Vedanta is poised for a Cairn merger

Having bought a majority stake in Cairn’s highly profitable Indian business in 2011, speculation has been mounting that the group will seek to expand Cairn India by buying out its former parent to create a global exploration and production business.

The possible swoop for Cairn comes at a time when markets value the Edinburgh-based explorer at less than the sum of its assets. Analysts pointed out last week that the company’s share price does not fully cover the group’s cash pile and its remaining minority stake in Cairn India.

The valuation of around £1.6 billion suggests investors think the board’s ambitious plans to explore relatively uncharted waters on the Atlantic margin will fail, burning cash without making the kind of major discovery needed to justify potentially difficult extraction.

Some investors fear the company could be “picked off” more cheaply than it deserves. But oil and gas researcher Sam Wahab, at broker Cantor Fitzgerald, says any bidder for the company would have to pay a substantial premium above the current share price. Nevertheless, its rumoured buyer has the firepower.

“Cairn India has $2.6bn [£1.7bn] in cash and cashflow of $1bn a year,” he said. “It has the resource base to do such a transaction.”

He added: “Cairn is obviously undervalued on an asset basis – this is a key entry point.”

Vedanta is itself said to be modestly valued following recent share price declines in the sector and may seek to use Wednesday’s fourth- quarter results to put some fizz in its shares with a potentially transformative offer.

Cairn holds licences to explore for oil in vast tracts of the Atlantic, from Greenland in the north to Senegal in the Tropics – such a portfolio would allow Vedanta to turn Cairn India into a global oil firm, financing exploration from its production revenues.

One of the main reasons for Cairn’s subdued valuation on the stock exchange is the relative failure of its first attempt to explore its Arctic prospect, which cost it about $1bn.

But chief executive Simon Thomson said that adventure had reflected Cairn’s status as a much larger company and it now plans to spend a more modest $300 million a year on exploration.

Brokers have tipped the stock to recover strongly if the company can strike oil at some of the relatively low-risk wells it is drilling this year, as the market regains confidence in Cairn’s skill with the drill bit.

Wahab said he will remain sceptical of the rumours unless he sees evidence of an offer. “Attempts by Indian oil companies to do deals have been notoriously slow in the past and fraught with difficulties,” he said.

But he said there are always companies “circling” in the oil and gas sector, and Scotland’s smaller, Aim-quoted drillers are also in the sights of those looking for acquisitions. He says firms on both the Norwegian and UK sides of the North Sea are ripe for consolidation.

Trap Oil and Bridge Energy are among those being eyed up by suitors.