Dana Gas - Mashreq Bank Rides to the Rescue Sukuk to be Repaid

 

An Essay on Criticism Seems a Valid Citation

Dana Gas announced on 15 October that it had secured a USD 90 million loan from the UAE's Mashreq Bank priced at Libor plus 3 percent. 

The loan matures in one year, but is extendable at DG's option for another four years.

As per the press release, the loan "will be repaid" when DG's Egyptian assets are sold.

Some thoughts.

First, the 3% margin is described as "initial".  That certainly sounds like it is subject to change.  AA for one would expect that as the loan is extended the margin is increased. 

Second, DG's Chairman asserted that this loan is a testament to DG's "financial and operational strength".  

That is a bit of a howler.

It reminds me of the repeated assertions of Damas' "proven business model" made some years back by the Abdullah Brothers.

DG is borrowing one year money at a 3% margin.

That is a rather large spread.

And more likely evidence of financial and operational weakness than strength.

In any case the long ordeal of the Sukuk holders is over.

Perhaps one man's gain will be another man's loss?

 

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.  .

Analysis of DG Restructured Sukuk Terms - Amended

Lasciate ogne speranza, voi ch’intrate

It's a lot more than just a forum non conveniens 

at least for some folks

In this post we’ll take a look at how investors in DG’s restructured sukuk (the “Nile Delta Sukuk”) fared in the restructuring.

Are they better off?

Our primary source is the Nile Delta Listing Particulars.   Details on the previous sukuk “Dana Gas Sukuk” are here.

This post should be read in conjunction with the post on “DG Sukuk Restructuring - Lessons for Other Investors” (hereinafter “Lessons”) for a more extensive analysis of the replacement sukuk.

First, let’s go back almost two years when AA in his capacity as (الفاضي يعمل قاضي ) gave some sage advice to sukuk holders about elements they should incorporate in the restructured sukuk, if possible.

To wit:

1. Recast the legal agreements to reduce exposure to Abu Yusuf-y legal maneuvering by the obligor/issuer.
2. Get more collateral and take possession now rather than relying on the obligor to deliver it later.
3. Increase amortization via interim payments and a cash sweep.
4. Shorten up the tenor to keep pressure on the borrower.

Recast the Agreements

1. Well, agreements were recast.
2. As described ad nauseam in Lessons the sukuk holders’ legal position hasn’t really improved. 
3. In fact they may be worse off because the Listing Particulars state that the if the Trust Assets (Ijara assets) have not  been transferred and legally registered in the name of the Trustee, then the learned courts of Sharjah may characterize the sukuk not as a financing transaction but a Sale and Purchase agreement.
4. In which case, DG will be obliged to take possession of the assets and return for any monies paid, including interest payments (so-called Periodic Distributions).  This as you will recall is one of the bogus arguments that DG raised with the previous sukuk.  Now the sukuk holders appear to have signed on to this interpretation.
5. AA hopes if this situation comes to pass, the learned courts of Sharjah will NOT opine that the sukuks are a single transaction and include the interest from the year dot in their calculation.
6. As noted in Lessons, the Listing Particulars highlight the risk (lay out a legal strategy?) that this new “ijara” structure may be subject to challenge on what are simply technical matters and not changes in interpretation of Shari’ah compliance principles though the latter remain a risk.
7. As also outlined in that post, the risk of Abu Yusuf-ery remains, the sad result of a confluence of factors associated with so-called Shari’ah compliant transactions, exacerbated by the risk of having to litigate in the eminent courts of Sharjah.
8. Hint:  If you’re looking for Shari’ah compliant structures, AA suggests equity in a firm that does not engage in transactions contrary to Shari’ah. Or you might want to consider sovereign sukuk issuers who are expected to be less prone to employing Abu Yusuf or his “tricks”.

Obtain More Collateral and Take Possession

1. More described “security” was ostensibly obtained, including some promises of  future security arising from what might charitably be described as high unlikely events, e.g., sale of DG’s fine Egyptian assets or payment of an arbitration award by Iran.   
2. One would need an electron microscope to assess the practical impact on the sukuk holders’ security position of the additional collateral, including the (  في المشمش ) type.
3. AA recommended taking possession of security now rather than waiting to attempt to exercise rights after default.  That didn’t happen.  One sad example: the Ijara assets apparently have not been registered in the name of the Trustee. As noted in Lessons and above, that opens a potential loophole big enough for Donald Trump’s ego to pass through comfortably.

