Dana Gas 1Q18 Earnings - No Sign of Change in DG's Prospects

"Looks Like the Runway's Too Short Even with Jet Engines"

DG reported net income of USD 14 million equivalent for the First Quarter of 2018. 

On an annual basis, that’s an ROE of roughly 1.9% based on the very simple assumption that each following quarter will have the same NI of USD 14 million and that equity will increase by the same amount.  

However, as the Company’s directors noted in their report, 1Q18 income benefited from a USD 13 million reversal its share of accrued operating costs at Pearl Petroleum no longer needed because of the settlement with the KRG.  Thus, 1Q18 operations generated a pathetic USD 1 million in net income.  Annualizing that amount results in net income of USD 4 million for 2018 and a projected ROE of 0.15%.  

DG is likely to do better than either of these scenarios.  

But it’s hard to see it reaching an ROE commensurate with its risk profile or performance robust enough for thinking creditors.  

The settlement with creditors will result in interest expense for 2018 between USD 23.3 million and USD 25.7 million, depending on the take-up of Tranche A.  Calculated as (a) USD 700 million for the first 7 months of the year at 4% and (b) either USD 420 million (full take up of Tranche A) or USD 560 million (no take up of Tranche A) for the last 5 months of the year at 4%.  When compared to 2017’s USD 66 million, this is a “savings” of roughly USD 40 million to USD 43 million.     

The Company will also benefit from the reversal of two months of interest accrued in 2017 on USD 700 million or roughly USD 5.8 million.  This represents the difference between 9% and the negotiated 4% which is retroactively effective as of 1 November 2017 based on the draft restructuring terms.  

In my post on 2017 net income I made the case that if one deducted non-operating items DG’s reported net income of USD 83 million was actually a loss of USD 57 million.   

Let’s make projections for 2018 based on both 2017 net income as reported and net income as adjusted (by AA) for non-operating one time events.  

If we add an interest “benefit” of USD 50 million (a generous round-up) to 2017 reported net income, 2018’s projected net income is some USD 133 million.  Projected ROE is roughly 4.5% compared to 2.94% for 2017.  An improvement but still well below what I’d consider --and hope you would too--the required return for a company with DG’s risk profile.   

If we look at my calculation of an operating loss of USD 57 million for 2017, and are a bit more generous on the interest benefit (USD 57 million), then on an operating basis DG breaks even in 2018.    

Neither scenario should be comforting to equity holders.  

Creditors thinking of Tranche B may want to “think again” particularly as the restructuring and proposed dividends are likely to significantly reduce DG’s cash this year. 

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. 

Comments 

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. 

 

Dana Gas "Swings" to Profit in 2017

DG Ready for Takeoff The Sky is the Limit

DG announced its FY 2017 results on 15 March.  Net profit was USD 83 million equivalent up from a USD 88 million equivalent loss in 2016. 

Does this mean that DG has turned the proverbial corner and that future results are likely to show similar and perhaps even improved results? 

You might think so reading DG’s earnings press release.   

“The turnaround was led by higher realised liquid prices, higher production in Egypt and tight management of operational expenses. Higher profit was also supported by the successful settlement agreement ('Settlement') with the Kurdistan Regional Government ('KRG'). However, Q4 net profit was impacted by an impairment charge of $34 million (AED 125m) against the UAE Zora asset following the year-end reserve report.”

While admittedly it's too early to state conclusively, as the picture above indicates, AA is not convinced that DG has a smooth flight path to a rosier future. There are some fundamental problems at DG.  It's hard to see these being corrected.  Another cautionary message to the unfortunate existing creditors of DG and to any potential ones.

1. DG’s 2017 Gross Profit was USD 118 million equivalent compared to 2016’s USD 103.  That’s a USD 15 million turnabout or just under 9% of the USD 171 net change between the two years.  So this led the “turnaround” only in the sense of occurring first in the income statement.  Note: Gross Profit = Gross Revenues –Royalties – Operating Costs and Depletion.   The Gross Operating Margin (GOM) in 2017 was some 26.22% versus a slightly higher percentage in 2016.  GOM = Gross Revenues/Gross Profit. 
2. The real “turnaround” occurred in other expenses and income which were a net credit of USD 3 million versus a net debit of USD 58 million in 2016. 

