Dana Gas Strikes Again - "It's Just a Contract"

The above should not be read to imply that AA considers this a minor lapse.

Dana Gas has apparently struck again, suggesting its earlier unilateral abrogation of its legal obligations under its sukuk was no fluke.  

It seems that in negotiating the settlement with the KRG, DG and Crescent Petroleum did not obtain the consent of MOL Group Hungary, a ten percent shareholder in Pearl, before finalizing the agreement with the KRG. 

As noted in earlier posts, the agreement among Pearl’s shareholders gives the minority shareholders—MOL, RWE, and OMV—certain rights including the ability to veto some decisions of Pearl. 

MOL asserts that the settlement with the KRG is a decision that requires shareholder unanimity and that it did not provide its consent.  I’ve provided excerpts from DG’s and MOL’s press releases below.  

But first some comments.

1. Counterparties considering concluding contractual arrangements with Pearl Petroleum and Dana Gas would be well-advised to carefully consider this “event” and whether it is further evidence of DG’s and PPL’s less than sterling record of honouring legal agreements. 
2. As a side comment, AA notes that behaviour of this sort, if unchecked, might lead to widespread adoption of a cavalier attitude to legal agreements on a wider basis.  Countries may even be tempted to re-read binding treaties and find imagined breaches of the spirit of an agreement. 
3. The hapless creditors in DG’s sukuk should carefully consider how to protect themselves in the ongoing restructuring negotiations.  What is the value of the word of a counterparty that appears to have a relaxed attitude towards legal obligations?  No doubt not USD 690 million.  Probably not USD 690.  
4. On the other hand, if Dana’s assertion is that MOL is using “legal technicalities” in an effort to extort benefits or to abrogate the existing Pearl shareholders’ agreement is correct (a mighty big “if”), then this would seem a case of karmic comeuppance.   Perhaps to be followed by Baghdad reopening the concession agreements when it has settled affairs with the KRG. 
5. In the arbitration proceedings will MOL be able to make a convincing case to the LCIA to DG's disadvantage that DG’s conduct with the sukuk and the shareholders’ agreement is part of a pattern of cavalier disregard and bad faith towards legal obligations? 
6. Will Abu Yusuf come up with another far-fetched distortion of Shari’ah to support DG’s actions re the KRG settlement?  If he does, will the LCIA “buy” it?
7. Are the fine courts of Sharjah standing by to issue an injunction if the LCIA proceedings seem to be going MOL's way?
8. Will DG’s shareholders providentially and of course completely of their own volition intervene in Sharjah’s fine courts to block the arbitral proceedings or award?  

Here’s the excerpt from DG’s press release. 

The Settlement Agreement with the KRG was welcomed and endorsed by Dana Gas, Crescent Petroleum, OMV and RWE, together holding 90% of the shares of Pearl. Unfortunately, MOL (a 10% shareholder of Pearl) unreasonably sought to link its endorsement of the settlement to a renegotiation of the terms by which it first secured its participation in Pearl back in May 2009 (namely its commitment to certain contingent payments) and now complains about Dana Gas and Crescent Petroleum for their handling of the settlement alongside Pearl, expressing dissatisfaction with the outcome as compared to the alternative of pursuing a final litigation and enforcement outcome against the KRG.

And from MOL’s press release.  I’ve boldfaced a key sentence which if true presents a world of trouble for DG and other shareholders. 

MOL Plc. (“MOL” or “MOL Group”) hereby notifies the market of the following:  MOL joined Pearl Petroleum Company Limited ("Pearl") in 2009 as a shareholder with a 10% stake and strong minority rights. Pearl’s shareholders include, among others, Dana Gas PJSC ("Dana Gas”) and Crescent Petroleum Company International Limited (“Crescent”). Dana Gas and Crescent, along with Pearl, entered into an agreement to settle Pearl’s long-standing dispute with the Kurdistan Regional Government of Iraq (“KRG”) on 30 August 2017 (the “Settlement Agreement”), without properly consulting MOL or obtaining requisite approval, in breach of MOL’s contractual rights. MOL accordingly served a default notice on Dana Gas and Crescent on 11 September 2017 in accordance with the mechanism agreed by and between the shareholders of Pearl. The default notice has severe legal consequences for the defaulting shareholders, their shareholdings in Pearl and their related entitlements. As announced by Dana Gas earlier today, MOL received a Request for Arbitration from Dana Gas and Crescent in the London Court of International Arbitration, disputing the validity of MOL’s default notice. MOL will take all appropriate steps to enforce and protect its rights.

