Thursday, July 6, 2017

Dana Gas Restructuring: Not So Current (Assets) Trade Receivables -- UPDATED

Not Snow Not Sugar

They say that "even Homer nods".  If a comparison is to be made with Homer and AA, it's more likely Homer Simpson not Homer. 
In my haste to release this post, I failed to include one very key detail.  
The KRG trade receivables are payable to Pearl Petroleum Limited not DG.  The use of the word "share" in DG's financials Note 17 and 28 is crystal clear. 
What does that mean?
  • DG's is unable to sell the TR because it does not have title. There could be restrictions imposed by PPL's contract with the KRG on transfer of title or assignment of proceeds by PPL to a third party, here DG.  As noted elsewhere, certain unspecified actions by PPL require 100% shareholder agreement.  It is not clear if this is one of those decisions.  If it is, then another shareholder--perhaps from among the three 10% shareholders--OMV, MOL, and RWEST--might frustrate a transfer.
  • As PPL is the payee/owner of the TR, any payments from the KRG go to PPL.  As such, there is the theoretical possibility that such proceeds could be trapped at PPL.  Presumably, PPL has been structured to avoid third party debt with shareholders providing any needed debt financing.  But there ae other liabilities that could interfere with the transfer of funds from PPL to DG.  For example, claims of environmental damages by the KRG, other contractual liabilities, or other third party damage, etc. 
  • As I read Note 28, the aggregate KRG TR owned by PPL are some USD 2.04 billion.  What that suggests is that if the KRG pays $100 to PPL, DG's share is $35.  Meaning in effect that for DG to collect the entire USD 713 million, the KRG will have to pay PPL USD 2.04 billion.  That certainly seems to lower the probability of a prompt payment and perhaps even payment. 
  • And to state the obvious, sukuk holders' do not have direct access to PPL's assets including the TR, but have access through DG's equity stake in PPL.  Not  a particularly comfortable place to be in. 
One other note and that's Note 28.  PPL is charging the KRG interest.  DG appears to be capitalizing its share in the TR balance carried on its books.  The related credit entry is not being booked to income (good move) but rather as a deduction from provisions.  As you'll note below, I had an unexplained difference in the KRG TR reconciliation which I attributed to interest.  This appears to provide the "answer" to a substantial portion of that difference.


DG’s ability to repay its creditors depends on the company’s ability to generate cash.  
In this post we'll look at Trade Receivables.  These are accrued amounts owed by customers that have yet to be paid, that is, converted from receivables into cash. 
DG is having a problem (first euphemism of the post) converting TR to cash.  If you bill your customers and they don't pay promptly or don't pay at all, you have a problem. 
Dana Gas Trade Receivables - USD Millions

1Q2017
2016
2015
2014
2013
2012
2011
Total Receivables
999
982
950
992
795
599
475
KRG
712
713
727
746
515
365
247
Egypt
283
265
221
233
274
234
228








% Total Equity
36%
35%
33%
37%
31%
25%
21%
% Retained Earnings
163%
163%
137%
172%
165%
172%
216%
  Source:  DG Annual Reports.
  1. DG income is dependent on two customers – the Kurdish Regional Government (“KRG”) in Iraq and Egypt.  As AA learned in business school, a successful business needs a good product and a diverse and credit worthy base of customers who actually pay.  In baseball a 50% average (for a hitter) would be outstanding.  In business, however, it isn’t good enough!
  2. Recently Zora UAE has begun generating revenue but only about 5% of the total.
  3. Total receivables have more than doubled since FYE 2011 largely concentrated in KRG “paper".

