ZCI supports Rothschild's valuation of its KCM shares

This report in The Post yesterday. I reproduce it in full as the issues are complex and I have little to add.

ZAMBIA Copper Investments (ZCI) has supported Rothschild’s valuation of its 28.4 per cent shares in Konkola Copper Mines (KCM), saying it correctly employed the discounted cash flow (DCF) method in determining the option price.

And the board of the ZCI is undertaking an assessment of Zambia Competition Commission (ZCC)’s statement that Vedanta Resources Plc could not buy additional shares in KCM without its authorisation.

In a statement posted on its website after minority shareholders claimed that Rothschild’s valuation of ZCI’s shares meant Vedanta Resources Plc would increase its stake in KCM at a very low price, ZCI stated that the industry standard for valuing producing mining assets was through the use of the discounted cash flow method.

“Rothschild has correctly employed the DCF method in determining the option price. Under the Call Option Deed, ZCI has no legal basis to challenge Rothschild’s valuation,” stated ZCI. “Vedanta now has the right to acquire ZCI’s interest at the Option exercise price and it must make this decision as soon as reasonably practicable after the Option Exercise Price was made known.”

Vedanta Resources Plc’s bid to acquire the 28.4 per cent shares owned by ZCI landed into trouble following its rejection by ZCI shareholders who feel cheated by the “undervalued” offer price of US $213.85 million.

The move faced further trouble from the Competition Commission which said Vedanta needs authorisation before increasing its stake in KCM through its Call-Option Deed with ZCI.

Vedanta currently holds a Call-Option Deed on the 28.4 per cent of KCM still owned by ZCI whereby they agreed that the latter, upon exit, would offer its 28.4 per cent shares in KCM to the former.

On January 17, 2008, independent investment bank N M Rothschild & Sons Limited, pursuant to their appointment by Vedanta and ZCI to establish the price at which Vedanta shall have the option to acquire ZCI's 28.42 per cent interest in KCM submitted their report.

Rothschild, who assessed the value as it stood in August 2005, came up with the figure of US$213.85 million for the 28.4 per cent, thus evaluating 100 per cent of KCM at US$750 million.

Vedanta has the right to accept or refuse to go on with the call, but ZCI cannot refuse to sell. As a result, Vedanta now has a reasonable period within which to accept or reject the valuation price as determined by the bank.

However, from the figure that Rothschild came up with, Vedanta seems to have struck another bargain and may not hesitate to go ahead with the purchase.

According to a submission by Jean-Luc Chaillan, the trouble is that ZCI shareholders feel the shares have been undervalued and Vedanta will buy the shares very cheaply as it did to the 51 per cent shares in KCM, as latest independent evaluations for KCM shares are far more than that of Rothschild.

Vedanta bought 51 per cent of KCM stock in November 2004 for a mere US$48 million. Back then, this sale came under fire from a cross section of Zambian industrialists, unions, political parties and the media, and was described as an outrageous pillaging of Zambian resources.

All the evaluations conducted by various financial audit agencies are way above the Rothschild figure.

For instance, Morgan Stanley & Company International, in a survey about Vedanta dated December 15, 2005, evaluated the 51 per cent of KCM at US$1.321 billion, which makes KCM worth US$2.590 billion, far above the US$750 million proposed by Rothschild.

Other subsequent assessments are even higher.

When the Rothschild evaluation came out, financial analysts Lehman Brothers, immediately concluded that it was a bargain on the part of KCM because KCM was worth at least twice the suggested amount.

The Zambian government could not give its position on the matter, as mines deputy minister Maxwell Mwale said the Zambia Consolidated Copper Mines Investment Holdings (ZCCM-IH) which holds some shares in KCM on behalf of the government could comment on the matter.

However, ZCCM-IH general manager Joseph Chikolwa, who could have given government’s position on the matter, was reportedly out of the country to comment.

