Vedanta Group's Debt-Servicing Ability: The Significance of Royalty Payments Under the ED's Scrutiny

Vedanta Resources Faces Regulatory Probe Over Brand Fees

The Enforcement Directorate's (ED) recent searches of the Vedanta Group's offices have once again brought the issue of brand fees, or royalty payments, to the forefront. These payments are made by domestic units to the London-headquartered holding company Vedanta Resources.

Significance of Brand Fees

For Vedanta Resources, brand fees are a crucial component of its cash flow. With an approximate debt of $5.3 billion, the company relies heavily on brand fees and dividends from its Indian subsidiaries to service and reduce its debt. Rating agencies estimate that brand fees and company dividends will cover $800 million to $1 billion in annual holding company debt service during FY26-FY29.

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Brand Fee Structure

The brand fee is a payment made by operating companies for the right to use the Vedanta brand and for strategic or group-level services associated with the brand. During Vedanta Ltd's April 29 earnings call, group chief financial officer Ajay Goel said the brand fee for the current Vedanta structure was "about 3 percent." However, after the demerger, Vedanta implemented an "unbundled" benchmarking framework, with separate royalty rates for each of the five new companies. The copper business will see a reduction in the brand fee from 3 percent to 0.75 percent.

Impact on Copper Business

The reduction in brand fee will have a significant impact on the copper business, with copper revenue expected to be around $3.1-3.2 billion in FY26. The lowering of the brand fee will result in an impact of about $65 million in FY27. This reduction is expected to lead to a 2.25 percent expansion in EBITDA margins for the copper business.

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Importance of Brand Fees for Vedanta Resources

Vedanta Resources sits above the operating companies and depends on upstreamed cash flows, primarily dividends and brand fees, to meet its debt obligations. Unlike operating companies, the holding company does not generate large operating cash flows on its own. Vedanta Resources has a principal repayment requirement of about $0.3 billion in FY27, along with an inter-corporate loan due to Vedanta Ltd, taking the principal requirement to about half a billion dollars. Interest would be "a shy of half a billion," implying a total need of around $1 billion at Vedanta Resources.

FEMA Probe

The ED is responsible for enforcing and investigating suspected violations of the Foreign Exchange Management Act (FEMA). While cross-border brand fees or royalties are legally permissible current account transactions under FEMA, the payments have to be done in specified manners. The transactions have to be at arms length and should not lead to shifting of profits offshore. A 2022 case saw the ED order the seizure of Rs 5,551 crore in the accounts of Xiaomi for allegedly violating FEMA rules and transferring money in the guise of royalty to three companies outside India.

The regulatory probe into Vedanta Resources' brand fees is significant, as any adverse findings could affect the cash flow that rating agencies and bond investors factor into the company's ability to service debt.