Has DG discovered a magic solution to controlling expenses?  Has its business fundamentally changed, leading to new ongoing "other revenue" stream?  Or has it benefited from one-off events?

If you guessed the latter, you’ve guessed right.  References to notes below are to those in the 2017 FY Audited Financials available here. 

1. DG had USD 26 million in other income (note 7).  Under the agreement with RWE regarding its investment in Pearl Petroleum Ltd, RWE owes DG additional payments when PPL pays a dividend.   PPL paid a dividend as a result of the settlement with the KRG.  Future PPL dividends are likely to be contingent on settlements with Iran’s NIOC.  Probably a low probability event. 
2. DG benefited from a USD 114 million reversal of Surplus over Entitlement (note 29) again resulting from the settlement with the KRG. 
3. These two items aggregate some USD 140 million in credits that are unlikely to recur.  Adjusting for these, 2017 results would be a net loss of some USD 57 million.  Income tax expense (note 9) appears related solely to DG’s Egyptian operations and so would not change based on these adjustments. 
4. One interesting side note – DG appears to have accrued interest on the sukuk at contractual rates for the full year – some USD 67 million.  Though as the Statement of Cash Flows shows the Company only paid total interest of USD 32 million out of the USD 71 million accrued. 

On that basis, DG has not turned the corner. 

1. With the recorded USD 83 million in 2017 net income, DG earned a whopping 2.9% on equity. More cellar than stellar. 
2. Assuming 10% is the minimum appropriate rate for the risk of this company (Disclosure: AA thinks it should be higher but doesn’t want to pile on DG) and that other expenses are roughly USD 100 million a year, DG has to earn net operating revenues of USD 382 million. If ongoing other revenue streams of this magnitude are not likely, then DG has to increase its net operating profit.
3. Assuming the 26% GOM would hold (and it probably wouldn’t given higher production), DG would have earn gross revenues of roughly USD 1.469 billion or 3.3x 2017 gross revenues. 
4. Alternatively, without a change in gross revenue, DG’s GOM would have to be roughly 85% which is almost certain not to happen.  If gross revenues were doubled, the GOM would have to reach 42% - another level that seems less than attainable.

Other Information in DG’s Financials

What else did we learn from DG’s FY 2017 annual report? 

1. Of the USD 1 billion KRG settlement, DG received USD 350 million of which USD 140 million is restricted for investments to increase production in the KRI. DG is able to utilize that amount for other purposes if it can raise financing.  Imprudent or uninformed is the financial institution that would lend to this discredited (that’s a partial pun) borrower for a venture in what might charitably be described as a squirrelly market.
2. Some (a) USD 695 million in be-whiskered KRG trade receivables and (b) interest due on them which had been deducted from Surplus over Entitlement have been “discharged”.  The KRG no longer is legally obliged to unconditionally pay these amounts.  Rather they have been transformed into additions to “petroleum cost” carried under “property, plant, and equipment”.  Under its concession agreement with the KRG, PPL has the right to recover certain costs of investment in the KRG from future production. If there is insufficient future production or none at all, the amount is lost.  If recovery of these costs requires an extended period, then the present value of the amounts recovered will be less than the amounts booked.  And it appears that unlike the trade receivables, PPL and thus DG have no right to interest on the unpaid amount.  In short, as part of the settlement PPL has transformed a sum certain debt payment into a contingent payment the amount and timing of which is uncertain with no protection by way of interest accrual.  On the other hand, as a practical matter this may have been the only way to “collect” this debt. 
3. The woes at Zora continue.  2017 production is 39% down from 2016.  The Company also assesses that “At present it is unlikely that further well interventions can be economically justified …” Financials page 5. 

Quibbles

As usual with AA, he just can’t resist a technical quibble.  Or two. 