Increase Amortization, Add a Cash Sweep

1. The sukuk holders had a partial victory here.  The sukuk has been reduced to just under USD 400 million.
2. But only the down payment was mandatory.  The additional payment got DG a reduction in rate.  DG made both.
3. But as of now DG have no further obligations to make principal repayments until final maturity of the sukuk in October 2020.
4. To add insult to injury, DG won the right to pay dividends of 5.5% of paid in capital (roughly USD 95 million) a year with the only requirement that after payment of dividends DG maintain USD 100 million in cash and equivalents.
5. To spell it out, it doesn’t matter what DG’s cash flow or income is.  If DG has money in the bank, it can pay dividends of roughly USD 100 million a year as long as after payment it still has USD 100 million in the bank.  
6. A very key point: DG prepares "consolidated" financials that include assets and liabilities of investee companies, including Pearl Petroleum.  Legally, DG does not own these amounts and cannot use them.  
7. In the past I've focused on the Pearl Receivables.  Now it's time to look at Cash and Banks.  Note 15 to DG's FYE 2018 AR page 89 contains information on Current Assets of Pearl appearing on DG's balance sheet - some USD 131 million which would include Pearl cash and A/R.  
8. From the MD&A (page 36) we know that DG's share of Pearl A/R was some USD 18 million.  A rough estimate (note the double caveat here) then is that about USD 100 million of Cash on DG's balance sheet is likely to really be Pearl's cash.  Unless Pearl dividends this money to DG, DG cannot use it for sukuk repayment or other purposes.  
9. The key issue here is whether the dividends restriction is based on the cash appearing on DG's consolidated financials or its parent only financials (not disclosed in the AR).  
10. By AA’s calculation USD 100 million is 25% of the amount due at final maturity.  Of course DG cannot reduce its cash to zero if it is to remain a going concern. Equally it cannot use Pearl's cash for its operations or for debt service.  
11. DG's cash is USD 400 million in bank as per consolidated financials. And on a parent only basis, perhaps USD 300 million.  In either case, DG can pay away just under USD 200 million before final maturity.   
12. Leaving USD 200 million (consoldiated) or USD 100 million (estimated parent only).   50% of the final principal repayment, ignoring cash it must retain for operations. Or in the worst case 25% of the final payment.
13. That appears to leave sukuk holders in the position of hoping that DG can generate aggregate net cash of about USD 300 million during 2019 and the first 10 months of 2020 (consolidated basis) or USD 400 (million parent only).  That’s based on the assumption that DG would not reduce its cash to zero to make the final payment and probably needs to retain at least USD 100 million to assure ongoing operations.
14. If it does not generate that cash, then there will be another restructuring.  As outlined above, the sukuk holders have scant legal leverage.

Shorten the Tenor

1. Tenor was kept reasonably short.
2. While the sukuk holders’ legal and collateral position is weak, the short tenor does keep some pressure on DG.  The threat of another messy restructuring and resultant worsening of banking and public relations may provide some leverage on DG.
3. Perhaps, the sukuk holders just trod the path of a typical commercial bank restructuring.  The lenders know that the proposed terms are not economically based.  That is, the borrower will be unable to make the payments in the time frame given.  But the terms will “sell” back in the head office.  And when the maturity is missed, someone else will be charged with restructuring.
4. In any case the sukuk holders may be in for the financial equivalent of a “Zeno’s dichotomy paradox” restructuring.  Each time they restructure they’ll get half way to full repayment.  At some point, I suppose, the amount will be such that a write-off will be less costly than the professional fees associated with another restructuring.
5. AA gives sound advice or so he imagines.  But, clearly,  (اليد في الميّة مش زي اليد في لنار ). 
6. Sukuk holders probably did as well as they could.  In the desert any water will do.
7. The lesson is to avoid the desert if possible.  Sound advice as usual from AA but of little use to those already "invested" in Nile Delta.
8. A cautionary tale that shows the importance of (فكر في الخروج قبل الدخول )

Analysis of DG Restructured Sukuk Terms -- Lessons for Other Investors

"دخول الحمام ليس مثل خروجه"

In this post we’ll take a detailed look at DG’s restructured sukuk (the “Nile Delta Sukuk”).