Dana Gas Strategy From Clever Boots to Clever Socks?

DG's New Strategy May Be Actually More Clever Than Depicted Above

As you’ve no doubt heard, following rejection from its creditors, Dana Gas withdrew its imagined generous offer of an exchange bond stripped of the conversion option and at an “attractive” 3% fixed interest rate compared to the 9% the Company paid until its moral principles “forced” it to withhold payment because “evolving” interpretations of Shari’ah voided the “Islamic” character of the sukuk. 

At that time according to press reports (Reuters here), the Company said it would pursue "litigation-driven outcomes". 

An initial assessment might be that Dana Gas has taken further leave of what scant senses it might have had.  Scant because its “clever boots” first strategy seemed an unnecessary provocation to the creditors and unlikely to succeed.  DG has a perfectly viable argument for a restructuring without resorting to what are almost certainly distortions of Shari’ah. 

On that score the uncharitable out there among you might say why should there be a difference between overall management of the business and financial management.  AA who fancies himself a charitable sort would of course never make such a comment. 

According to the report by Bloomberg, DG’s “evolved” strategy is based on successfully litigating one of the two following outcomes: 

1. Unwind the sukuk transaction from origin, repay the outstanding principal (roughly USD 690 million) but offset the allegedly now non-Shari’ah compliant “profit” (interest) payments made over the life of the sukuk (some USD 635 million over the life of the transaction). 
2. Convert the sukuk to equity in the Trust Assets (note the potentially fatal limitation agreed by the Sukuk holders in their initial irrational exuberance).  Based on profit earned by the Egyptian assets and the value of these assets now, DG reportedly believes that the sukuk holders owe it USD 150 million.  Details in the Bloomberg article.   

Abu Yusuf certainly has been a busy chap parsing the law.

Some observations. 

At first hearing a litigation-driven strategy sounds like a crackpot idea.

But there have been rulings in the past by UAE courts (Abu Dhabi based) that support such an approach, though AA understands that judicial precedent is not binding in the UAE. Back in the 1980s or thereabouts, UAE banks’ practice of lending on an overdraft basis and capitalizing interest “came a cropper” when borrowers couldn’t or wouldn’t pay.  NBAD took one such borrower to court.  The borrower noted he had recently “seen the light” and as a good Muslim could not pay interest as it would violate Shari’ah.  Producing bank statements he “proved” that on a cash-on-cash basis he had already repaid the original principal amount of his borrowings and more.  The learned judge ruled in his favor.  NBAD had to issue a check to the borrower for some million AED (the “overpayment”) and cancel the balance of his loan on its books.  One would hope that there has been change in judicial thinking in the Emirates since then but one doesn’t always get the “hope and change” wished for.   

As I read DG’s initial announcement, a key point of DG’s strategy is the assertion that evolving interpretation of Shari’ah made the transaction non-compliant. 

One could argue that that means that at some point the transaction was Shari’ah compliant.  If that is the case, then the date the transaction became non-compliant becomes very important in terms of the legality of profit payments.  Those before the new interpretation were perfectly halal.  Those after not. 

One might argue that the date of DG’s announcement of non-compliance is prima facie the date of non-compliance.  If DG were aware of non-compliance before that date but were silent, then should it be subject to paying damages to the sukuk holders perhaps equal to or greater than the profit payments they received between the end of Shari’ah compliance and the date of announcement?  Does Shari’ah impose a greater obligation on a mudarib with respect to rab al maal than a conventional loan arrangement would?

If Shari’ah holds that a change of interpretation is retroactive back to the inception of the transaction—which AA doubts--, then despite their best intentions the parties did not actually agree to a Shari’ah based transaction but instead agreed to conventional (non-Shari’ah) bond.  If so, then shouldn’t the non-Shari’ah terms as negotiated and agreed by the parties bind the parties?  Indeed with this development, might the sukuk holders be entitled to insist on a non-Shari'ah bond?

A telling point could well be if DG has engaged in non-Shari’ah based transactions.  This would establish that they do not only finance on a Shari’ah basis. As to the first point, on page 78 of its 2016 annual report Dana refers to the “Shari’ah tranche” of the Zora financing which clearly means there was at least one non-Shari’ah tranche to this financing.  That indicates to AA that DG’s conversion to “Islamic” principles is of recent date and no doubt feigned. 