1. In its FYE 2017 Financials, DG observes that its 2017 net income of USD 83 million represents a 194% turnaround from the 2016 loss of USD 88 million.  That’s an interesting calculation.  If, for example, DG earned USD 1 million in 2016 and USD 83 million in 2017, then the net change would have been an impressive 82 times or 8200%.  But going from a loss of USD 88 million in 2016 to USD 83 million in 2017 is only 194%!  Trust this is an outlier error in DG's financial calculations.
2. In commenting on DG’s 2017 results AA’s favorite GCC financial newspaper apparently misread the quote above from DG’s press release causing GN to say that “Revenues of the company went up to $450 million in 2017, from $392 million a year earlier due to higher oil prices, increase in production in Egypt and tight management of operational expenses, the company said on Thursday.”   DG’s quote referred to net income not gross revenues which are before any expenses.

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: Comments on KRG Settlement

Unless you’ve been asleep you’ve already read about the settlement between the Kurdistan Regional Government and Pearl Petroleum announced on 30 August by Dana Gas. 

Most of the headlines focused on the USD 1 billion payment by the KRG to Pearl Petroleum and did not discuss other aspects of the transaction.  The market reacted with characteristic irrational exuberance. Hence this post.

To start a side comment. In a rather bizarre but not uncharacteristic move, DG did not confirm PPL’s receipt of the payment until 5 September after receiving “numerous market enquiries”.  Apparently, neither DG’s crack investor relations staff nor its management thought that there were parties who would be interested in knowing for certain that the KRG actually made the payment.

Not a particularly “brilliant” move to sit on such critical and positive news but sadly par for the course at DG.  Or as AA’s brother no doubt would have it, “shelled another dolly.” 

Here’s an extract from the joint KRG/PPL press release published by Dana Gas.

The agreed settlement highlights are as follows:

1. The KRG will immediately pay Pearl (PPL) a sum of US$600 million.
2. The KRG will also immediately pay Pearl a further US$400 million to be dedicated for investment exclusively for the aforesaid further development to substantially increase production.
3. Pearl will increase gas production at Khor Mor by 500 MMscf/day, a 160% increase on the current level of production (the "Additional Gas"). The Additional Gas, together with significant additional amounts of condensate, is expected to begin production in approximately two years.
4. The balance of sums awarded by the Tribunal ($1,239 million) is no longer a debt owed by the KRG and will be reclassified as outstanding cost recoverable by Pearl from future revenues generated from the HoA areas.  The profit share allocated to Pearl from future revenues generated from the HoA areas are adjusted upwards to a level similar to the overall profit levels normally offered to IOCs under the KRG's Production Sharing Contracts. This adjustment reflects the larger investment risks and costs involved in the development of natural gas resources compared to oil developments. After the recovery of costs and a return on investment by the Consortium, 78% of revenues generated from the HoA areas will be for the account of the KRG, and 22% for the account of Pearl.  
5. The Parties have clarified the Khor Mor block boundary coordinates and the KRG has awarded the Consortium investment opportunities in the adjacent blocks 19 and 20, and added these to the HoA areas, with commitments by the Consortium to make appraisal investments on these blocks, and developments if commercial oil and gas resources are found.  The KRG will purchase 50% of the Additional Gas on agreed terms to boost the gas supply to power generation plants in the Kurdistan Region.  The other 50% of the Additional Gas (250 mmscf/d) will be marketed and sold by Pearl to customers within Iraq or by export, or can be sold to the KRG as well to further boost power generation within Iraq.
6. Pearl will also expand its local training and employment programs towards achieving maximum localization and content, as well as supporting local communities through its active Corporate Social Responsibility (CSR) programmes.
7. The Parties have exchanged mutual releases, waivers, and discharges in relation to all claims in relation to the Arbitration and related court proceedings. The Parties have also amended and clarified the HoA language and terms, including extension of the term of the contract until 2049. 

Now for a closer look. 