Our primary text is the listing particulars for Nile Delta published on the Irish Stock Exchange last August.   For those who want comparatives, here’s equivalent information for “Dana Gas Sukuk” the previous incarnation.

The DG restructuring saga provided investors some important lessons.  Not only the hapless group that invested in Dubious Gas, but also those considering other “Islamic” investments or doing business in the UAE.

Analytical comments (appearing below in italicized bold face) will be both descriptive and prescriptive.

Descriptive for those who’ve already entered the hammam (investors in the sukuk).  Other than a secondary sale they are “in” for what appears to be a prolonged bath.  As an aside, AA sincerely hopes he is wrong.

Prescriptive for those lucky investors who haven’t yet entered but may be considering so-called “Islamic” investments or dealing with obligors in Sharjah.  AA undertakes this task knowing full well that while repetition is said to be effective in teaching donkeys, history shows that teaching investors is a more difficult task.

Shari’ah Compliance

The self-averred devoutly scrupulous members of DG’s Board and management were mightily troubled that the previous sukuk was no longer Shari’ah compliant due to a change in scholarly interpretation on al-mudarabah transactions.  So much that they felt compelled to reject their contractual obligations.  As part of the proposed restructuring, they offered sukuk holders an opportunity to right that wrong with a Shari’ah compliant instrument.

What was the outcome?

As the Listing Particulars succinctly state on p 48:  “No assurance can be given as to Shari’ah rules.”

While the Shari’ah Advisory Board of Dar Al-Shari'ah has opined that the sukuk is Shari’ah compliant, the LP notes that there are no assurances that it will be deemed so by other Shari’ah scholars and boards.

You may also recall, and if you don’t, AA will remind you that DAS opined that the previous sukuk was Shari’ah compliant.  That’s not to cast aspersions on DAS scholarship or diligence.

It’s a simple fact that there is no central body that gives a definitive pronouncement on Shari’ah compliance.

As well a subsequent change in interpretation decided such transactions were not Shari’ah compliant. Whether this was intended to be retroactive or not was not explicitly stated.

This by itself should give pause to investors contemplating Shari’ah transactions for two reasons.  For the faithful -- compliance with religion.  For those prudent in conducting financial transactions  -- enforcement of issuer obligations.

Simply put if you’re looking for Shari’ah compliant investment opportunities, your best bet is equity.

Legal Enforceability

But there is more here that should increase anxiety.  Prudent investors usually craft legal agreements to protect their rights to enforce the issuer’s obligations in this world.

The learned courts of Sharjah accepted the argument that while Dana Gas Sukuk was Shari’ah compliant at inception a subsequent changed interpretation about the compliance (or in this case non-compliance) of mudarabah transactions made it non-compliant.  No grandfathering was granted to transactions began prior to the change in interpretation.

As the LP wryly notes on page 45:  “Investors may have difficulties in enforcing any English court judgments or arbitral awards, which do not satisfy the requirements of UAE laws, against Dana Gas in the courts of Sharjah.”

The history of the Dana Gas sukuk restructuring suggests that “may have” above is more appropriately written as “almost certainly”.   While there is no doctrine of case precedent in the UAE, prudent investors probably would want to avoid these courts.

Investors should pay particular attention to the courts whose acquiescence is required for enforcement.  The LP disclose the various shortcomings in key GCC/MENA legal systems not only regarding enforcement of foreign court judgements but also creation and enforcement of security rights.

But there are more than legal warnings in offering memoranda.  By creating the DIFC, the Ruler of Dubai made an unequivocally unfavorable statement about Dubai and UAE courts.  The DIFC is a partial answer.  But as events in Asia suggest, one would be well advised not to “bank” on “one country two systems”.

Reliance on Complex Structuring

These transactions involve elaborate structuring.

