Discover more from Boring Money, by Shreedhar
Vedanta wants to split into six because its parent is in too much debt
Or how the world runs on hope
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If you’re a billionaire who owns multiple companies, one of the reasons for you to have multiple companies and not just one is to insulate your companies from each other. That way, one of your companies can do risky stuff, take loans, etc. while your other companies can do their own not-so-risky businesses. Forming multiple companies mitigates the risk of the entire ship sinking if one company blows up.
But what if you’re not the risk mitigating personality? What if you don’t care and you just prefer dumping all your businesses into one company? Sure, this is risky. But hey, you own the company! As long as you’re careful, the risks don’t matter.
But they matter to your investors! Usually—and this is definitely not a rule set in stone—public market investors like companies that operate in similar lines of business. If you’re a cigarette company but also export vegetables on the side, it can get a bit confusing for your investors. If they can’t invest in your addictive chemicals business without also investing in your organic vegetables, they might prefer not investing at all.
If you split your company into two, you’re going to get that investor who wants to invest in your cigarettes and you’re going to get the investor who wants to invest in your vegetables. The result is that if a company splits into multiple companies with separate lines of business, the total market value of the new, smaller companies can be more than that of the one big company which existed earlier.1
All this said, here’s Vedanta Ltd:
The board of Vedanta Ltd. approved a plan to separate the business into six listed companies: aluminum, oil and gas, power, steel and ferrous, base metals and Vedanta Ltd., the company said in a statement Friday. For every share of Vedanta Ltd., investors will receive one share of each of the five new companies.
Anil Agarwal is the billionaire owner of Vedanta Ltd. Until recently, he liked having all his business inside one company. Last month, he decided that maybe it was better if he split his company into six.
This might have something to do with it:
A heavy debt load at the holding company has increased the urgency to simplify the structure. Vedanta Resources Ltd., the parent of Vedanta Ltd., has $2 billion of bond repayments due in 2024 and another $1.2 billion in 2025.
Anil Agarwal owns his stake in Vedanta Ltd via Vedanta Resources, another company which is registered in the UK. And Vedanta Resources is in a lot of debt! It has to repay $3.2 billion by 2025 and that’s not even all of it.
Bonds bonds bonds
If you buy a company’s stock, you probably think that the company has a sound business model, its management is making wise business decisions, the market for its services is large enough, stuff like that. But if you buy a company’s bonds your calculations are different. I wrote last year:
If you’re a lender to a company, you don’t really care where the money that’s repaid to you comes from as long as you’re paid back. If you buy a company bond, you don’t have to bet that the company will succeed; only that the company survives long enough to pay you back. The money might come from the company’s business (it isn’t), from the owner’s personal fortune, or hell, even from the most recent lender.
Lenders—or, in this case, bond investors—just want to get paid! Here are some of the bonds issued by Vedanta Resources:
In 2020, $1 billion with an interest rate of 13.875%. The purpose of this bond issue was to repay earlier bonds that were maturing in 2021.
In 2019, $400 million at 8% and $600 million at 9.25% to repay bonds that were maturing the same year.
In 2017, $1 billion at 6.125% to buy back some of the bonds maturing in 2019 and 2021.
You see what’s happening? Vedanta Resources has been borrowing a billion dollars every couple of years for the last 6 years to repay the bonds it had issued earlier. And every new bond issue is riskier than the last,2 so Vedanta Resources has to pay more interest on the new bonds.
Interest rates were famously down in 2020. Everything was being funded practically for free. And yet, Vedanta Resources issued bonds with a nearly 14% interest rate. 3 This wasn’t a choice—no one wanted to lend to them for any less. Interest rates are up now so I can’t imagine what the lenders would want now.
Size of the pie
One way for a company to get debt is to issue bonds. We just saw how Vedanta Resources particularly enjoyed issuing bonds. Another way for a company to get debt is to borrow against its assets. Just around the time Vedanta Resources issued those expensive 14% interest rate bonds in 2020, it also started borrowing against its stake in Vedanta Ltd. Today its entire stake in Vedanta Ltd is pledged for loans.
Vedanta Resources can’t sell its shares in Vedanta Ltd to repay its debt because they’re all pledged. It can’t issue any more bonds because the interest would be unaffordable. It also can’t borrow any more against the shares, because hey they’re already all collateral.
But the hope is that the demerger goes through and investors prefer buying six smaller companies versus one company. If that happens, the size of the pie goes up and Vedanta Resources may be able to sell some shares. Or borrow even more, for that matter. It’s a lot of hoping but entrepreneurs are usually optimists. Anil Agarwal certainly seems to be.
I want to emphasise again that this is not a rule! It might turn out that no one really wanted to invest in your vegetables in the first place and were only in it for the cigarettes, in which case your standalone vegetable company won’t be worth a lot. But it’s a generally accepted idea that splitting a company increases the combined market value.
Every time Vedanta Resources new bonds solely to repay the older bonds, in some ways, it failed to repay the money it owed earlier. So the risk of default for the newer bonds goes up.
Interest rates in the US in 2020 were nearly 0%! So Vedanta was paying 13.9% over that. Today the interest rates are around 5%. Would Vedanta pay 18% as interest on a billion dollars?