As regards Scenario #2, the Bloomberg article contains an assertion ascribed to the Company that the Egyptian assets only generated USD 60 million during the life of the sukuk.  If the Bloomberg report is true, this is a rather shocking admission by DG’s management of failure.  Equity holders may want to take note.

More to the point, sharp-eyed creditors, pardon me, the creditors have demonstrated scant sharp eyes so far so let AA rephrase. The creditors’ advisors will no doubt parse this calculation carefully.  Presumably it does not include “profit” (interest) payments because the determination of profit is before the sharing of profit between mudarib and investors. 

As regards the USD 450 million valuation for the Egyptian assets, Section 3.2 of the offering memorandum refers to the distribution of the “realisation of the net proceeds” the Trust Assets.  AA is no lawyer but that would seem to argue that DG cannot merely give the sukuk holders shares in the Egyptian venture based on its own valuation, but rather that the Egyptian assets have to be sold.  If the proceeds are not enough to repay the sukuk, other of the Trust Assets have to be sold.  Since this is a limited recourse transaction, if all the Trust Assets are sold and the sukuk is not redeemed in full, then the creditors have no further recourse.  Requiring sale of the assets could upend DG’s strategy of claiming funds back from the creditors.  It is not without danger to the creditors given the limited recourse nature of the sukuk.  But since the creditors have a weak hand given that feature of the deal, a credible threat to “wreck” the Company might bring it to its senses.  If not the sukuk holders might take comfort in making DG share their pain. 

That DG has adopted this highly risky second strategy suggests to AA that DG believes it has a good chance of winning the case, plans to beat creditors into submission though interminable court action in the UAE, or has run out of viable alternatives.  That is, this is a desperation play:  the Company sees no other option.  That implies that DG’s management has assessed that DG’s value is minimal.  The rejected four-year deal would have given breathing space for a miracle in the form of the receipt of a substantial arbitral payment, collection of receivables, etc.  With that deal off the table, the state of the emperor’s clothes or lack thereof will become obvious. 

As regards, victory in the courts or prolonging the legal battle, perhaps the “fix” is already in the home town court.  As noted in other posts at SAM, the December hearing date is one indication.  Another is the complex but highly convenient requirements of the Sharjah court to lift its injunction frustrating DG’s ability to comply with the London court’s requirements.

Alternatively, DG may be hoping to drag matters out in the lengthy judicial process in the UAE’s fine courts similar to the roughly six-years of legal to-ing and fro-ing  between the National Bank of Umm al Quwain and Global Investment House Kuwait, hoping that this will wear the creditors down. Some details here on that epic legal battle which was finally “settled” via an out of court settlement. 

AA hopes that Emirati courts and rulers understand the impact a court decision in DG’s favor would have on the legal credibility of the UAE judicial system, local companies’ access to cross-border financing, and more widely on “Islamic” finance beyond the UAE.   

AA notes, however, that “hope” isn't really a basis for investments or for correcting problems with investments.  As to AA's judicial "hope", “change” may as well prove elusive.   

Dana Gas Restructuring: Full Repayment of Sukuk Threatened by Weak Cashflow

Looking for the Flow

In a previous post I looked at DG’s stale Trade Receivables, today let’s take a look at the company’s ability to generate cash. 

If the title hasn’t given away the plot, AA’s analysis is that it is likely to be insufficient to repay the Sukuk within five years absent a non-operating event. 

We’ll base the analysis on the “Consolidated Statement of Cashflows” in DG’s annual reports in lieu of developing a more formal model because the intent is to provide a directional rather than locational result.  

This is historic information.  

Why on earth is AA using past data? 

Well, there's nothing on the horizon to suggest a fundamental change in DG's existing business, collection of receivables, etc.  Zora would have to grow exponentially to make a difference.  If new business with better paying customers could be found in other countries, DG probably would be hard pressed to secure financing for a variety of reasons and such business, if finance were available, would take time to develop.

To set the stage a few words about accounting cashflow statements. 