First, to attempt to create the “Islamic” equivalent of a bond.  Much of this involves the use of Abu-Yusuf-y transactions.   Often poorly or incompletely executed in light of legal requirements.

Second, to attempt to mitigate the legal risks of local jurisdictions.  Key transaction documents are made subject to the laws of what are perceived to be more investor friendly jurisdictions.  But as several cases, including DG, have shown ultimately this does not work unless the key local jurisdiction where enforcement will take place plays along.

The result is many “moving parts” which affords desperate issuers opportunities to seek to undermine the structure.

Before we turn to Nile Delta, let’s look at the case of Golden Belt Sukuk discussed in an earlier post on this site.

Investors wanted a bond-like structure with a fixed interest rate.  So clever lawyers created a transaction in which the Trustee on behalf of the investors would lease Maan’s properties in KSA back to him at a fixed rental.  However, for probably imagined to be very good reasons, the transaction did not require that he actually sell and re-register the properties in Trustee’s name.

Investors ignored (but the Offering Circular did not!) that a local KSA court was likely to compare the rental charge due under the sukuk to market rentals for similar properties.  And, if the sukuk rentals were above market rental rates, adjust the sukuk rentals according.  And, for some reason the local law requirement for a “wet” signature to make a document legally binding was missed.  But why quibble? What could possibly go wrong? Quite a great deal.

Back to DG on page 51 (the Nile Delta) Listing Particulars makes the following points about the transfer of the Trust Assets.

1. While the Purchase Agreement for the Trust Assets is governed by English Law, substantially all of the initial Ijara Assets are located in the Emirate of Sharjah.  
2. To the extent that the laws of the Emirate of Sharjah and, to the extent applicable in Sharjah, the federal laws of the UAE are applied in relation to any dispute relating to the Purchase Agreement or the transfer of the Ijara Assets, there are doubts whether an ownership interest in certain Ijara Assets can be effectively transferred without registration of the transfer with appropriate authorities. 
3. Accordingly, no assurance is given that any ownership interest in the Ijara Assets will be effectively transferred to the Trustee.  
4. Oops – not really a sale and transfer.  
5. Also note the bit about applicability of UAE federal laws in Sharjah.  One might be advised not to “bank” on UAE federal laws saving one in this transaction, if indeed one imagined they might. And perhaps in other transactions in other Emirates.

But the LP goes on to note potential remedies. 

1. Dana Gas has agreed in the Purchase Undertaking to indemnify the Issuer for the purposes of redemption in full of the outstanding Certificates in the event that any transfer of the Ijara Assets is found to be ineffective. 
2. Given the issuer’s past behavior, no doubt a source of great comfort to some investors.
3. In the event that the Trust Assets are not purchased by Dana Gas for any reason, the Delegate will seek to enforce the above provisions of the Purchase Undertaking.   Seek? Indeed! Achieve? Well, that did not seem to work out so well with the previous incarnation.
4. It is likely that, in any action heard by them, the courts of Sharjah would review the transaction as a whole and seek to uphold the intention of the parties to treat the arrangements as a financing transaction on the terms agreed, provided that the transaction is not recharacterised as a sale and purchase of assets as described below.   As they did with the previous sukuk?
5. A Sharjah court may characterise the transactions contemplated by the Transaction Documents as a sale and purchase of assets that is void as a result of the failure to register the transfer of the Ijara Assets as described above and may therefore refuse to enforce the indemnity in the Purchase Undertaking. 
6. Accordingly, Dana Gas would be required to return the purchase price it received for those assets to investors less any amounts already paid to investors in respect of those assets (i.e. Periodic Distribution Amounts paid under the Certificates). As a result, in this particular situation, investors in the Certificates may not receive back the full amount of their investment. 
7. This is a familiar argument.  Where have I heard it before? (Purely rhetorical question.) Positioning for October 2020 and another convenient attack of conscience?
8. Prospective investors should note that, to Dana Gas’ knowledge, this matter has not been considered by the courts of Sharjah, therefore there can be no assurance as to the approach that would be taken by the courts of Sharjah in such circumstances.  Since the legal concept of case precedents does not exist in Sharjah, does it matter whether or not they have?

