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Institutional EYE

Commentary on Corporate Governance Issues

Debt default risks of the holdco must not sway Vedanta’s Independent Directors

The failed delisting will only result in increased pressure on Vedanta Limited’s cash flows to support group debt: it has already committed a USD 1.05 bn support to its parent company. Independent Directors, more so than ever before, need to arrest the financial support to the group, which comes at the cost of the minority shareholders’ interest. In maintaining a passive stance, the Independent Directors are failing in their fiduciary responsibilities.

The failure of delisting puts both the promoters and the investors in a difficult spot. For the promoters, their access to cash flows to support group debt has been curtailed by the continuing need to manage minority shareholders. For shareholders, they will continue to bear the brunt of cash flow leakages to the holding company, at the cost of their returns and dividends.

The Vedanta group is heavily leveraged (Exhibit 1) with debt on 31 March 2020 aggregating USD 15.1 bn (Rs. 1.11 trillion), almost half of which resides in Vedanta Resources Limited (the holding company, referred to as holdco). This is further aggravated by the debt raised for delisting Vedanta Limited (VEDL) – the group raised USD 3.15 bn (Rs.231.5 bn1), of which USD 1.75 bn (Rs.128.6 bn1) was in the form of a 3-month short term loan while USD 1.40 bn (Rs.102.9 bn1) comprised 3-year amortizing bonds at an annual coupon of 13%. Holdco debt aggregating USD 2.2 bn (Rs.161.7 bn1) – not including the short-term debt raised for the delisting – is scheduled to be repaid from April 2020 through December 2021. Since the holdco has no meaningful standalone operations, for the debt to be repaid, it will need access to the cash flows of its operating subsidiaries – VEDL and VEDL’s 64.92% subsidiary, Hindustan Zinc Limited (HZL).

If past behaviour is a reasonable prediction of the future, then VEDL’s shareholders must expect increasing cash outflow to the parent company at their expense. The most recent example of this is VEDL deviating from its dividend distribution policy and not paying out the Rs. 45 bn of interim dividend (for FY20) it received from HZL to its shareholders. Instead, it decided to extend a loan aggregating USD 307 mn (Rs. 27.23 bn), repayable in June 2021, via its foreign subsidiaries to the holdco in the first quarter of FY21: this is part of its USD 1.05 bn (Rs. 79.05 bn) commitment to support (in terms of loans and guarantees) the holdco debt. The 2015 $125 mn loan by one of Cairn India’s subsidiaries to one of Vedanta’s subsidiaries is another such transaction, skirting the need for shareholder approval (see our report ‘Vedanta’s delisting: Yet another replay’). In December 2018, Vedanta’s overseas subsidiary Cairn India Holdings Limited (CIHL) paid a part sum of $200 mn (Rs 14.31 bn) towards purchase of an economic interest in a structured investment in Anglo American PLC from Volcan. The ownership of the underlying shares, and the associated voting interest, remained with Volcan. VEDL extended these loans under the garb of better cash management and attempted to entice shareholders with a promise of better-than-treasury returns.

HZL’s shareholders are unlikely to face the same risk (as VEDL’s shareholders) of loans being extended to the holdco, largely because we expect the Government of India’s 29.54% shareholding and two board seats will play a stronger role in potentially containing such largess. However, it is likely that dividend outflow from HZL will remain high: the on-balance-sheet cash of Rs. 154.8 bn on 30 June 2020. For the holdco, though, its economic interest in HZL is 32.5% (holdco owns 50.14% in VEDL which owns 64.92% in HZL), which means that it can access at best USD 0.7 bn (Rs. 50.4 bn) if HZL were to pay out its entire cash as dividend.

With the increasing pledge of equity shares – 22.83% equity held by VEDL in HZL was pledged on 30 September 2020 – investors may run the risk of a potential change in control at HZL. To this extent, lenders must satisfy themselves that the shareholder agreement between the Vedanta group and the Government of India provides for a change in control in case of default.

There is no cross-default risk – if the holdco defaults on its debt, there are no implications for VEDL and HZL. The debt in both these operating subsidiaries can easily be supported by their operating cash flow: VEDL’s debt is rated CRISIL AA/Negative/CRISIL A1+ and HZL’s debt is rated CRISIL AAA/Stable/CRISIL A1+. Therefore, there is no rationale for shareholders of VEDL and HZL to support any cash outflow to the holdco: it is purely a need of the promoters.

VEDL has been using the regulatory loopholes to support the holdco debt. In giving loans through subsidiaries, it is avoiding the need for shareholder approval: the loans are related party transactions and would require the approval of majority of minority shareholders. Even so, giving these loans through subsidiaries needs the shareholder approval of the parent company (VEDL in this case), and the board’s acquiescence.

In approving these transactions, either formally or tacitly, IiAS believes VEDL’s board has failed in its fiduciary responsibility to protect the interests of VEDL’s shareholders. Both VEDL’s board and the holdco’s Independent Directors are eminent, well-established personalities (Exhibit 2 and Exhibit 3) who, in joining the board, have lent their reputation to the group. In allowing cash flow support to the group, and in bypassing the need for shareholder approval, they are doing a disservice to minority shareholders and themselves. VEDL’s Independent Directors need to stand up to the promoter – Anil Agarwal joined back the board on April 2020 and is now the Chairperson – and separate the interests of the company and its shareholders from the promoter’s desperation brought on by the group debt.

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