss Securities Limited

5 Table 5 : Fair valuation of combined entity at INR250/share Post-Restructuring : Sesa-Sterlite SOTP valuation India zinc VAL Applicable multiple (x) 6.0 Applicable multiple (x) 5.0 FY13E EBITDA (INR mn) 47,387 FY13E EBITDA (INR mn) 14,944 Silver applicable multiple (x) 8.0 Enterprise value of business (INR mn) 74,721 Silver EBITDA (INR mn) 21,072 Less: Debt (INR mn) 195,031 Enterprise value of business (INR mn) 452,895 Add: Adjusted CWIP (INR mn) 75,639 Add: Cash + Investments (INR mn) 177,478 Valuation of VAL (INR mn) (44,672) Less: Debt (INR mn) 4 Sesa Sterlite valuation share (INR mn) (44,672) Equity valuation of HZL (INR mn) 630,369 Sesa Sterlite valuation contribution per share (INR) (15) Sesa Sterlite valuation share (INR mn) 409,110 Power business Jharsuguda Sesa Sterlite valuation contribution per share (INR) 138 Equity valuation based on DCF (INR mn) 54,088 Copper Price/book (x) 2.1 Applicable multiple (x) 5.0 Sesa Sterlite per share in power Jharsuguda (INR) 18 FY13E EBITDA (INR mn) 11,077 Iron ore Enterprise value of business (INR mn) 55,386 Equity valuation of iron ore business (INR mn) 118,025 Add: Cash + Investments (INR mn) 39,217 Less: Debt (INR mn) 40,880 Sesa Sterlite per share in iron ore (INR) 40 Sesa Sterlite valuation share (INR mn) 53,724 Sesa Sterlite valuation contribution per share (INR) 18 International zinc business BALCO Applicable multiple (x) 5.0 Applicable multiple (x) 5.0 FY13E EBITDA (INR mn) 18,177 FY13E EBITDA (INR mn) 19,252 Enterprise value of business (INR mn) 90,883 Enterprise value of business (INR mn) 96,259 Add: Cash + Investments (INR mn) 11,590 Add: Cash + Investments (INR mn) 1,356 Less: Debt (INR mn) 0 Less: Debt (INR mn) 39,203 Valuation of international zinc (INR mn) 102,473 Add: Adjusted CWIP (INR mn) 11,997 Sesa Sterlite valuation contribution per share (INR) 35 Valuation of BALCO (INR mn) 70,409 Sesa Sterlite valuation share (INR mn) 35,908 Valuation of synergy benefits Sesa Sterlite valuation contribution per share (INR) 12 Synergy benefits (INR mn) tax set off, one time 17,100 Multiple 1 MALCO (unlisted) Synergy benefits (INR mn) recurring 1,000 EV of power plant of 100 MW (INR mn) 4,500 Multiple 5 Add : net cash on balance sheet (INR mn) 1,870 Total synergy benefit valuation (INR mn) 22,100 Equity valuation (INR mn) 6,370 Sesa Sterlite valuation contribution per share (INR) 7 Sesa Sterlite valuation contribution per share (INR) 2 Total valuation (INR mn) 848,887 Cairn India No. of shares (mn) 2,964 Cairn fair value (INR/share) 342 Gross value of SIL (INR/share) 286 Cairn company fair valution (INR mn) 656,640 Less : Holding 20% 36 Sesa Sterlite valuation share (INR mn) 386,761 Fair value per share (INR) 250 Less : Debt transferred (INR mn) 295,000 Current market price per share (INR) 204 Sesa Sterlite valuation share (INR mn) 91,761 Upside (%) 22.7 Sesa Sterlite valuation contribution per share (INR) 31 Source: Edelweiss research 5 Edelweiss Securities Limited