In summary a highly structured instrument composed of several transactions subject to the laws of more than one jurisdiction with enforcement dependent on the jurisdiction—which just happens to be the one with the least reliable legal system—about whose validity as Shari’ah compliant there is no assurance.

A transaction that is therefore highly fragile.

Providing a borrower in distress the opportunity to seek to undermine the entire structure.

If you’re already in the hammam, you don’t have many options.  Striking when the iron is cold isn’t going to get you much.

If you’re thinking about investing, (فكر في الخروج قبل الدخول ).

It’s very simple.

1. Do not deal with people you do not trust.
2. Make sure the contract between you and your counterparty is specific – amounts, dates, rights and responsibilities—and contains a realistic path to enforce your rights.
3. Never rely on your contract to correct deficiencies in (a) your counterparty’s character and (b) local law. 
4. No matter how much some clever lawyer tries to persuade you he has "fixed" problems with his brilliant structuring. Be suspicious of transactions that have complex structures.  They often fall apart in times of distress.
5. Make sure, as much as you can, that if you have to enforce your rights under a contract, you will get a fair shake in the legal system and in certain jurisdictions a fair shaykh. Or in other words, that the law is fair and reasonably predictable.
6. If any of these elements are missing, take your money and business somewhere else.

Dana Gas: FYE 2018 and 1Q2019 Financial Performance - A Brighter Picture But Not by Much

A 5 Watt Bulb is Brighter than 2 Watts

Last December I made a bold prediction based on DG’s 3Q18 financials that the company would have a break-even year or at best case perhaps earn a 4.5% ROAE.  

DG’s 2018 financials  (but not its glossy annual report) have been released. 

Let’s take a look and see how prescient AA’s prediction was.  

Net income for 2018 is what might charitably be described as “disappointing”, a net loss of USD 186 million driven by impairment provisions of USD 250 million.  USD 187 million for the write-off of the Zora field and USD 59 million for certain Egyptian assets (or perhaps uncertain Egyptian assets).  

Pretty far off from AA’s less than less than "prescient" prediction a scant five months ago.  

In the MD&A section of the report DG’s Directors emphasize that the 2018 impairment provisions were “non-cash items” and that “On a like for like basis, excluding one off impairments, profit from core operations increased to USD 64 million (AED 234 million) as compared with USD 5 million (AED 18 million) in 2017".  

On that basis, DG earned an ROAE of some 2.35% using total shareholders’ equity as reported on the balance sheet.  If we adjust 2018 equity for the non-cash impairment that year (add it back) then ROAE is 2.27%. 

In the Directors’ “best” case, a dismal return.  

Certainly well below the risk-adjusted return DG should be earning given its business concentration in risky markets.  Equally well below the return it should be earning ignoring risk.  

However, the picture in 1Q19 is brighter, but only marginally in an absolute sense.  

Net income of USD 35 million, largely driven by a USD 10 million reduction in interest expense.   If this pattern continues, projected ROAE for 2019 is some 5.3% much better than 2018.  

But still subpar for the risk.  No longer pitch dark.  But a 5 watt bulb is cold comfort.  

There was other good news.  

Continued reasonably good collection of receivables from Kurdistan.  

A less favorable 70% collection rate in Egypt, including some receipts in Egyptian pounds.  A less than happy approximate USD 9 million increase in Egyptian receivables.  Both factors –accepting funny money (Egyptian) and increasing receivables --something to keep an eye on.  

DG also reported that it and Pearl had prevailed in their arbitration (LCIA) with MOL over the KRIG settlement. 

So is DG out of the woods?  

Not quite yet.  

While better than 2018, the projected ROAE is still not at a level that a company with this risk pattern should be earning.  

One quarter does not a turnaround make.   

More importantly the factor driving the turnaround is financial not operational.  The current interest charge is based on a non-market rate.  Once the company has to borrow at market rates again, this financing advantage will disappear.  And financing will be important if DG is to materially grow its business.  

With an approximate 5% ROAE, there will also be little opportunity to use financial leverage to increase shareholders returns materially.  And, if lenders demand more than the ROAE, leverage will actually diminish ROAE.