Dana Gas Trade Receivables - Past Due Analysis
Total Amount Current Past Due Not Impaired
Year USD Millions <120 Days >120 Days
1Q2017
999 7% 5% 88%
2016 982 5% 14% 81%
2015 950 8% 8% 85%
2014 992 11% 19% 70%
2013 795 16% 18% 67%
2012 599 17% 17% 66%
2011 475 23% 33% 45%
DG Annual Reports Note on Trade Receivables.
  1. Over the period FYE 2011 through 1Q2107, the proportion of past due receivables has almost doubled, while the amount of current receivables has declined dramatically.
  2. While DG’s presentation is technically “true”, that information does not convey the extent of the past dues. 
  3. Yes, some 88% of TR are past due by more than 120 days.  But that's akin to the difference between saying “I hit Jimmy” and “I hit Jimmy and killed him”.  Both are technically true statements about the same event.  Yet, the first is misleading.  (Second euphemism of the post.)
  4. Reading DG’s financials one might think that because TR are classified as “Current Assets”, the outward limit would be one accounting cycle or 1 year.  So no TR would be past due more than 365 days. That’s clearly not the case.  
  5. From Slide 11 in DG’s 1Q2017 Investor Presentation, it’s clear that a good portion of TR date from 2014 and earlier  
  6. Side Note: DG charged the KRG past due interest at 9% according to its no doubt “Shari’ah” interpretation of its contract beginning in 2013.  In 2016 following an arbitration award, some USD 121 million in accrued interest for 2015 and 2016 was reversed, being the difference between the accrued amount and the Arbitration approved rate of Libor plus 2%.  If you use the amounts of billing and collections shown in the slide, you will have an unexplained difference (even when including the 2015 and 2016 interest reversals) which likely is the effect of other interest transactions.   There's only a minimum problem of USD 4 million constant difference on the Egyptian TR.
  7. As per Slide 11, KRG collections over the period 2015 through 1Q2017 were USD 175 million and billings were some USD 246 million.  Note  
  8. For the purpose of this analysis, we’ll apply collections on a LIFO basis (against current billings) and FIFO (against the oldest billings).  Billings are actually applied as per contract terms, which are unknown, but this exercise will give us a range of possible outcomes. 
  9. If the USD 175 is applied on a LIFO basis, then some USD 700 million plus is more than 2 years past due.
  10. If the USD is applied on a FIFO basis, then some USD 500 million is more than 2 years past due. 
  11. Either way that’s a dismal picture.  
  12. As the table immediately above indicates, at FYE 2014 there were substantial past due amounts from prior years.  Given the KRG’s share of TR, there are likely to be substantial amounts of KRG receivables past due for many years.  AA is guessing 5 or more years.  Some clear present value implications.  
  13. Collections from Egypt over the same period were some USD 217 million and billings USD 267 million.  Note Egypt TR at FYE 2014 were USD 233 million.  
  14. On a FIFO basis, Egypt receivables would be more current with substantial amounts close to 2 years past due. 
  15. On a LIFO basis, the past due tenor would lengthen out to more years. 
The presentation of past due receivables in DG’s financials raises some interesting questions for the Company and its auditors. 
  1. As per DG’s financials, TR are generally contractually due between 30 to 60 days.  At what “time” point does a receivable that is past due cease to be a current asset?  AA would think that receivables past due over 1 year would no longer be “current” assets to say nothing of those overdue for multiple years. 
  2. If receivables are overdue an inordinate amount of time, when does an allowance become necessary?
Let’s turn to DG’s 2016 Annual Report for their “case”. 
  1. Accounting Policies Note 2 Page 58 "Loans and Receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are included in current assets, except for maturities greater than 12 months after the end of the reporting period. These are classified as non-current assets. The Group’s loans and receivables comprise ‘trade and other receivables’."  
  2. Accounting Policies Note 2 Page 59 "Trade and Other Receivables Accounts receivable are stated at original invoice amount less a provision for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off when there is no possibility of recovery."  
  3. Financial Risk Management Note 32 Page 81 "(i) Trade Receivables The trade receivables arise from its operations in UAE, Egypt and Kurdistan Region of Iraq. The requirement for impairment is analysed at each reporting date on an individual basis for major customers. As majority of the Group’s trade receivable are from Government related entities no impairment was necessitated at this point." 
AA’s observations: 
  1. Despite stated maturity, the Trade Receivables haves whiskers on them like the old undisposed of items in your refrigerator (see picture above) that start stirring around when the door closes and the light goes out.  Including them (the TR) in current assets on the basis of dishonored contractual maturities does not seem appropriate. (Third euphemism of the post).  Any more than referring to the feral food inhabiting the dark corners of your refrigerator as “fresh”.  At the very minimum, the “time” buckets in the aging should convey more accurately the extent of past dues, e.g., past due 1 year, 2 to 3 years, 4 to five years, and over five years. 
  2. DG’s non-impairment argument based on obligors being "government related" is laughable.  Assuming DG are correct, then there is no need for provisions or worry about Puerto Rico. It’s not only government-related, it’s government.  No one seriously thinks that PR is a solid credit.  
  3. But there's more. No one should be mistaking the KRG or Egypt for investment grade or even BB borrowers.  Both Iraq and Egypt are rated B (non-investment grade).  There is a world of credit quality difference between say Switzerland and Iraq. 
  4. When a B credit does not pay for a prolonged period, provisions are not just a good idea.  They’re required. Even if the obligor is a government related. 
  5. What makes the argument even more absurd is it application to the KRG.  Not only is the KRG a sub-sovereign, but at some point in the (near) future, Baghdad is likely to reinforce that sub-sovereign status with vigor, perhaps with the help of two neighboring countries.  Then DG may face an argument similar to the one it is making about the Sukuk: that the existing contract with the KRG is illegal and unenforceable and thus the debt is void.  
AA can understands why the DG has adopted its stance on the TR: self preservation.    

But AA does not understand their external auditors’ position, though I will give them credit for noting in their 2016 FYI audit report page 41: "Considering the uncertainty around recoverability of trade receivables from KRG, we have included an emphasis of this matter in this audit report."   

AA will be taking a look at DG's ability to generate cashflow in a coming post.  

Perhaps this post and that one will suggest reasons why DG have thought it “wise” to adopt their “clever boots” maneuver on the Sukuk.

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