Indian riches allow Cairn to focus on Greenland

Cairn Energy has confirmed speculation that it is to sell up to 51 per cent of its cornerstone asset, Cairn India, to Indian diversified miner Vedanta Resources in a deal worth up to $8.48bn (£5.46bn). The proceeds will allow Cairn to return a substantial sum to shareholders and will leave the group with considerable exploration exposure, most notably in Greenland. News of its first two Greenland wells is expected on Tuesday 24 August when Cairn announces its first-half results.

The deal led analysts to raise their target prices for Cairn, and while the group will retain exposure to Indian upside through a residual shareholding, the obvious question is: what is Cairn going to do next? That in part depends on the results of the wells currently drilling on the Alpha prospect, offshore Disko Island in west Greenland. No updates have been released since drilling started on 1 July. No news isn't necessarily bad news, but removing the bedrock of Cairn India increases the group's exposure to Greenland drilling fortunes and earlier-stage operations in Albania, Bangladesh, Nepal and Tunisia, and with it the risk profile of the FTSE 100 constituent. This could see Cairn farm down its sizeable Greenland interests and/or seek to acquire positions in additional exploration frontiers to diversify risk.

Questions have also been raised about the merits of the deal for Vedanta, which wants to move closer to its stated ambition of creating an "Indian natural resources champion". Vedanta will become the second diversified miner after BHP Billiton to venture into oil and gas. But BHP entered oil and gas projects at the exploration stage - it is the operating partner of Falkland Oil & Gas - and this offers the potential of substantial upside on drilling successes.

In contrast, Vedanta will be acquiring a sizeable but developed asset whose value has largely been proven (and much of it will be extracted) by Cairn. Gross production from Cairn India's flagship Rajasthan asset is expected to be 125,000 barrels of oil equivalent per day (boepd) this year. This is forecast to rise to 175,000 boepd next year with a longer-term target of over 240,000 boepd. Planned capital costs in 2010-11 total $1.4bn (£0.9bn). Debt funding the acquisition will increase Vedanta's gearing to 37 per cent by its own calculations, although it expects the deal to be immediately earnings enhancing.

IC View

Not withstanding the potential return on cash to shareholders, Cairn rates fairly priced at 483p in advance of the Greenland drilling update expected next week. Vedanta also rates fairly priced at 2,192p pending deal finalisation.

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