There's a real negative on the operational side: the write-off of Zora.  It was DG's one revenue stream from a creditworthy country. Admittedly small, but perhaps with a potential to grow.

There's also another cloud on the horizon.  

DG is looking at a roughly USD 400 million principal payment on the sukuk in October 2020 some 17 months from now.  

With USD 442 million in cash as of 1Q19, an almost certain USD 95.5 million dividend this year and one next year which is likely to be approved and paid prior to repayment date, there’s little margin for error. 

The sukuk lenders/investors did not or could not impose any real control on DG's payment of dividends.  They agreed that DG could pay dividends equal to 5.5% of paid-in- equity on the condition that after such payment, DG would have cash of at least USD 100 million.  And they did this knowing the repayment due in October next year was going to be a multiple of USD 100 million.  Roughly 4 times.

If DG is able to honor the repayment obligation in full, and that’s not certain, it could be left with little cash for its business.  

In such a case it’s hard to imagine investors and lenders rushing to support DG, but then they (lenders and investors) routinely demonstrate little common sense in their underwriting. 

So the future while brighter (5 watts instead of 2 watts) isn't bright enough to lift DG from the dog investment category.

Dana Gas Restructuring: The “Art” of the Deal

Unconstrained Mirth at the Announcement of an Imagined Successful Negotiation  

Asian analysts are divided on whether the picture is from 13 May or 12 July of this year.  As you’ll recall, Dana Gas announced its “successful” restructuring on the former date, “accretive to all stakeholders”.  On 12 July the conclusion of another allegedly fantastic deal was announced.  By at least one account (Twitter?) this one “irrevocably sealed” with a handshake. 

Early on in its negotiations with creditors, DG adopted a rather pugnacious strategy, reminding AA of the “hit them back harder” strategy advocated in a business book published first in 1987 by a self-proclaimed dealmeister under the same title as this Blogpost. A remarkable coincidence!  Hence, this remark.  

Let’s review how DG was able to apply this “winning” strategy and negotiate a “fantastic” deal with its creditors. 

On 3 May 2017 DG issued a press release stating that it would commence restructuring negotiations with its sukuk holders because its cash flow problems made full repayment of principal on 31 October 2017 impossible as it needed to conserve cash.  

On 17 May 2017 the creditors announced that they hired advisors for the restructuring.  DG announced that it hired its own set of advisors on 5 June. 

Subsequently, on 6 June 2017, in a conference call with sukukholders DG announced a set of principles which it later codified in a 13 June press release:  

1. Illegality:  Due to changes in interpretation of Shari’ah, the existing sukuk was no longer compliant with Shari’ah or UAE law. Consequently, DG in good conscience could not make any payments, including the upcoming profit payments in May and October 2017. 
2. New instrument:  To be Shar’iah compliant.  
3. Tenor:  4 years with bullet repayment.  
4. Profit Distributions (Interest): Less than half of the 9% rate on the sukuk with provision for unspecified amount to be paid in kind (PIK), i.e., additional debt.  
5. Prepayment:  At company’s discretion with no prepayment penalty. Something not usually granted on a fixed rate debt instrument.  

DG also advised that it had asked the eminent courts of Sharjah to rule on the legality of the existing sukuk.  

This was the company’s first offer. Like anyone else negotiating in the suq, including the suq al mal, probably an opening offer intended to start negotiations with the expectation that that final terms would differ.  

In quick order thereafter the company advised that it had obtained restraining orders in Sharjah, the Cayman Islands, (effective 13 June), and the UK (apparently effective June 16) preventing the sukukholders’ agents from taking action against the company to enforce their rights.  Rather quick action given DG’s announcement that it hired advisors on 5 June.  

On 27 July DG advised the sukukholders that its “previously contemplated offer” (apparently the 13 June “proposal”) “is now off the table, and that the Company is pursuing litigation driven outcomes” as per its 31 July press release.        

What happened?   

According to an apologia for DG published by Al-Khaleej newspaper –available on DG’s website--under the title “Dana Gas has, from the outset, been transparent and sought fair solutions for Sukuk holders and has been justified in its actions to protect all of its stakeholders.”  Move over Gulf News you've got a strong competitor in local "journalism".