1. DG is a 35% shareholder in PPL so at a first cut, DG’s share of the USD 1 billion payment is USD 350 million.  Sounds good, but there are at least a few wrinkles.
2. That money is at Pearl not DG, though DG will show the USD 350 million in its September financials, just as it shows its 35% share of PPL’s aggregate trade receivables.  If and until PPL transfers funds to DG, DG will not have use of the funds.
3. Also note the money in two tranches.  One of USD 210 million and one of USD 140 million.
4. Let's start with the second amount the USD 140 million. That amount will not be available for DG to use as it wishes because the USD  400 million tranche is required to be spent in the KRG to expand production, assuming of course that PPL honors its commitment to the KRG. 
5. As regards the first amount DG's USD 210 million share of the USD 600 million, how much of this DG will ultimately obtain unrestricted use of depends on Pearl's cash needs, particularly if PPL will require more than USD 400 million to fund the promised increase in production.   If the amount exceeds USD 400 million, then any funds ultimately transferred to DG and its partners for their own use will be lower than the USD 600 million discussed above. 
6. PPL has agreed to release the KRG from its obligation to pay the remaining USD 1.239 billion of the arbitral award.  However, this amount is not completely forgiven or “lost”.  It’s been transformed into a “recoverable cost”.  Under concession agreements, the operator is entitled to recover its invested costs plus a certain return (not specified here and I could not locate it in DG’s financials or other information it publishes) before the profit sharing mechanism becomes operative. 
7. What this means is that PPL and thus DG and its partners will recover this amount over time, if the Kurdistan fields produce.   PPL is thus highly incentivized to ramp up and maintain production as soon as possible.  That’s the good news. 
8. The bad news is that this is an installment payment which is estimated to begin some two years hence.  On a present value basis then PPL will recover less than the USD 1.239 nominal sum.  Depending on the timing of production, the amount may be much less. 
9. The KRG has increased DG’s share under the profit sharing agreement to 22% and has extended the concession period to 2049.  That gives PPL the opportunity for additional earnings and will counteract to some extent the present value loss on the USD 1.239 billion.  Just how much is not clear as again it will depend on the timing of cashflows. 
10. Dana will also be able to sell 50% of the Additional Gas for export neatly side stepping further exposure to the KRG's creditworthiness.
11. PL and the KRG have issued mutual releases on arbitral claims.  You will recall that earlier this year PPL was reported to be pursuing some USD 26.5 billion in claims against the KRF for alleged damages. On a positive note, the settlement of all claims may lead to an increase in KRG payments of outstanding be-whiskered trade receivables which would help DG’s cash flow but not its profit.   The stale receivables have already reduced DG’s realized profit from that reported by the operation of present value.  Nonetheless, more cash in hand would provide DG additional flexibility in conducting its operations.  Were it so inclined—an assumption for which there is scant evidence so far—the cash could be used to repay the sukuk.  This claim has been dropped as language from the preface to the press release indicate. 

The Parties have mutually agreed to fully and finally settle all their differences amicably by terminating the Arbitration and related court proceedings, and releasing all remaining claims between them, including the substantial damages asserted by the Consortium against the KRG.

While there is both some good and some not so good news for DG in the PPL settlement, on balance it probably is a net positive.  AA suspects that those who have read the news of the settlement and are expecting a cash bonanza at DG will be like the bankers who are anticipating "rich investment banking fees" in Saudi Arabia.

But Is this good news positive enough for AA to change his recommendation against investing in DG equity or debt? 

A resounding no. 

The first rule of investing is not to invest with issuers who have demonstrated that they cannot be trusted to honor obligations.   

Dana Gas: A Closer Look at Pearl Petroleum Limited

This post takes a closer look at DG’s لؤلؤ of an investment, Pearl Petroleum Ltd. BVI which accounts for the lion’s share of DG’s bewhiskered Trade Receivables.  

What can we learn about how Pearl is doing from DG? In performing this exercise we’ll ignore for the moment that cash payment by the KRG has severely lagged billing.   If DG’s information is lacking (a question that might not really need to be asked), do we have alternative sources of information? How do we exploit that information?  

Why take a closer look? 

According to press reports, DG’s management has admitted that its Egyptian operation has generated only USD 60 million in net profit during the ten-year life of the sukuk and just this month advised that Zora field production was down some 49% from the “corresponding quarter” in its 1H2017 interim financial report.  With a track record like that, taking a look at DG’s “jewel” is well worth the effort.