6 Table 7: Working of current target price (TP) of Sterlite of INR 165/share Table 6: On an existing basis, revised TP of Sterlite works out to INR150/share Sterlite fair value existing basis Sesa Sterlite fair value per share (INR) 250 Merger ratio (x) 0.6 Sterlite valuation per share existing basis (INR) 150 Current market price per share (INR) 116 Upside (%) 29.7 Source: Edelweiss research Pre-Restructuring : Sterlite fair value SOTP valuation India zinc VAL Applicable multiple (x) 6.0 Applicable multiple (x) 5.0 FY13E EBITDA (INR mn) 47,387 FY13E EBITDA (INR mn) 14,944 Silver applicable multiple (x) 8.0 Enterprise value of business (INR mn) 74,721 Silver EBITDA (INR mn) 21,072 Less: Debt (INR mn) 195,031 Enterprise value of business (INR mn) 452,895 Add: Adjusted CWIP (INR mn) 75,639 Add: Cash + Investments (INR mn) 177,478 Valuation of VAL (INR mn) (44,672) Less: Debt (INR mn) 4 SIL share in valuation total (INR mn) (13,178) Equity valuation of HZL (INR mn) 630,369 SIL share in valuation per share (INR) (4) SIL share in valuation total (INR mn) 409,110 Power business Jharsuguda SIL share in valuation per share (INR) 122 Equity valuation based on DCF (INR mn) 54,088 Copper Price/book (x) 2.1 Applicable multiple (x) 5.0 SIL per share in power Jharsuguda (INR) 16 FY13E EBITDA (INR mn) 11,077 Power business Talwandi Sabo Enterprise value of business (INR mn) 55,386 Equity valuation based on DCF (INR mn) 0 Add: Cash + Investments (INR mn) 39,217 Price/book (x) 0 Less: Debt (INR mn) 40,880 SIL per share in power Talwandi (INR) 0 Valuation of standalone business (INR mn) 53,724 Val.of standalone business per share (INR) 16 International zinc business BALCO Applicable multiple (x) 5.0 Applicable multiple (x) 5.0 FY13E EBITDA (INR mn) 18,177 FY13E EBITDA (INR mn) 19,252 Enterprise value of business (INR mn) 90,883 Enterprise value of business (INR mn) 96,259 Add: Cash + Investments (INR mn) 11,590 Add: Cash + Investments (INR mn) 1,356 Less: Debt (INR mn) 0 Less: Debt (INR mn) 39,203 Valuation of international zinc (INR mn) 102,473 Add: Adjusted CWIP (INR mn) 11,997 SIL per share in international zinc (INR) 30 Valuation of BALCO (INR mn) 70,409 SIL share in valuation (INR mn) 35,908 Total valuation (INR mn) 642,125 SIL share in valuation per share (INR) 11 No. of shares (mn) 3,361 Gross value of SIL (INR/share) 191 Less : Holding 20% 26 Fair value per share (INR) 165 Source: Edelweiss research 6 Edelweiss Securities Limited

7 Simplifying the group s structure Fig. 1: Existing corporate structure of Vedanta Group Table 8: Working of current TP of Sesa of INR 257/share Pre-Restructuring : Sesa fair value FY13E EBITDA (INR mn) 31,520 Applicable multiple (x) 4.50 EV (INR mn) 141,839 Cash as on March 2012 (INR mn) 18,906 Addl. debt taken for Cairn stake purchase (INR mn) 33,314 FCCB considered debt (INR mn) 9,406 Market cap (INR mn) 118,025 Sesa no of shares (mn) 869 Sesa fair value ex Cairn (INR/share) 136 Cairn fair value (INR/share) 342 Cairn fair company valuation (INR mn) 656,640 Sesa stake in Cairn (%) 20.1% Cairn value attributable to Sesa Goa (INR mn) 131,985 Sesa Goa no of shares (mn) 869 Cairn value attributable to Sesa Goa/share (INR/Share) 152 Holding company discount (%) 20.0 Fair value attributable to Sesa Goa (INR/Share) 121 Total fair value of Sesa (INR/Share) 257 Company fair valuation of Sesa (INR mn) 223,612 Source: Edelweiss research From the current complex holding structure of Vedanta Resources, the new proposed structure gets all holdings under one umbrella to be called Sesa Sterlite. Vedanta s 79.4% holding in Konkola Copper remains unchanged. 7 Edelweiss Securities Limited

8 Fig. 2: Proposed corporate restructuring Proposed transaction steps Step 1: Sterlite to merge with Sesa Goa 8 Edelweiss Securities Limited

9 Sesa Goa to issue 3 shares for every five shares held in Sterlite Industries. Sesa Goa would also require to issue ADS to the existing ADS holders of Sterite. Step 2: VAL to be consolidated into Sesa Sterlite Vedanta s stake in VAL will be consolidated in Sesa Sterlite through merger of Ekaterina Limited ( Ekaterina ), a 100% subsidiary of Vedanta in Mauritius, with Sesa Goa. In consideration, Sesa Goa will issue 72.3 mn shares to the shareholders of Ekaterina based on the share swap ratio. Post this VAL to demerge its aluminium business undertaking into Sesa Sterlite. Demerger shall be effective after VAL becomes a subsidiary of Sesa Sterlite pursuant to the merger of Sterlite and Ekaterina. Step 3: MALCO to merge into Sesa Goa. 9 Edelweiss Securities Limited

10 In consideration, Sesa Goa to issue 78.7 mn shares to the shareholders of MALCO based on the share swap ratio. Shares held by MALCO in Sterlite will get extinguished on merger. Power plant of MALCO will be transferred to VAL as part of the same Scheme. Step 4: SEL to merge into Sesa Goa. In consideration, no shares to be issued as SEL will be a wholly owned subsidiary of Sesa Sterlite Step 5: Transfer of Cairn India s stake 10 Edelweiss Securities Limited

11 Currently, Vedanta holds a 38.8% stake in Cairn India through two subsidiaries, Twinstar Energy Limited ( TEL ) and Twinstar Mauritius Holdings Ltd. ( TMHL ). TMHL had acquired a stake in Cairn India by borrowed funds from Vedanta and banks. Bloom Fountain Limited ( Bloom ), a wholly owned subsidiary of Sesa Goa, shall acquire shares in TEL. 11 Edelweiss Securities Limited

12 Edelweiss Securities Limited, Edelweiss House, off C.S.T. 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