What rather sad and unprofessional behaviour by the sukukholders forced what was no doubt DG’s reluctant hand?  

In Al-Khaleej’s words:  

”However surprisingly (and unlike previous and normal practice) the committee refused to even meet and instead, in a very unusual and hostile ill-advised step according to Houlihan Lokey, one of the leading international financial advisers specialising in debt restructuring, the Company received threatening letters and a draft default notice that would have greatly harmed both the Company's ability to secure its outstanding cash receivables and realise the value of its enormously valuable assets; and negatively affecting all stakeholders including the Sukuk holders themselves.” 

First, a shout out to the phrase “its enormously valuable assets”.  Those would be the ones that over a rather prolonged period have been unable to generate an acceptable ROA or ROE, even ignoring risk, to say nothing of generating cash in a timely fashion.  

Second, earlier like Al-Khaleej I believed that HL was one of the leading international financial advisers specializing in debt restructurings.  Taking Al-Khaleej’s quote of HL at face value, my opinion has changed. I’m guessing that it’s more likely they were experts in restructuring church and charitable organization debts where more genteel creditor behavior is more likely to be commonplace.  In purely commercial deals creditors can be quite hostile when an obligor announces its inability to pay--an event which highlights the manifest failure of the lenders’ or investors’ underwriting of the deal at inception.   

In general debt restructurings are not pleasant affairs.  AA has been regaled by his elder brother and other equally reliable sources with stories of irate creditors verbally abusing the obligor and its advisors as lacking integrity and business sense, threatening to call a default and “destroy” the borrower.  And generally behaving “shirty”.  

In one case an unsecured creditor threw a rather heavy object at an obligor’s outside advisors when that advisor had the temerity to note that unsecured creditors were lower in legal priority of payment than secured ones.  In another case where an aggressive creditor rejected an initial restructuring proposal with a string of profanities directed at a former senior US government official who had returned to his lawyerly and advisory roots.  

Even more so if the obligor is a serial defaulter as is the case with Dubious Gas.  On top of that the company raised a rather preposterous defense against payment after having promised in the sukuk not to challenge the legality of the instrument.  See  Page 108 "Events of Default" (c) in the Prospectus.  

To add insult to injury DG prepaid other creditors in preference to the sukukholders sometime prior to 11 May.  Some cash is more worthy of preservation that other cash, I suppose.  A reasonable creditor would seem justified in ascribing manifest bad faith to the obligor. 

No wonder the creditors made the threat they did.  More here.  A perhaps rougher elbowed group of creditors would have called default immediately.   

Finally, according to the Al-Khaleej account, the threatening letter was sent on 23 May 2017.  On 6 June the company conducted a conference call with sukuholders.  Not a meeting in person, but a meeting nonetheless.   No doubt the sukukholders were less than enthusiastic about DG’s proposal as would be “normal practice”, especially given DG's less than good faith behaviour outlined above..  

Whatever the case here, subsequently, DG was quick off the mark (especially if advisors were hired on 5 June) with a blitz of legal actions. To boot the eminent courts of Sharjah seemed squarely on its side.  DG had seized the initiative from DG’s creditors.    A providential prepayment of other bank obligations prior to 11 May 2017 reduced the risk of creditor contagion.   

From all the above, it sure looks to AA like DG was preparing to take a hard line well before the 23 May “threat”.  

But DG has more up its sleeve, according to Bloomberg, DG also noted that the assets in the Trust--primarily, the company’s fine Egyptian assets--had dismal returns. DG have well-established track record in this field and were clearly speaking from experience and expertise.  DG noted that if it were to unwind the sukuk ab initio (because of its illegality) and recast the “profit payments” in excess of the assets true return as principal repayments it would then owe the sukukholders only USD 55 million.  On the other hand were it to covert the sukuk to equity in the fine Trust Assets, the sukukholders would owe DG some USD 150 million.  You will perhaps note an apparent contradiction between asserting these fine assets generated minimal returns and a valuation of some USD 850 million.  Such are the mysteries of “Islamic” finance and GCC finance.   For more on DG’s strategy/threat see my post here.  

