Cairn India Ltd. IPO

Background

• Cairn India Ltd (Cairn) is a newly incorporated Indian company promoted by Cairn Energy PLC, a crude oil and natural gas exploration and production company of UK. Its core area of focus is South Asia: it holds material exploration and production rights in India, Bangladesh and Nepal.
• Cairn was incorporated on 21 August 2006 to consolidate Cairn Energy’s business and interests in India. Cairn is acquiring its assets and business through acquisition of Cairn’s subsidiaries: Cairn Energy Australia Pvt Ltd (CEA), Cairn Energy hydrocarbons (CEH) and Cairn Energy India Holdings B.V (CEIH).
• Cairn India has been exploring and operating in India for over 12 years in partnership with the GoI, state governments, regulators and key industry participants such as ONGC. Cairn has working interest in various oil and gas blocks spread primarily across the Cambay Basin, the Krishna Godavari (KG) Basin and Rajasthan. In addition to this, Cairn has bid for around 12 blocks (eight deepwater, one shallow water and three onshore).
• For the six months ended 30 June 2006, the total gross production rate from fields in which Cairn operates was approximately 87,500 boepd (barrels of oil equivalent per day) of which company had a working interest in 24,000 boepd. It currently operates 12 offshore platforms, approximately 250 km of sub-sea pipelines and 3 processing plants.
• Rajasthan block development’s first commercial production at Mangala will start during 2009. The commencement of production from the Bhagyam and Shakti fields will be within six months and the Aishwariya field within 12 months of commencement of production from the Mangala field. All of the major regulatory clearances have already been obtained.
• Cairn has made a pre IPO placement at Rs.176.48 per share to PETRONAS International Corporation Ltd (10%), Merrill Lynch International Investment Funds & ABN AMRO Bank N.V., London Branch (0.72% each) & 0.43% to other domestic players (excluding green shoe option).
• Post-issue the total number of shares of the company will increase from 122.7 crore to 176.5 crore, bringing down the stake of the promoter (Cairn Energy Plc.) to 69.5%, excluding the exercise of the green-shoe option by the company.

Objects of Issue:

• For development in the Rajasthan block and additional drilling activities in Ravva and Cambay blocks with an investment of Rs.5,525 crore (approx.)
• For exploration and appraisal activities with an investment of Rs.691crore.
• For cash consideration to be paid to Cairn UK Holdings Ltd as consideration for shares of Cairn India Holdings Ltd.

Strengths

• Estimated total gross proved plus probable (‘‘2P’’) reserves from the fields in which Cairn India has interests is 754 mmboe (million barrels of oil equivalent) approx. and its net working interest in these 2P reserves is 472 mmboe. Most of the 2P reserves are estimated to be in the Rajasthan block, in which Cairn has 70% working interest. Also, the gross contingent resources attributable to these fields are 413 mmboe.
• Cairn India will operate approximately 20% of India’s oil production by 2010. Cairn’s share of gross oil production would increase from around 21,500bopd (barrels of oil and condensate per day) to over 125,000 bopd (without considering the profit oil share of the government) over the next four to five years. A 5.8 times increase from existing production.
• Cairn India has long and proven exploration expertise in India, It has made 30 hydrocarbon discoveries since 1994, including three of the seven landmark discoveries of India.
• Cairn India commenced natural gas production of the Lakshmi field in the Cambay Basin in less than 30 months following discovery and, at the Ravva field in the KG Basin, Cairn India increased crude oil production from an initial 3,700 bopd to 35,000 bopd in 26 months and ultimately to the current plateau of 50,000 bopd in 1999. Hence, has a proven track record in efficient exploration activities.
• Cairn India is also an established low cost operator in India. The average combined direct field operational expenditure at all the production facilities was less than U.S. $1 per boe in the first half of 2006. The cost of producing oil from the Mangala field of Rajasthan will be around USD 3.5- USD4 (bopd).
• India is currently the sixth largest consumer of oil and gas, a net importer of crude oil and natural gas. In 2005, India consumed 115.7 million tonnes of crude oil, yet it produced only 36.2 million tonnes. Thus, domestic demand for hydrocarbons far exceeding supply in recent years, and expected to continue to do so. The International Energy Agency has predicted that between 2003 and 2030 India will experience an average annual oil demand growth rate of 2.7%, in contrast, the predicted world growth rate is expected to be 1.4%.

Weakness

• Crude from the northern fields is of waxy nature, which tends to solidify quicker than is commonly the case for most producing oil fields. This presents both extraction and transportation risks.
• According to a leading daily, Oil Corporation (IOC) has sought heavy discounts from Cairn for buying crude oil from Rajasthan to compensate for lower quality of crude to the tune of USD 5-USD10 per barrel.
• MRPL to purchase crude oil under the Rajasthan Block has challenged before SEBI some disclosures made by the company regarding building a pipeline to evacuate crude. GOI has appointed MRPL the official nominee whereas ONGC (promorter MRPL) maintained that it would be ready to buy crude from Barmer only if it is economically feasible.
• Since the commencement of significant investment in the exploration and appraisal of the Rajasthan Block in 2002 and, in the near future, due to the development of the Mangala field and other fields in the Rajasthan Block, Cairn India is expected to be cash flow negative.

Valuation

The offer price band is Rs 160-Rs 190. Based on the consolidated financials of CEA, CEH and CEIH for the year ended December 2005, profit after tax (PAT) stands at Rs 92 crore. Based on existing financials, there is no significant EPS. However, companies like Cairn are valued based on projected earnings and cash flow & discovered reserves. Hence, the current PE ratio is irrelevant.

On a comparative valuation basis, Cairn’s is being offered at much higher EV multiple of 13.3-15.8 compared to just 0.4 of ONGC. However, in case of ONGC the company's huge subsidy burden in the form of the under-recoveries tends to act as a drag on its stock's valuations. But the offer is also at a substantial premium to the other listed exploration companies.