1. There are two methods for preparing / presenting a statement of cashflows.  One (the “direct” method) is based on actual cashflows both inflows and outflows.  This provides better information for analysis. 
2. The second is (the “indirect” method) which begins with reported net income and then makes adjustments for certain non-cash items (e.g., depreciation, allowances for impairment, etc.) producing Gross Cash Flow from Operations (“GCFO” or “GO” in this post).  Then a set of further adjustments for changes in the balances of non-cash current assets and current liabilities, resulting in Net Cash Flow from Operations. (“NCFO” or “NO”).   An increase in a current account is a “use” of cash a decrease a “source” of cash.  It’s the opposite for current liabilities where an increase is a “source” of cash and a decrease is a “use” of cash.   Another issue net changes in account balances are used.  This masks actual cashflows, e.g., for receivables it’s the net of new unpaid billings and cash collections on all outstanding receivables.  It’s important to understand that GCFO does not represent cash collected by the company which it then “spends” to increase current assets (e.g., receivables).  What has happened instead is, for example, that some revenue included in accounting net income has not yet been collected.   
3. There is a way to refine the information from an indirect cashflow using notes to try and disaggregate the “net” changes in accounts.  I haven’t done that for the reason noted above.  

The chart below shows DG’s cashflow over an eight-year period.  Note the “traditional” approach to presentation has been adapted to fit the margin constraints on the blog.  That is, years are vertical rather than horizontal. 

Dana Gas Cashflow Analysis  -  Amounts USD Millions
	GCFO	WC + Tax	NCFO	Invest	Finance	Net CF		NO/GO
2016	145	-63	82	-111	-120	-149		57%
2015	345	-142	203	41	13	257		59%
2014	386	-284	102	-55	-67	-20		26%
2013	358	-233	125	56	-141	40		35%
2012	408	-231	177	-57	-67	53		43%
2011	434	-335	99	-93	-53	-47		23%
2010	285	-154	131	-126	-59	-54		46%
2009	176	-71	105	-31	-78	-4		60%
Total	2,537	-1513	1,024	-376	-572	76		40%
Average	282	-168	114	-42	-64	8		40%

Source:  DG Annual Reports

Some observations on the cashflow. 

1. Over the period 2009-2016, DG has converted only 40% of its Gross Cashflow from Operations to “cash”.  The main culprit over the period is a USD 847 million increase in Trade Receivables.
2. If the future is like the past, then NCFO is unlikely to be significantly different than the USD 114 million average over the past eight years.  Note:  NCFO does NOT include finance costs, e.g., "profit rate" (interest).  
3. So USD 570 million is a reasonable estimate of NCFO over five-years.  That's before investments and finance.  
4. If DG needs to maintain investment at average levels—USD 42 million per year—that leaves USD 360 million for debt service.    
5. Assuming annual level principal payments of USD 138 million a year at a 9% p.a. interest rate total payments are some USD 876 million over the five years.  At a 3% interest rate total payments of USD 752 million. 
6. At 9% the shortfall is USD 516 million (roughly 60% unpaid) and at 3% USD 392 million (52%).   
7. Full repayment of the USD 690 million in outstanding sukuk principal and interest therefore appears unlikely (first euphemism of this post) absent significant new developments.
8. One such development would be a fundamental change in cashflow generation from operations, e.g., Zora generating significant cash, Iranian gas sales finally occurring, highly profitable business in a new market.  
9. Another would be a non-operating event or events that change this unhappy picture.  The KRG and Egypt could pay their past due receivables.  The KRG or IRI might pay DG all or some of the USD billions they owe DG according to arbitral decisions.   DG could sell some of its assets with the proceeds directed to creditors. AA is ruling out—perhaps prematurely—DG purchasing a winning El Gordo ticket given DG’s steadfast self-proclaimed adherence to Shari’ah.  Though I suppose a providential re-interpretation of   الميْسِر  and 2:219 by the Company's modern day Abu Yusuf might occur.  An event perhaps more likely than the others outlined in this paragraph.

With this as backdrop, AA is preparing a “What Then Is to Be Done?” post for the creditors chock full of "sage" advice. 

Because AA suspects that the probability of fundamental changes in operations or the occurrence of a non-operating event is low, AA is reaching out for readers' assistance.. 

Readers who know of an Islamic equivalent to St. Jude Thaddeus Patron Saint of Lost Causes or suitable دُعَاء‎‎ are invited to post details.  All five mathhabs are welcome. 

This could be an important pillar of the creditors’ recovery plan.  It would be shame if it was not included.