Dana Gas Information on PPL

As I posted earlier, DG’s disclosure regarding Pearl Petroleum Limited is rather limited.  For some reason no doubt well-reasoned and Shari’ah compliant, DG does not disclose its share of net income in PPL but only gross operating income. 

As regards Shari’ah, AA supposes that there has been evolving interpretation of what “selling” or “wet corn” means (Muslim/Abu Hurairah) or “selling without disclosing defects” (Ibn Majah/ Wasila bin el-Asqa). 

AA has trawled through DG’s audited financials note on joint operations and prepared the following summaries. 

Let’s start with the statement of condition aka “balance sheet”. 

DG Info: PPL Balance Sheet USD Millions
Year	CA	NCA	TA	LIABS	EQUITY
2016	2,117	726	2,843	194	2,649
2015	2,123	777	2,900	89	2,811
2014	1,950	790	2,740	100	2,640
2013	1,358	823	2,180	45	2,135
2012	1,088	848	1,935	25	1,910
2011	670	878	1,548	28	1,520
2010	343	908	1,250	58	1,193

Technical notes:  

• The joint operations note presents only DG's share of PPL's assets and income.   
• To get PPL level information, one must divide DG's share by 0.35 in 2016 and 2015 and by 0.40 for the earlier years shown.  Why the change in 2015?  DG sold an additional 5% to RWE in 2015.  
  

Comments:

• DG “consolidates” its share of PPL’s assets and liabilities in preparing its (DG’s) financial statements. When it does so, it eliminates intra-group (DG and PPL) transactions. Therefore, it’s possible that PPL’s balance sheet is larger than shown above. 
• What could such intergroup transactions be?  Intra-group company loans, accounts receivable payable by PPL, etc.

Now to the income statement.  

DG Info:  PPL Income Statement USD Millions
Year	NET REV	OPCOST	GPROF	CHGEQ	DOI/OCI
2016	223	100	123	-163	-286
2015	406	97	309	171	-137
2014	618	88	530	505	-25
2013	575	105	470	225	-245
2012	645	85	560	390	-170
2011	565	73	493	328	-165
2010	205	15	190	348	158

Technical notes:  

• Same methodology as with the balance sheet to convert the information DG presents on its share of income to the aggregate income for PPL. 
• As noted DG only presents PPL’s Operating Profit not Net Income. 
• Using the change in equity (CHGEQ) as a proxy for net comprehensive income, I have computed the amount required to plug the gap in CHGEQ.  This is labeled DOI/OCI.  Derived Other Income (including other expenses not in gross operating profit) and Other Comprehensive Income.  (AA's calculations are in red typeface.)
• Examples of OCI would be change in carrying value of PPL’s contractual rights, value of reserves, etc. 
• DOI would include the interest that PPL accrued on the unpaid KRG receivables.  Recall that when PPL reversed the interest at 9% DG’s share of the reversal was USD 121 million or roughly USD 346 million for PPL in aggregate.  However, the arbitral decision allowed PPL to charge interest at L+2%.  Looking at note 28 in both 2016 and 2015, the change in interest due is some USD 68 million, implying (note that word) that the net of the reversal of the 9% interest and the accrual of interest at 2% was USD 68 million or roughly USD 194 million for PPL.   

So with DG’s “wet corn” tucked under the “dry” corn, we’re left with questions about PPL’s balance sheet and its income performance before allocation of DG expenses to PPL. 

Other Sources of Information on PPL 

It would seem like we’re at a dead end. 

But there are other sources of information on PPL.  DG has four partners in PPL.  Crescent, OMV Austria, MOL Hungary and RWEST Germany.

Crescent is a private company and does not appear to disclose its financials.  You’ll find Crescent on the web at http://www.crescent.ae/home.html.  Note that the Chairman of Crescent is also the Chairman of DG. Other apparent members of the Chairman’s family are on DG’s board.  Crescent is DG’s largest shareholder and thus would have rights to seats on DG’s board.   

Having a bit to do at work, AA looked only at the financials of OMV and MOL.  Preparing info on PPL from RWEST is left as an exercise for the student. Expect an announcement soon on the opening of Arqala University!  It’s going to be a huge success more so than Arqala Steaks –also under formation. 

