Tuesday, June 12, 2018

Dana Gas Sukuk First Look at Restructuring Terms

Dr. Arqala Will See You Now

On 5 June Dana Gas reported progress in reaching an agreement with 93.69% of its sukukholders for a “consensual” restructuring.  Later this month DG will be seeking shareholder agreement to the deal which was outlined in a 13 May press release.  
AA has just resurfaced after an intensive several months of work (not every investment turns out well) so initially missed the 13 May press release. 
While fully detailed terms haven’t been released yet, let’s take a first look at what we know. 
The USD 700 million sukuk which matured in October 2017 will be restructured in two tranches.  
Tranche A – Early Exit Option 
Up to a maximum of 25% of the face amount of the existing USD 700 million sukuk (USD 175 million) will be offered for immediate payment at 90.5% of the face amount of the sukuk.  Those responding within 7 days of the formal offer (“early election”) will receive an additional 2.5% flat of the face amount or a total of 93%.   No interest will be paid.  
Assuming a 31 July conclusion of the deal (roughly DG’s target date) and full take-up of the USD 175 million Tranche A, some USD 13.1 million in interest will be due-- 6 months at 9% and 9 months at 4% (the new “profit” rate) because DG’s last interest payment appears to have been made in April 2017.    
Including the “to-be-lost” interest in the calculation results in an effective discount of the total amount owed to holders of 15.8% or, if the early election is made, 13.5%. 
Tranche B – 3 Year Sukuk Maturing 31 October 2020  
The sukuk will have a three-year tenor starting from 31 October 2017 – the maturity of the existing sukuk.  It will be structured as a “wakala” with underlying “ijara” / “deferred sale” obligations.  
The new “profit rate” will be 4% per annum. 
Holders who make an early election to enter the deal will receive a similar 2.5% flat fee of the face amount of their tendered sukuks. 
DG will make an upfront payment of 20% of the face value of the existing instrument allocated to Tranche B (75% of USD 700 = USD 525).  This will result in a new sukuk with a face amount of USD 420 million. 
The terms call for a prepayment of 20% of the face amount of the existing sukuk (USD 105 million) within the first two years, i.e. no later than 31 October 2019.  That will reduce the sukuk to USD 315 million.  If DG does not make the prepayment within the specified time, the profit rate will increase to 6% per annum.  
DG will be allowed to pay dividends up to 5.5% of the paid in capital of DG (USD 1.9 billion equivalent) or roughly USD 105 million per year, subject to a minimum liquidity requirement of USD 100 million.  The dividend allowance is not tied to actual cashflow. 
All net free cash proceeds from the results of the NIOC arbitration and sale, if any, of Egyptian assets for repayment of the Sukuk.  There are also provisions relating to the buyback of the new sukuk under certain circumstances.  Not particularly clear, but then this is a summary.  
DG’s May 2018 Corporate Presentation appears to provide some additional information on this latter topic. Comments on page 5 state that, if Tranche A is not fully taken up, DG will use the remaining amounts allocated to Tranche A to buyback new sukuk at the market price within 9 months of closing of the restructuring.  If there is insufficient offer, then DG will prepay sukukholders pro-rata at par.   From the wording it seems that when the May report was issued, no deal had been struck with sukukholders. So these terms may not have been modified.   
Danagaz WLL has apparently been removed from the security package, perhaps compensated with the above. 
Better Structure: Shorter tenor, more periodic amortization, additional “collateral”. 
You’ll recall, and if you don’t AA will remind you, that very early on AA wrote that the sukukholders needed to shorten the tenor (from five years), obtain interim principal repayments (no bullet structure) and secure more collateral.  To an extent that seems to have occurred.  To be very clear, AA is not claiming any credit for this outcome.  The sukukholders’ advisors don’t need AA to tell them the obvious.  
Reaching agreement is like some telephone calls with President Macron.  One doesn’t know all the details or what the course of negotiations was.  Like sausage one just has to eat it.  No doubt the case here.    
But as an outside commentator, AA will exercise his right to highlight things that might be better without the responsibility to make them so. 
Prepayment Failure: Doesn’t trigger acceleration of maturity.  
Failure to make the interim prepayment does not appear to constitute an event of default that allows acceleration of the sukuk.  Ideally it should be particularly given this issuer. Rather the penalty seems to be only an increase in the interest rate.  Realistically, if the Company can’t pay, a higher interest rate won’t be much deterrence.  
Dividend Payments:  Risks of cash leakage controlled?   
According to the transaction summary, approximately, USD 105 million in dividends can be paid each year—subject to maintenance of the USD 100 million minimum liquidity requirement—because  the dividend “allowance” is based on USD 1.9 billion in paid-in-capital at a 5.5% rate.  It is not tied to DG’s cash generation which would be preferable from a creditor standpoint, i.e., dividends tied to new cash generation.  
We don’t have sufficient details about the minimum liquidity requirement to know if it protects against leakage of cash needed to repay principal via dividends.    
The key issues are that DG's ability to generate cashflow from operations has been volatile, there are operating issues in Egypt and the UAE, much of its USD 636 million in cash as of 1Q18 will be expended on the restructuring, and the dividend allowance on its face appears overly generous.   
Over the past five years DG’s cashflow (defined as the net change in cash on the Statement of Cashflows adjusted to remove non-operating cash receipts–the sale of 5% of Pearl to RWE, the RWE dividend, the KRG/Pearl settlement, new borrowings, etc.) has been very volatile, averaging approximately USD 46 million per year.  While future cashflow (2018 forward) will benefit from an approximate USD 50 million a year reduction in interest expense, there seems to be little margin for error, absent asset sales or settlement with NIOC., the timing of which appear uncertain, if they will occur at all.  That’s particularly the case if sizeable dividends are paid.   
At closing of the restructuring, DG will have expended some USD 300 million of its USD 636 million in 1Q18 cash and banks (an amount which excludes USD 140 million earmarked for development of Pearl).  The prepayment on Tranche B will use another USD 105 million, reducing the remaining 1Q18 cash balance to USD 230 million and the sukuk principal to USD 305 million.  
Compounding risks, the final principal payment may be due shortly after the prepayment.  If it’s made on the last day (31 October 2019), only 12 months will remain until final maturity.  
Tranches A and B:  Sukukholders’ interests aligned?
The early exit option and ongoing market buybacks represent a potential preference to some creditors over others.  It will be interesting to learn, if possible, if those institutions that elect early exit were key in negotiating the restructuring.   There is a fundamental conflict of interest between those who are whole dollar creditors and those who acquired their stakes at a discount.  
Which option would you choose? 
So having raised that point, what would AA do if he had been unwise enough to purchase the sukuk?  
Take the early exit for three key reasons.  
First, if one doesn’t trust a potential business partner or issuer, one simply doesn’t do business with him.  No need for any further analysis.  
Second, if basic legal protections are lacking in a market, you can’t rely on the law to compel your counterparty to comply with the contract or the local courts to execute the judgments of foreign courts.  You are on the high wire without a safety net.  Usually, this is another deal breaker, unless your business puts the burden of risk preponderantly on the counterparty.  For example, you are a seller of investments rather than a buyer.  But is it worth the risk and bother?  
When the Ruler of Dubai created the DIFC, he sent a very clear message about the state of the law and courts in the UAE.  If you weren’t paying attention then, the recent decisions of the Sharjah Court hopefully caught your attention.  
Third, at the issuer level, DG exhibits high operating and credit risks.  Weak performance and a contration in squirrelly markets (that’s a technical term in case you don’t know).  DG has a “rich” history here (but not in the financial sense).  Future prospects do not appear bright. 

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