KCM is owned 51 per cent by Indian Vedanta; 28.4 per cent by ZCI, a legal entity from Bermuda; and 20.6 per cent ZCCM-IH (88 per cent of which is owned by the Zambian government).

ZCI shareholders also argue on dividends that did not accrue to them.

In the statement recently released on its website, ZCI stated that it had in fact received dividends on its shares subsequent to the exercise of the Call Option, although these have not – in the view of ZCI’s board – reflected the levels of free cash flow as determined in accordance with the Shareholders Agreement.

ZCI’s representatives on the board of KCM have strenuously argued for the distribution of higher dividends.

“Our considered view of our legal position is that we have no right to force a further or higher distribution of KCM’s reserves,” ZCI stated. “Rothschild had to value KCM as it perceived KCM’s assets at the Exercise Notice date, August 12, 2005. Rothschild had to ignore any information available after August 2005.

ZCI’s technical consultants made strong representations before the process began to ensure that IMCL considered the right data. IMCL appear to have had some difficulty in compiling the necessary technical data for the DCF model, since little information was available from August 2005.”

ZCI’s share price is the only available market valuation of ZCI and hence of ZCI’s share in KCM, since it is ZCI’s only non-financial asset.

As announced on 7 November 2005, ZCI and Vedanta originally attempted to agree on a list of documentation which would have enabled Rothschild to conduct a “desktop” valuation without the need for a full technical review of the assets.

ZCI and Vedanta were unable to agree on the list of documents, since ZCI felt that Vedanta wanted to include documentation which gave a very pessimistic view of the value of the assets.

Thereafter, terms of reference were agreed instructing Rothschild, with its mining consultants IMCL, to conduct a full technical review of the assets.

“During negotiations on Rothschild’s terms of reference it became apparent that the parties disagreed about the relevant date for the valuation,” ZCI stated.

“ZCI believed that the valuation should be conducted on an up-to-date basis, as at the date of Rothschild’s report, whereas Vedanta believed that the valuation should have been conducted as at the Exercise Notice date.

“The issue of the valuation date was particularly important as copper prices, and analysts’ price forecasts, rose significantly over the period in question.

“The parties then entered a lengthy arbitration process, under the terms of the Call-Option Deed, which was not concluded until July 2007.

“The conclusion of the arbitrator was announced on 25 June 2007. The arbitrator held that the valuation should be carried out as at the Exercise Notice date (i.e. 12 August 2005). There are no grounds for ZCI to appeal that decision.”

ZCI further stated that it remains bound by the terms of the Call-Option Deed, adding: “The Zambia Competition Commission has, however, asserted jurisdiction over the transfer of the shares and stated that its permission is required before completion of the sale can occur. The Board of ZCI is examining this presently.”

ZCC said the execution of the Call-Option Deed between Vedanta and ZCI was subject to authorisation.

ZCC wrote to the two parties advising them of the legal requirements of seeking authorisation from the commission before they could effect the transaction, according to the laws of Zambia.

Section 8 subsection (1) of Cap 417 of the Laws of Zambia states that: “Any persons who in the absence of authority from the commission whether as a principal or agent and whether by himself or his agent, participates in a merger between two or more independent enterprises engaged in manufacturing or distributing substantially similar goods or providing substantially similar services;

a takeover or one or more such enterprises by another enterprise, or by a person who controls another such enterprise shall be guilty of an offence and shall be liable, upon conviction, to a fine not exceeding K10 million or imprisonment not exceeding five years or both.”

Subsection (2) of the same section further states that: “No merger or takeover made in contravention of subsection (1) shall have any legal effect and no rights or obligations imposed on the participating parties by any agreement in respect of the merger or takeover shall be legally enforceable.”

Vedanta Resources Plc has since engaged Lusaka Lawyer Eric Silwamba to start legal proceedings against those objecting its plans to acquire additional shares in KCM.

It is yet to give its position on the matter as a press query had been sent last week.