OMV Information on PPL 

Here’s the data compiled from OMV.

First, the balance sheet. 

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Technical notes: 

• Despite its 10% ownership share, OMV accounts for PPL as an equity investment because it has substantial control over PPL because as I noted earlier some PPL decisions require shareholder unanimity. 
• OMV reports data for PPL’s balance sheet and income statement so there is no need to adjust numbers. 
• OMV only began reporting separate data on PPL in 2014.  Before that PPL was aggregated with another equity accountee. 
• I’ve used year end spot exchange rates for the balance sheet (ECB) and averages for the year (IBRD) to convert OMV’s reporting currency (euros) to USD.   You’ll also find this info at the Deutsche Bundesbank with slight variations to the IBRD average rate, a cautionary note about the potential for “different” versions of the same data from well-regarded sources.  I used the IBRD average rate for HUF to convert MOL data so for consistency I used IBRD for OMV as well.  Where there was a lapse, e.g., 2016 average for the euro in the IBRD data, I used the Bundesbank data. 
• CA and NCA are current assets and non-current assets respectively.  The same C and NC prefixes are used for liabilities.

Comments:

• Three things of note from the OMV data.
• Noncurrent liabilities are disclosed.  Based on other information in both OMV and MOL’s financials, these amounts primarily consist of loans extended by shareholders to PPL.   The difference between NCLs and the derived loan balances may consist of accrued unpaid interest.
• Side Note:  The loans were extended at Libor plus 2% which both OMV and MOL describe as a “market” rate.  AA would like to borrow some money from a “market” that rates Kurdistan risk this low because AA could probably get a loan at Libor minus 2%.   
• In 2015 OMV restated PPL’s equity as of 2014 or more precisely marked it down roughly USD 1.5 billion.  There is no restatement of PPL’s equity in DG’s financials. 
• OMV’s calculation of equity is higher than DG’s for 2014-2016.

Now to the income statement.

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Comments:

• As you’ll note OMV did not restate income in 2015 for 2014 which AA believes indicates 2014 restated equity reflects a change in reserves or contractual value of PPL’s rights in the KRG. 
• Also OMV’s operating profit differs from that of DG.  It’s not clear what’s causing this, but AA believes it is the difference between gross operating profit (net revenues less depreciation and operating costs) as reported by DG and net operating profit (which includes other expenses) as reported by OMV.
• Not a particularly “pretty” profit picture.

MOL Information on PPL

MOL Info:  PPL Balance Sheet  USD Millions
Year	CA	NCA	TA	CL	NCL	Equity
2016	2,345	658	3,003	138	1	2,864
2015	2,123	686	2,809	88	229	2,492
2014	2,038	690	2,728	98	248	2,382
2013	1,415	716	2,130	49	253	1,829
R2012	1,122	734	1,856	24	490	1,342
2012	1,122	3,556	4,678	24	490	4,163
2011	684	3,582	4,266	28	644	3,595
2010	345	3,607	3,952	61	782	3,108

Technical Notes:

• Like OMV, MOL uses the equity method to account for PPL. MOL’s reporting currency is Hungarian Forint (HUF).
• It reports PPL’s aggregate balance sheet and income statement except for 2010-2012 when it reported only its share of the balance sheet and income.  Figures for those years have been divided by 0.1 to calculate PPL’s aggregate balance sheet. 
• I used the same IBRD source mentioned above for average annual rates for the HUF and laboriously copied fiscal year end spot rates from NMB (Hungarian Central Bank) website. 

