Dana Gas - Potential Negative Effects from Proposed UD 350mm Pearl Petroleum Bond

Great White Whale or Great White Tiger -- AA Stays in the Hunt Until the End

This post is an “early warning” about a potential negative impact of the proposed USD 350 million new Pearl Petroleum bond on the creditworthiness of Dana Gas’s Nile Delta Sukuk.

As the italicized words in the previous sentence indicate, we won’t know the extent of the impact until the final terms of the proposed issue are published and the deal is placed.

Reuters reported that Pearl  in the market for a USD 350 million bond and has hired Bank of America Merrill Lynch and Morgan Stanley as “joint global co-ordinators and book runners” with  Shuaa Capital as a “co-manager”.

At this point, I’d note that the term “underwriter “ has not been used which may indicate this is a “best efforts” transaction – reasonable given the preliminary subzero (non-investment grade) credit rating.

More detail—though still preliminary--on the proposed issue can be found here in a Fitch Ratings press release on its preliminary rating for this transaction. Fitch has assigned preliminary  B - rating (non-investment grade) to the proposed issue, subject to satisfactory review of the final documents.

What are the implications for the unfortunate holders of the Nile Delta Sukuk?

First, as a matter of law, debt service payments on the new bond will have priority over Pearl dividends to shareholders.  Thus, reducing the amount of cashflow to Dana Gas.

How much?  The amount of reduction will depend on Deal Terms (final maturity, the principal amortization schedule--AA hopes this isn’t a bullet--, and the coupon) which are currently unknown.  As well, it will depend on underwriting standards applied.

Second, looking at the Fitch press release a couple of additional potential problems emerge.

The issue is a senior secured facility.

Two consequences.

Pearl’s assets are going to be pledged for the new bond.  While DG’s interest in Pearl isn’t pledged as security under the Nile Delta Sukuk, these assets do provide support for DG’s creditworthiness.

Fitch estimates that in the case of a going concern reorganization or sale of Pearl, the USD 350 million bondholders are likely to have a 50% recovery.  That means nothing for DG or the other Pearl shareholders in this case. If the company goes completely bust, then the USD 350 million bondholders will have the first “cup of pain”.  Pearl’s shareholders will be no worse off unless they have provided some support on the bond.

To put this into context as of FYE 2018, some 26% of DG’s reported assets were its share of Pearl’s assets.  And that USD 818 million “share” was  some 32% of equity.

Given Pearl's dismal rating, AA would hope (but is prepared to be disappointed) that the bondholders will place solid "protective" covenants on Pearl.  A key area would be controls on cashflow. That would directly affect DG.

On that topic Fitch notes that it expects dividends starting in 2020 to be lower than this year’s projected USD 550 million (DG share roughly USD 193 million), probably because that is included in the draft documents it has seen.

How much lower isn’t specified. Presumably that will be related to the Deal Terms.   Hopefully, this bond will not repeat the Sukuk’s unfortunate failure to relate dividends to cashflow.

Pearl is a significant contributor to DG’s cashflow.  Constraints on Pearl’s dividends paid will have an impact on DG’s ability to repay the sukuk.  Keep in mind that DG has use of cash when it receives dividends from Pearl.

Note that DG’s financials show DG’s share of Pearl’s cash and receivables.  But those amounts are not directly available to DG.  See Note 15 2018 Annual Report.

According to a very rough analysis of that Note, DG may be reporting as much as USD 100 million in its “Cash and Banks” that belongs to Pearl.  Money that DG cannot use until Pearl issues dividends.  See that analysis here part of an earlier post recently amended.

Sadly there is more.

If you'll read DG's 2Q2019 Investor Presentation, you'll see that DG is considering the strategic sale of its "fine" Egyptian assets.  Potentially good news for the Nile Delta Sukuk holders as these assets are pledged to them.

But for the shareholders probably not so good.

DG appears to think it's a good strategy to focus its "portfolio" on Pearl, essentially turning DG into a Kurdish investment. I trust I don't have to spell out the risks in that strategy.  .