Given the propensity of the eminent courts of Sharjah to see things DG’s way, including allowing the company to pay a dividend in the midst of a debt restructuring and in contravention of the UK High Court’s ruling, and basically refusing to apply other foreign court decisions on DG, it doesn’t seem unreasonable that they would see things DG’s way on this topic as well.    

One side note, investors who bothered to read the sukuk prospectus would not have been surprised by the actions of the eminent courts of Sharjah.  

Let’s take a look at the fantastic deal that DG secured for itself from an apparent position of strength and a no-nonsense take-no-prisoners approach.   

1. Tenor:  Three years instead of DG’s originally proposed four years.  Commencing from October 31, 2017.  
2. Profit Rate: 4% instead of the company’s 3% rate.  A partial win, but note that the average life of the sukuk has been shortened dramatically by the down payment and promised prepayment, though as structured the latter does not appear to be mandatory. 
3. PIK – No PIK.  
4. Principal Repayment:  No bullet repayment. DG will use USD 385 million of its cash to make a principal payment on signing.  Assuming sukukholders are smart enough to sign up for Tranche A (immediate payout at a discount), the principal amount of the sukuk will be reduced from USD 700 million to USD 420 million, roughly a 36% reduction.  
5. Prepayment:  Another USD 105 million prepayment no later than 31 October 2019, 15 months from anticipated signing in August 2018.  If made, the prepayment will reduce the sukuk to USD 315 million or 55% of the original USD 700 million.  If DG fails to prepay, the profit rate will increase to 6%.  Failure to pay appears not to constitute a default.  
6. Additional Obligations:  Promise to use all net free cash from NIOC settlement or sale of the fine Egyptian assets to buyback sukuk under certain undisclosed terms.  Neither the NIOC settlement nor the proceeds from the sale of the Egyptian assets are collateral.  Both of these are potential but probably not highly probability future events (assets).  A sale of the fine Egyptian assets has probably been harmed by DG’s trash talk about their multi-year disappointing performance not to mention the whiskers on the associated receivables. Recent moves by the USA to apply financial pressure to Iran could reasonably be expected to frustrate an NIOC payment if settlement were reached.  What is notable here though is that DG has accepted an obligation to use the NIOC settlement as a source of prepayment even though it is not part of the Trust Assets.   
7. Dividends:  Ability to pay 5% of paid-in-capital as dividends subject to certain undisclosed minimum cash maintenance requirements.  Potentially a stake into the heart of the sukukholders’ repayment prospects if this is not structured properly.  

It doesn’t seem that DG’s hard-nosed “clever socks” strategy has resulted in any real benefit to the company in terms of the restructuring unless we assume that a less confrontational negotiating style would have resulted in repayment of the full amount upon signing as well as board and senior management members pledging their first born offspring to the sukukholders.  

Not only did DG not get its wishes, but also DG has committed its cash windfall from the KRG settlement to repayment of the sukuk.    

But there’s more. 

Real damage has been done to the company.  

The cash drain is happening at the time when DG asserts it needs cash for needed development of its operations.   DG's clever socks strategy has burned a lot of bridges.  

Existing creditors and potential creditors with half a brain (note that caveat) have probably been alienated; though DG may be able to “bank on” bankers’ and investors’ chronic ADD and the rather large bloc of creditors and investors with little credit skills or sense.  See the Abraaj saga for examples of the latter.  

There is another lesson here.                   

If you’ve found what appears to be a clever business strategy in a book, check out the bona fides of the author before you act.  What is the business track record of the author? Is the author a true "captain of industry"?  Or been involved in serial shipwrecks?  

If you also see the author, even if he or she claims to be a billionaire, hawking steaks, wine, or dubious educational institutions on the TV, it may be a testament to his or her (a) less than stellar track record in business and thus (b) lack of real business acumen.  

After all, how many successful businessmen or women engage in such peripheral activities when they could earn additional billions in their more lucrative mainframe pursuits?  Lloyd Blankfein hasn’t come around to Chez Arqala offering gardening or pool services.  Warren Buffet isn't doing reality TV.

When reality collides that violently with image, it’s probably wise to heavily discount the advice. 

It's also wise to ensure a sound understanding of the correlation of forces.  If conditions are not good, even a "wise" strategy can fail.