Comments: 

• Both MOL and OMV report very similar balance sheets for 2014-2016 which AA takes as indicating that this exercise has produced a fairly accurate picture of PPL’s balance sheet for those years. 
• Note that their equity numbers are equal for the period 2014-2016 and different (higher) than DG’s. 
• But there is a significant difference between MOL and OMV regarding the restatement of PPL’s equity.  At MOL the restatement occurs in 2013 for fiscal 2012 and is a much larger amount USD 2.8 billion versus USD 1.5 billion at OMV for fiscal 2014.   It is unclear what caused this timing difference. 
• NCLs as reported by MOL track those reported by OMV.  With the longer data period at MOL we can see the shareholder loans have declined to next to nothing from roughly USD 782 million in 2010.  
• Looking at the change from 2015 to 2016 in NCLs, at a 35% share, DG received roughly USD 80 million in repayments from PPL in 2016.  Because these are intergroup transactions, they would not be reflected in DG’s consolidated statement of cashflows. 
• The USD 80 million was likely reflected in consolidated cash as DG’s 35% share of PPL’s total cash. Once payment to DG was made DG’s consolidated cash balance would not change.  If DG prepared and disclosed parent only financials, we should see the USD 80 million as a separate transaction there.   

Now let’s turn to MOL’s version of PPL’s income statement. 

MOL Info PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	MOL
2016	223	235	154	388	0
2015	357	-188	293	106	11
2014	618	524	28	553	55
2013	575	470	17	487	84
2012	645	564	5	570	57
2011	565	494	-8	486	49
2010	205	192	5	197	20

Comments: 

• Similar to OMV, MOL’s restatement of PPL’s equity did not result in a restatement of net income which seems to bolster AA’s theory that this is a valuation change of contractual rights or reserve values. 
• But OMV and MOL part company on income. 
• MOL’s calculation of net income tracks closely the change in equity and is much large and more consistently positive than OMV’s.  OMV does not appear to consider OCI. Yet the difference between the two is apparently not solely the result of OCI. 
• Based on MOL’s calculation, PPL appears to be a highly profitable investment. 
• But there is a wrinkle here.  Despite recognizing larger net income, in 2016 MOL stopped accruing income on PPL shifting to a “cash basis”.    That is not a vote of faith in PPL’s prospects or the ability of the KRG to settle the trade receivables. 

Summary 

• We’ve been able to recreate PPL’s balance sheet in more detail than DG has provided.  This can serve as a basis for further analysis by other interested parties, e.g., sukuk holders’ advisors, equity analysts, and equity holders. 
• However, this exercise has not resulted in a completely identical set of financials.  As regards the balance sheet, there is an approximate 10% of so difference between DG’s value of equity and that reported by OMV and MOL.  
• More importantly for a meaningful analysis, there are striking differences in PPL’s income as reported by DG, OMV, and MOL. 
• DG only provides gross operating profit not net income or net comprehensive income.  The above mentioned “interested parties” may wish to push DG to provide additional information.  For starters, to disclose its calculation of PPL net comprehensive income before and after allocation of DG expenses. 
• OMV and MOL have very different net income figures for PPL. While PPL is a small fish in OMV’s and MOL’s operations, parties interested in those companies may also wish to understand more about PPL’s performance. 
• As noted, this does not seem to be solely the result of MOL considering OCI while OMV does not as OCI does not equal the difference between OMV and MOL’s figures.
• Interestingly, DG, OMV, and MOL are all audited by Ernst and Young, though it's important to note that each of the firms are legally separate partnerships within the global E&Y “family”.
• Differences among these companies' accounting for PPL is the result of differences in accounting practices. DG “consolidates” its share of PPL.   OMV and MOL use the equity method to account for their respective holdings in PPL. But, as noted above, OMV and MOL have remarkably different results for net income. 
• Finally, this approach to reconstructing/estimating undisclosed information by using other sources might be useful to bankers, investors, and other interested parties for a range of other transactions and obligors.  Where there is more than one partner in a venture and that partner is listed in a reasonably well regulated market, there may be disclosures available.  One can also look to counterparties to a transaction who may disclose details in their public disclosures that their counterparty does not. 
• Side Note: On that topic, early in AA’s career, a dearly respected white-haired mentor told AA how a colleague of his had recreated a rudimentary set of Aramco financials from SEC-mandated disclosures by the listed US oil companies who were Aramco shareholders at the time.  This chap later off-handedly discussed key elements of Aramco’s financials with the company, much to the consternation of Aramco officials who were concerned about the reaction of the “new” Saudi shareholder.